Week in View

Latest market views from the BlackRock Multi-Asset Client Solutions Group

Market Background

Following another positive week for risk assets, we will put recent moves into context and ask to what extent the good outcomes in January have set the scene for the rest of the year. Since the start of the year US equities have risen around 5%, European stocks are slightly higher having climbed almost 7%, and we have seen some pretty strong returns in many emerging markets. India has led the way with a gain of 20%, retracing some of the market’s underperformance last year. At the same time there have been reasonable gains in commodity prices; copper is up around 10% and gold slightly higher, but the gains have not been universal, with oil and wheat lagging the rally.

Peripheral bond yields in Europe have declined since the start of the year. Ten-year yields in Italy and Spain are now below 6% and 5% respectively. Risk-on behaviour has been evident in currency markets. A wide range of emerging market currencies have strengthened significantly in recent weeks and the euro has moved off its lows, particularly against the dollar, witnessed towards the end of last year.

However, it has not been a full risk-on environment in at least one important respect. Breaking the general pattern of recent years, widespread gains were made in a number of risk assets, but high quality sovereign bond yields (Germany, UK, US) did very little, falling back slightly to the bottom end of their recent ranges.

What has driven the risk-on period?

Turning We are not in a world where we are deluged by avalanches of good news, but overall bad news has not been as bad as feared last autumn. As risk premia are still quite high and positioning remains quite conservative, it doesn’t take much good news for risk assets to move higher.

1) Improving global economic backdrop

Stronger performance of the US economy has become increasingly evident in recent months and growth looks set to be in a range of 2-3% this year. This is a moderate rate at this stage in the cycle, but it is clearly some way off recession.

Recession risks in Europe are clearly much higher, with what appears to have been a recession starting last year. However, recent economic numbers from Europe have been less bad than feared and there are signs that the European economy may be stabilising, with better data from Germany in particular. We would emphasise this is at very early stages and we can identify a number of negative factors for Europe. Nonetheless, the reality is the European economy, contrary to expectations, has not been falling to pieces over the past few weeks.

Finally, although emerging economies in general are still slowing, they are not slowing as sharply as many had feared, with upside surprises from many economic data releases.

There were widespread concerns of a co-ordinated global recession last summer, but the global economy now seems to be on a moderate growth path, which while far from spectacular is also in aggregate far from recession.

2) Policy background

The second support for risk assets has been the policy background as central banks have become increasingly active. In December, the European Central Bank (ECB) acted to boost liquidity in the European banking system, which has reduced some of the financial tail risks in the region. Last week the US moved to a more transparent means of communicating policy changes, signalled they expect short-term interest rates to rise in mid-2014 rather than mid-2013 and strongly hinted that there would be further quantitative easing if necessary. In the UK we are likely to see a modest amount of quantitative easing in the first half of the year and in many emerging economies the shift from quite tight to looser monetary policy is clearly underway. Over the past few weeks we have seen reserve ratio cuts in India and China; rate cuts in Indonesia, Taiwan and Thailand; Brazilian rates falling and the central bank suggesting it would like to get short term rates below 10%. This is an important feature as tightening in monetary conditions in emerging economies was one of the reasons the global economy slowed last year. This is clearly reversing and we think there is still some more to go.

Outlook

It is unlikely the rest of the year is going to see such strong gains as over the past few weeks. We expect loose monetary policy to remain a feature, particularly as headline inflation rates fall, but is important to put that in the context of the significant fiscal tightening underway globally and the challenges posed by undercapitalised banking systems.

The US is likely to grow moderately this year and at some stage we are likely to see a turn in emerging economies from growth slowdown to some acceleration. There still appear to be material growth risks in Europe and the region could still disappoint to the downside despite recent numbers, pointing to some form of stabilisation.

There are still no signs of irrational exuberance in markets. Despite the rally, risk premia still appear relatively high and positioning relatively conservative. Given the nature of recent moves, the better than expected growth environment is now better discounted by markets and a period of range trading at least in the short term seems probable.

Highlights for the Week Ahead: 30 Jan-3 February

Economic Diary:

Monday: US personal income, EC business and consumer confidence.

Tuesday: US consumer confidence, Germany unemployment, Taiwan GDP, UK Gfk consumer confidence, Japan PMI manufacturing.

Wednesday: US ISM manufacturing, Euro area PMI manufacturing, China PMI manufacturing, India PMI manufacturing, Indonesia CPI, Korea CPI, Thailand CPI, Singapore PMI, Peru CPI, UK PMI manufacturing.

Thursday: UK PMI construction.
Friday: US employment, US ISM non manufacturing, Euro area PMI services and composite, UK PMI services, Japan PMI services/composite.

Corporate Diary: