Standard Life Investments

Published Article

Citywire - Global Strategy - More to do


Whisper it quietly, but the world economy has been performing rather better over the winter than the naysayers and doom mongers would like you to believe. Indeed, while there are some undoubted risks which require monitoring, the economic surprises have clearly been to the upside in most of the major economies over the past few weeks.

The start of each month is a useful time for economists as a series of business surveys are released. They fall under the title of the Purchasing Manager Indices (PMI); different groups of senior managers in various sectors give feedback about their businesses including order books, delivery times and input price pressures - dry stuff indeed. However, one of the necessities to be a global strategist is to dig deep into such data and correlate it with other information. It does correlate rather well. The global PMI series, covering all major economies, tracks global industrial production, and also the relative performance of global bonds versus global equity markets. It is not a leading indicator, but it does give a useful steer about where we are now and which direction we are heading.

Last year there was a noticeable slowdown in economic activity in many regions – indeed the media was full of stories mid year regarding a double dip recession. We thought not, and indeed our call was correct. The Global All Industry PMI series did fall close to recession levels but has recovered steadily since then. December’s number of 53.0 suggests growth slightly below trend at year-end. The good news within the surveys though was an upturn in order books, again not strong but certainly lifting spirits.

The stock market has performed positively in most countries in the early part of 2012. There has been very little news from companies, apart from retail statements about difficult trading conditions over winter, but the economic data has been helpful. In December, for example, we saw the US unemployment rate fall to 8.5%, its lowest level since late 2009. In China, annual money supply growth rose to 13.5% in December, suggesting that the central bank is slowly easing policy to support the economy. Even in Europe, the Ifo business index showed Germany is holding up well.

Our Focus on Change approach forces us to look ahead, not backwards. What could dampen this improvement in economic activity into the spring, and cause another tumble in stock markets? The much discussed European debt crisis remains the centre of attention, with a failed sovereign bond auction likely to cause problems. Two other issues are worth monitoring; the first is oil. Brent reaching almost $125 per barrel in 2011, before falling back to $95, was one of the major drivers of the slowdown, and subsequent recovery, in business activity. More recently, the sanctions facing Iran and the subsequent tensions in the Straits of Hormuz have forced the price of Brent back over $110 per barrel. Gasoline costs are starting to respond. We have long warned that prices above $130 would be a serious headwind to investor sentiment.

The second is company news. 500 US companies are about to report their fourth quarter profits, and more importantly give their outlook for 2012. After a period when economic data has been supportive, signs that more companies are reporting a squeeze on margins would be troubling for share prices. The third is inflation in China. Investors have been pricing in a helpful decline in headline inflation which could allow the authorities to ease policy even further. However, there have been reports, yet again, of higher than expected food-price inflation, which could cause the Chinese authorities to delay or pause their policy loosening.

On balance, we expect financial markets to remain range-bound for the early part of 2012. The economic data is improving, but for share prices to head much higher we need evidence to suggest that the upturn in corporate profits is becoming better entrenched, and senior management are willing to put their cash to work in terms of investment or hiring. It is too soon to say that the worst of the winter is over.

Andrew Milligan, Head of Global Strategy, Standard Life Investments