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GLOBAL economic growth remains resilient despite the most significant monetary policy tightening cycle in four decades — diminishing the chances of a hard landing.
That’s what Pendal multi-asset portfolio manager Alan Polley sees in his team’s economic cycle model.
“Last year we were concerned the services sector — which was holding everything together — might turn down and join the manufacturing sector in contraction,” says Polley.
“It appears that isn’t happening.”
Pendal’s economic cycle model is signalling continued economic growth to start 2024 due to:
The robust start to 2024 comes despite last year’s widespread expectations of a significant downturn in economic activity on the back of rapid rate rises, says Polley.
“No one told the American consumer that 550 basis points of interest rate increases is supposed to lead to recession,” says Polley.
“Consumers just haven’t let up the way everyone thought they would.
“Unemployment is still low. Everyone’s still spending, everyone is still comfortable for now.
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“Consumers and companies appear to be learning to live with the heightened cost and interest rate environment.”
The outlook for economic growth is an important input into the prospects for markets and relief at the fading prospects of recession has powered markets higher in recent months.
Markets have been mulling three potential scenarios for the global economy:
“The probability of a soft-landing scenario has increased,” says Polley.
“Last year, no landing was near zero probability and there was a significant hard landing probability.
“Now, the base case is still the soft landing, but the probability of a hard landing has materially decreased.
“The whole economic distribution appears to have shifted to the right and that is what is providing support to the market.”
Pendal’s economic cycle model analyses the level and rate of change of leading economic indicators such as consumer and business surveys.
It also examines how economic data surprises either positively or negatively.
The model is one of three key indicators which inform the multi-asset team’s active asset allocation process – alongside a valuation model and a model that analyses market trends and technicals.
It has a long-term track record of picking turning points in the economic cycle, Polley says.
The turnaround in the economic outlook is founded on a rebound in services activity and improvements in the outlook for manufacturing.
“Manufacturing was in contractionary territory all throughout last year – and still is – but we’re now seeing some positive movement,” says Polley.
“In the last month, the services sector has also bounced off the fence between expansion and contraction and is now back into expansionary territory.”
There has also been a broadening in the number of countries with positive outlooks, says Polley.
“Last year we had very poor country-breadth – most places were contractionary or weak except for the US. Last month, we started to see increased breadth from a regional perspective.”
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Polley says the model shows the US has maintained and improved its positive score, Europe is improving from deep contraction, and emerging markets are starting to gain a little strength.
“We measure the percentage of economies that are showing positive economic scores. Last year we got down to 31 per cent positive and 69 per cent negative. Now, it has moved to 77 per cent of countries on the positive side.
“All of this is suggesting that despite the high level of accumulated interest rates, what we’re actually seeing in the data is the economic environment getting some more support.”
Historically, rapid interest rate rises have often led to recession. However, despite the fastest rate hikes in four decades, the expected economic downturn has not eventuated.
Polley says this is likely due to a blunting of the monetary policy transmission mechanism.
“We all expected the effect of 550 basis points rates rises on economic activity to be significant, but it hasn’t happened yet.
“So, why has the transmission mechanism been blunted? There were very large saving buffers that were built up during the pandemic. There were significant fiscal excesses as well. And there was the pent-up demand for services post-pandemic lockdowns.
“But a big part of the reason that rate rises have not permeated through to the physical economy is because everyone took advantage of low rates and termed out their borrowings. Consumers fixed mortgages; businesses refinanced at very low levels.
“They were able to do that because we had rates so low for such a long period of time.”
Still, the rising chance of a benign economic outcome provides little immediate opportunity for investors as markets have largely priced in the soft-landing scenario by pushing equity valuations higher, says Polley.
“There’s no real bull market gains to come from thinking about a soft landing from here,” says Polley.
“If you think there’s more market gains ahead, then you really need to be of the view that the no landing scenario is increasingly likely – and we think it’s a bit hard right now to increase that probability given the concern around the lagging effects of substantial cumulative global interest rate hikes.”
Instead, the recent strength in markets is an excellent opportunity to rebalance away from the best performers in a portfolio, he says.
“While we are neutral on the outlook, it’s important to take advantage of this strong market rally. We certainly advocate the rebalancing and selling some of the gains and going back to neutral positions.”
Alan is a portfolio manager with Pendal’s multi-asset team.
He has extensive investment management and consulting experience. Prior to joining Pendal in 2017, Alan was a senior manager at TCorp with responsibility for developing TCorp’s strategic and dynamic asset allocation processes covering $80 billion in assets.
Alan holds a Masters of Quantitative Finance, Bachelor of Business (Finance) and Bachelor of Science (Applied Physics) from the University of Technology, Sydney and is a CFA Charterholder.
Pendal’s diversified funds provide investors with a variety of traditional and alternative asset classes and strategies.
This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current at February 21, 2024.
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