Before the UK’s decision to leave the European Union (EU), the global economy was experiencing a deep structural transition. A more sustained and balanced economy was still achievable, despite low growth and low inflation during this process. However, with new uncertainty in Europe post-UK referendum, we have downgraded our global growth outlook for 2016 and 2017. Although we still think the world economy can avoid major disruption, we are less confident than before. We believe that the global economy will remain in a prolonged period of low growth and low inflation, with a risk of political paralysis.
Post-Brexit Uncertainty Alters Our Global Growth Outlook
GDP Growth (YoY %)
Sources: Pioneer Investments, CEIC, as of July 15, 2016.
In this “Low Low trap” scenario, we believe that the consequences of Brexit will be mainly felt in developed markets, in Europe in particular, through deterioration in confidence and in investments. Inflation in Europe is expected to stay low for longer as negative output gap struggles to close. The US economy is expected to perform relatively well.
Emerging Markets (EM) will, in our perspective, be more resilient than Developed Markets (DM), although some of the East European economies with relatively tight economic and financial links to the EU might suffer considerably. The major threats for EMs are the strong dollar, low commodity prices and China’s potential mismanagement of its economic transition, all conditions that now seem relatively under control.
In the short-term, we believe Central Bank support will be vital to preserve the stability of global financial systems. However, over the medium-term the economic scenario appears more scattered and dependent on the evolution of the political debate and actions implemented, especially at the European level. If appropriate policy responses are delayed, the risk for derailment from the deep structural transition required could rise further.
Within this delicate framework, we keep a defensive approach in risk assets, in particular in Equities. We are more positive on EM equities compared to DM equities and we like in particular China and India. In a world of ultra-low bond yields and weak earnings growth in DM, EM could be a source of return for investors in the coming months, even in the bond and currency space.
In the LowLow trap scenario, we believe that asset allocation should focus on effective diversification to manage possible periods of turmoil driven by rising risks to the global scenario. In our view, gold and the USD may act as hedges against these risks. Non-directional strategies and additional diversification through alternative asset classes becomes, in our view, a structural element in the asset allocation.