December 2015 - Allianz Global Investors

December 2015 - Allianz Global Investors

12
Volume 7, Issue 12
Allianz Global Investors
Insights
December 2015
Global View
2016 Outlook: Volatility Ahead
The opportunities and risks on the horizon
for 2016 are similar to those that emerged
in 2015. Economic growth will remain low,
monetary policy should stay extremely
benign even as the US takes a divergent path,
and politics and geopolitics will add volatility
to the policy mix. As a result, we expect asset
markets to be more volatile as well, favouring
active investment styles that have the potential to deliver attractive alpha returns during
a time when beta returns may be low.
Dull and fragile economic growth
As 2015 progressed, estimates for global
gross domestic product (GDP) growth were
steadily revised lower. Our expectations for
2016 remain cautious, given the ongoing
environment of financial repression.
◾◾ The US delivered mixed results in 2015
and we foresee a similar outcome in 2016,
with the economy expanding 2%–2.5%.
ramifications for commodity-producing
countries and many economies in Asia.
◾◾ Europe was a surprise in 2015, with
quantitative easing (QE) and sustained
euro weakness pushing growth higher.
With Europe’s waning appetite for austerity
and the European Central Bank’s
commitment to QE, we are optimistic that
growth rates can be sustained into 2016.
While global economic growth remains dull
and fragile, there are emerging signs for
optimism in the medium term. Global trade
now accounts for nearly half of world GDP,
demonstrating the success of globalization.
New deals like the Trans-Pacific Partnership
should boost trade and a similar deal
between the US and Europe may be on the
horizon. China’s “one belt, one road” policy
will also help drive investment in many
developing economies.
◾◾ China has been slowing for some time,
which will have continued serious
Inflation? What inflation?
For financial repression to work, some
inflation is needed to erode the real value of
02 Perspective on Asia-Pacific
02 GrassrootsSM Research
5 Themes Driving China’s Economy
Through 2020
Gauging the Local Impact of Weaker
Energy Prices
Neil Dwane
Global Strategist
high debt levels. Yet inflation globally
remained subdued during 2015, and there
are many reasons to expect more of the
same in 2016 – chief among them are low oil
and commodity prices, lower trade prices
and subdued wage increases, especially
in Asia and Europe.
However, local service inflation should be
resilient globally and many output gaps
are beginning to close; this is traditionally
(Continued on page 4)
03 Viewpoint
Analysing the Ability of Low Yields to
Shrink Mountains of Debt
Allianz Global Investors Insights
Perspective on Asia-Pacific
5 Themes Driving China’s Economy
Through 2020
Recent developments in China are poised to
have a long-lasting impact on the country’s
future. Of particular interest is the Fifth
Plenary Session of the 18th Central
Committee of the Communist Party of
China, which was held in late October.
At this meeting, the party approved a
blueprint of the 13th Five-Year Plan, which
will guide China’s economic and social policy
from 2016 through 2020. The plan’s major
areas of focus include:
1. Broad-based innovation for institutions,
technology and culture.
2. Balanced development, involving industrial
upgrades, information technology
advancement, new urbanization and
agricultural modernization.
3. Ecological civilization, emphasizing
energy conservation and environmental
protection.
4. Social welfare, addressing needs for
education, vocational training, social
security and insurance protection.
5. Population policy, allowing all families
to have up to two children.
Investors should bear in mind that these
policy objectives or initiatives will become
the main themes of China’s economy and
stock market for the next five years.
Raymond Chan
CIO Equity Asia Pacific
Another key message that warrants market
attention is the lowering of China’s economic
growth target to around 6.5 per cent per year.
It is encouraging to see China’s leaders
(Continued on page 4)
Service Industry Outpaces Industrial Sector
China is making significant progress in its transformation to a consumption- and services-led
economy.
50.00
46.00
42.00
38.00
34.00
30.00
Industry, Value Added (% of GDP)
Services, Etc., Value Added (% as of GDP)
1990
2000
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Source: The World Bank as at 31/12/2014.
GrassrootsSM Research
Gauging the Local Impact of Weaker
Energy Prices
In light of energy-industry weakness in
the US—and in Texas in particular—
GrassrootsSM Research spoke with a variety of
retailers in outer suburban and rural
communities of the state to gauge the
local-level economic impact of the
energy sector’s struggles.
We found that for three-fourths of the farm
and ranch, home improvement and hardware
store sources we interviewed for the study,
the economic slowdown in the energy sector
had not affected their stores. Strength in the
tech, government and health care sectors
appear to have been fueling those local
economies.
2
The remaining one-fourth of sources—
nearly all in areas near oilfield activity, which
indicates they were affected by layoffs and
oilfield-related purchasing—said the
economic slowdown in the energy sector
has, in fact, slowed sales either slightly or
significantly, with job losses leading to
lower consumer spending and a slowdown
in housing construction.
At the same time, most of our sources believe
their local economy has stabilized or is
improving, suggesting that they believe the
worst effects of the oil slowdown are over.
According to one source, “I think the oil price
has gone as far south as it’s going to go, and
Kelly Reuba
Global Head of GrassrootsSM Research
the people who are going to get laid off have
been laid off. Now, it’s just waiting for the
[upturn].” Another explained, “Dallas-Fort
Worth in general is really pretty strong right
now. Texas isn’t the one-trick pony it was
30 years ago.”
(Continued on page 4)
Allianz Global Investors Insights
Viewpoint
Analysing the Ability of Low Yields to
Shrink Mountains of Debt
The modus operandi of financial repression is
simple: If an economy can grow faster than
the interest burden on its public debt, it can
reduce its debt ratio. What matters is how
the implicit interest payable on its national
debt interacts with growth and inflation.
Primary budget performance is another key
factor. A primary budget reflects public
sector revenues and expenditures, although
without considering interest and debtservicing charges. As such, it is a key indicator
of budget discipline and enables us to assess,
for example, if a finance minister is making
use of a positive budget situation arising
from low interest rates – which may well
shrink the country’s mountain of debt – or
simply spending more elsewhere.
To find out whether financial repression will
help the US reduce its high public debt level –
which it has helped the country do in the past
– we turned to our own proprietary analysis.
Our model did not aim to identify a certain
level of debt sustainability for reducing
national debt; rather, we only aimed to
illustrate how financial repression works. In
the end, our model clearly shows how
investors in government bonds are helping
to reduce the national debt of the US
through lost yield income.
Assumptions
We began with an annual growth rate of 3.1
per cent till 2030 and 2 per cent thereafter
(an Organisation for Economic Co-operation
and Development estimation) and an implicit
interest rate in the US of 3.5 per cent for 2015
and 3.7 per cent in 2016. With this starting
point, we assumed an increase in yields to
what could presumed to be a “normal” level
of 4.4 per cent by 2022. The European
Insurance and Occupational Pension
Authority’s ultimate forward rate was our
reference for what are considered “normal”
interest rates, but we have also considered
the fact that inflation rates in the US have
always been about 0.5 percentage points
higher than in the euro zone over the past
20 years, and the US Federal Reserve is
charged with the dual mandate of price
and labour market stability.
Results
Our model found that if inflation were to stay
at 2 per cent, the US debt ratio would initially
decline slightly, but it would then rise again
in line with yields and slowing growth
potential. The effect of financial repression
would thus be very limited – and it would
only be truly effective if inflation rates were
to move higher. Further analysis showed that
an inflation rate of 4 per cent per annum
would, in fact, be able to reduce the
country’s mountain of debt to 60 per cent by
2036 – all else being equal. We also
determined that adding an average of 0.5
percentage points more in real growth over
the years would only change the overall
picture slightly, although in this case the debt
ratio of 60 per cent could be reached even
at 2 per cent inflation.
Hans-Jörg Naumer
Global Head of Capital Markets & Thematic Research
We thus found that making changes in a
country’s primary budget would offer more
scope for action and be able to impact the
debt ratio more quickly and deeply –
especially given that it is indeed easier to
increase a primary budget surplus than it
is to increase growth.
Applied more broadly to global economies,
our model indicates that the current lowyield environment can hardly help reduce
debt ratios on its own. At the same time,
the very same financial repression is also
creating financing conditions for public
budgets that are extremely favourable
for reducing debt more effectively.
3
Allianz Global Investors Insights
(Continued from page 1)
Global View
a harbinger of inflation. Moreover, one “black
swan” event in particular could change the
game: If the serious geopolitical situation
in the Middle East were to worsen and
affect the supply of oil, it would be bad for
economic growth – but good for inflation.
Monetary policy remains loose as
divergence begins
As more central banks reduced interest rates
to the bone and moved into QE mode,
monetary policy around the world continued
converging in 2015. Yet 2016 will see the first
major divergence of monetary policy if, as
expected, the US Federal Reserve raises
interest rates. As a result, we expect more
currency volatility, which will make it even
harder to find attractive returns from
international equity and bond markets.
Politics
Local politics are always closely aligned
with monetary policy, and we expect they
will shape investment returns in 2016.
◾◾ Europe had its usual rollercoaster ride in
2015, enduring another Greek crisis, and
the UK’s referendum on staying in the
European Union will now be a focus
for the region.
◾◾ Asian countries are grappling not only
with China’s growing assertiveness
but also the fallout from its economic
rebalancing efforts.
◾◾ E xpectations are high that Brazil’s
president may be impeached for
corruption, thereby throwing its
economy into unpredictable stasis.
4
◾◾ Events unfolding in the Middle East bear
careful watching, with echoes of the Cold
War returning as Russia and the US back
different sides.
◾◾ The biggest political story in 2016 will be
the US elections, with neither Democrats
nor Republicans settled on a clear
candidate. The electorate seems to want
to try something different, although this
should not produce notably different
economic policies.
Investing in a world of volatility
and illiquidity
Over the course of 2015, volatility returned
to markets and correlations between many
asset classes broke down. We expect more
of this in 2016, as policy and politics highlight
differences in the global economy. Within
the low-interest-rate environment, many
market segments have seen the growing use
of extreme leverage and algorithmic trading,
which is both exacerbating volatility and
causing markets to become more illiquid –
especially with QE causing investors to herd
together in the hunt for return and income.
In this environment, we will be flexible and
active to put our clients in a position to
benefit from volatility at an asset-class level.
We will also use in-depth research, and focus
on quality and sustainability, to help them
navigate markets where taking risk is a
necessity. As monetary policy diverges, we
expect to see our clear philosophies and
long-term processes deliver the alpha that
investors are searching for – particularly in
a world where beta returns will be much
lower and more volatile.
For more on this topic, read Neil Dwane’s
complete 2016 outlook at www.allianzgi.com.
(Continued from page 2)
Perspective on Asia
putting more emphasis on growth quality
and on the structural transformation toward
an economy led by consumption and services.
In fact, we have witnessed meaningful
progress on this front already. As shown in
the accompanying chart, since 2012, the
services industry has overtaken the industrial
sector to become the largest contributor
to China’s gross domestic product.
(Continued from page 2)
GrassrootsSM Research
However, when asked about the broader US
economy, one-fourth said they believe it is
currently deteriorating, while a few believe
it is improving. In general, our sources
remained concerned about the lack of jobs.
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AGI-2015-11-29-13863 | 01320