We are not in the habit of being irrationally optimistic, or bullish, given the unpredictable nature of investing and the world in general.  However, despite the relatively chaotic political backdrop which the west has experienced over the last year, the health of the global economy has gradually improved.  Although the UK has retreated from a leading position to lagging the G7 in terms of growth, the rest of the world is now growing above trend.

Since this time last year, the global economy has experienced this rise in economic growth together with a rebound in inflation (as commodity prices recovered).  In this environment, both the Federal Reserve in the US and the Bank of England have been inclined to treat interest rates rises with care, although the European Central Bank and the Bank of Japan have maintained loose policy.  The jump in growth initially triggered a concern that the risk of deflation, which has been a persistent theme in recent years, would be replaced by a risk of accelerating inflation.  However, in recent months global inflation has stabilised and is not threatening to breach central bank targets in most advanced economies.

Hence, economic growth is now above long term trend in all of the major advanced economies simultaneously (as shown below), and this is supportive of expansion for large multinational companies, a key driver of our investment strategy.

A brief tour of the world

In the US, the Trump administration’s stated aim is 3% growth, but with an increasingly less optimistic assessment of the government’s plans regarding infrastructure spending and fiscal stimulus, the US growth forecast for 2018 is likely to be nearer 2.1%.  The benign growth and inflation backdrop is somewhat surprising in the US due to low levels of unemployment (16 year low) which have thus far not caused pressure on wage inflation.  It may be that long term inflation expectations have been adjusted by the persistent low inflation experienced in recent years.

Growth in the Eurozone is expected to accelerate from to 1.8% in 2017, although high unemployment and poor real wage growth persists in certain nations.  Even in Germany, where unemployment has reached a new post-reunification low, wage growth and inflation are not showing significant upward pressure. The long process of economic healing after the Eurozone crisis continues, with the ECB providing support, the banking system gradually recovering, less austerity measures, and a further improvement in competitiveness in peripheral economies.  The economic recovery will however leave unaddressed many serious flaws in the monetary union, including the need for a genuine fiscal and banking union, and more cooperation on trade imbalances between Germany and others.   In Britain, growth is expected to fall from 1.6% this year to 1% in 2018, as households are squeezed by prices rising faster than incomes following sterling’s depreciation after the referendum.

The experience in emerging markets is mixed.  In Brazil and Russia, which are emerging from recessions, inflation has fallen quickly and should stabilize at low levels.  Central banks in both countries are likely to maintain loose monetary policy.  Growth in the Chinese economy is anticipated to ease from 6.8% last year to 6.6% this year and 6.4% in 2018.  Core inflation drifting up, although significant overcapacities suggest this will be a slow process.  China’s slowdown is significant and risks the stability of the overall global upturn.  Meanwhile, growth in India is expected to increase to 7.3% in 2017 and 7.7% in 2018 maintaining its position as the world’s fastest growing economy.  Economies that recently experienced currency weakness, for instance Turkey and Mexico, have seen inflation move higher, but this is likely to be temporary and will fall back when higher import prices filter through to the economy and the currencies stabilize.

Potential global risks

A key risk remains that market is not prepared for the return to ‘normal’ interest rates in the US.  This could occur due to inflation shocks, or because the market has misunderstood the US Federal Reserve’s new target real interest rate.  Another risk is that Britain’s planned exit from the EU could trigger a reversal of European integration ambitions.  Lastly, there remains the risk of a rapid slowdown of economic growth in China – a ‘hard landing’.  Managing the de-leveraging of the credit bubble, while simultaneously sustaining growth at an acceptable rate, is a difficult tightrope to walk, and requires flexible policy responses.  Growth of 4%, or less, would impact global growth by around 1% and cause a sharp drop in commodity prices.  The government may be forced to re-inflate the economy.

Conclusion

The consensus is for a sustained, modest, recovery in developed countries, with greater convergence of performance among the major economies.  Interest rates are likely to rise in a steady controlled fashion in the US and the UK.  The threat of deflation will gradually ease, and the ratios of government debt to GDP, while historically high, will not cause crises.  The generally benign global economic environment, combined with questions over the UK’s economic health emphasises the importance for UK based investors of investing globally and focusing on long term trends.

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