Deflation haunts global equities
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Anthony Fensom is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.
Negative interest rates in Japan and Europe have added to concerns over whether the monetary authorities still have the financial firepower to slay the feared demon of deflation.
According to the global equities team at Nikko Asset Management (Nikko AM), global equity markets' poor start to 2016 followed artificially high equity risk premiums due to years of quantitative easing (QE), along with high profit expectations and worries over competitive currency devaluations emanating from China and emerging market debt.
As per Morningstar's typical recommendation, the international fund manager suggests investors target "companies that are not seeing ongoing pressure on profitability"--in other words, stocks with sustainable economic moats.
While Nikko AM does not think a deflationary bust is imminent, it says the warning signs are Main Street being affected along with Wall Street, such as through reduced availability of credit for car loans; rising job insecurity leading to higher savings rates and lower wage hikes; and lower gasoline prices being saved rather than spent.
Morningstar spoke to Edinburgh-based Iain Fulton, investment director of global equities at Nikko AM specialising in the consumer staples, consumer discretionary and technology sectors, about his views on the global economy and the outlook for equities.
Nikko AM has raised the question as to whether a structural repricing is underway for global equities amid worries over deflation. What are the risk factors in terms of deflation and how might it be combated?
Our view is broadly that we're in a macroeconomic environment characterised as "growth frustration"--there's frustration around slow growth and some fairly fancy monetary policy being designed to try and kick-start growth and stave off that deflationary threat. The threat has been there, particularly for traded goods, and a lot of that relates to the strength of the dollar since the end of QE in 2014.
A large amount of credit during QE was created and borrowed by companies offshore, borrowing in dollars while their revenue streams were non-dollar denominated, and as the dollar continued to rise we saw the beginning of a tightening phase. So you've seen that most acutely in traded goods and manufactured goods where that deflationary impulse has been much more pronounced.
The best way we can see it, particularly in the US, is that the recovery is not strong but it's not that bad, so it's this growth frustration--we're stuck in the middle, we're not growing rapidly but we're not falling off a cliff. Markets have moved up, people are looking for the next leg and then we go back to the other side. So we have this sector rotation that could characterise markets for a while.
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