John Greenwood, Invesco chief economist, says in his latest quartely outlook that the economies of emerging Asia and Latin America will provide the strongest growth.
Commodity prices have been subject to a variety of crosscurrents in the past year. For example, the steep downturn in China’s growth rate in mid-2012 led to sharp falls in iron ore and coking coal prices. Looking forward, in contrast to previous business cycle upswings it is highly unlikely that in 2013 any of the major economies will see a surge of liquidity or a sudden upswing in business activity of the kind that would be needed to generate a sustained surge in demand for commodities. It is also the case that fears of inflation (e.g. from additional QE, or a further cut in eurozone interest rates) are gradually dissipating. In other words, the expectations that dominated market psychology over the past year or two and that helped to feed short-term moves in commodity prices, are no longer so prevalent. As central bankers keep saying, inflation expectations are wellanchored. The fundamental driver behind this trend is that balance sheet repair is inherently disinflationary, or even deflationary. Consequently as long as the major economies are in balance sheet repair mode, commodity price surges can only result from weather or supply disruptions such as we see from time to time in the agricultural complex.
One other factor that has arguably contributed to more lasting moves in commodity prices is the large amount of financial capital committed to commodity investments in modern financial markets, especially through ETFs. However, there are clear signs that some of the precious metal funds have been losing support as banking problems around the world are gradually resolved and inflation remains subdued.
Stock markets in the developed world have performed well over the past six months, led by the United States. The underlying logic that explains this – at least for the US – is that the health of the US private sector is gradually recovering. After a traumatic shake-out in 2008-09, US households are at last seeing their wealth and incomes starting to recover; US non-financial companies are enjoying healthy profits and can raise funds cheaply on financial markets; and the US financial sector is finally returning to growth and profitability, albeit at lower (and safer) levels of leverage.
The big question for investors is whether other developed economies need to see comparable changes in the financial health of their major sectors, or whether the US remains so dominant that it can drive the financial performance of other markets irrespective of local conditions. If other markets can ride on the coat-tails of the US upswing, then the urgency for balance sheet repair diminishes. However, there is a risk to regions such as the eurozone and the UK: if they fail to repair their financially broken sectors their economies could become a sort of sideshow, cut off from the global upswing – in much the same way as happened in Japan in the past two decades.
In the emerging world where balance sheets are generally in much better shape and where Asian and Latin American currencies are often tied informally to the US$, it is much easier for markets and economies to follow the lead of the United States. The only problem is their heavy dependence on exports to the weaker parts of the developed world such as the euro-area and the UK. For this reason I expect a year of moderate growth, not exuberant recovery.