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4/28/2015

TheLongRun,IntheShortTerm|MacroStrategyUpdate

15 January 2015
Macro Strategy Update

The Long Run, In the Short Term


Executive Summary: We maintain our view that the world is not headed for a recession and
growth will continue. Long term trends are changing and we must be aware and capitalise
on it. Commodity importers and exporters will experience very different growth trends, whilst
the US looks set to lead the world economy once again. In the short term, be ready for higher
volatility as financial markets grapple with asset repricing once the Fed hikes rates. Looking
across asset classes, there is no better place to be than in equities, but be ready for
downdrafts this year.

Article
Global Economics.
In our previous article, we touched on diverging global growth trends and posited that the
world as a whole would likely not enter a recession but instead get stuck in second or third
gear. So far, macroeconomic data suggests that this remains the case, Composite PMI
numbers which are currently slowing from the levels achieved in mid2014 but still above 50
(Fig 1). Global GDP growth is still below long term trends but we expect it to gradually pick up
given a potential consumption boost from lower commodity prices (Fig 2).

Fig 1: Composite PMI Of The Various Economic Regions Remain Expansionary

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Fig 2: Global GDP Growth To Slowly Grind Higher

In our 16 Dec 14 article, we alluded that cheap oil was beneficial for the majority of countries
in the world. The chart below shows the inverse correlation between growth and oil prices.
The effect should start to filter into the various economies by the second half of the year and
this would contribute to the growth tailwinds (Fig 3).

Fig 3: Positive Growth Effects From Cheap Oil

We would like to point out some important long term trend changes which strengthen the
case for US ascendancy in the world economy once again. There is no denying that key EM
countries exhibited stellar growth in the 2000s. On a relative basis however, US growth has
been increasing significantly since the 2008 financial crisis such that the growth differential of
EM countries during the past decade has declined and is expected to shrink further (Fig 4).

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Fig 4: Shrinking EM vs US Growth Differential It Last Crossed In 1999

The US continues to lead the world in productivity and technological innovation, benefiting
from favourable demographics including immigration and quality of education, and the
lions share of world R&D spending. With this advantage and coupled with the relatively slow
wage growth of the past 5 years, the US is second only to China in terms of manufacturing
cost competitiveness (Fig 5). This is obviously not a fluke or one time occurrence, but a long
term structural shift which will benefit the US economy for many more years to come.

Fig 5: US Productivity and Cost Competitiveness Is A Structural Shift

With the divergence in growth paths and subsequent divergence in monetary policy
between the US and the rest of the world, it is likely that the cycle of US dollar appreciation
continues for a few more years (Fig 6). The consequence is a negative view on commodities
and volatility in both currencies and markets of weaker EM countries.

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Fig 6: Dollar Strength Due To Trend Change And Diverging Monetary Policy

Expectations for Europe remain relatively muted as the positive effect of a cyclical rebound is
likely offset by headwinds arising from uncoordinated reforms and political uncertainty. Near
term political risks arise from the Greek parliamentary elections in late Jan, and other
elections in UK, Portugal and Spain in 2015 could hinder structural reform if populist parties
gain more vote share. On a positive note, there are signs that the drag from austerity
measures are slowly waning (Fig 7), and hope that the ECBs QE program will provide the
necessary kickstart that the Eurozone needs (Fig 8).

Fig 7: The Drag From Fiscal Austerity In the Eurozone Is Waning

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Fig 8: ECB QE Program And The Likely Effects

Looking at EM and in particular emerging Asia, we expect these economies to continue to


perform well in relation to global peers. The central government in China appears content to
accept slower reform to ensure greater stability in the economy, as shown by small stimulus
measures throughout the past two years (Fig 9). South Korea and Taiwan which are tech
heavy economies with strong export links to US should also benefit from US strength. For the
majority of the economies, lower commodity prices will help consumption and investment
and lower inflation.

Fig 9: Expect China To Continue To Guide And Moderate The Economy Through Targeted
Stimulus

Market Implications.
We raise the prospect that 2015 brings an era of more volatile equity, fixed income and
currency markets. With the Fed expected to start rate hikes in July, the resulting shift in the
yield curve and across the board asset repricing will definitely introduce more volatility into
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markets (Fig 10). Repricing in bonds would likely lead to rising yields which would result in an
unpalatable negative return especially for investment grade issues (Fig 11).

Fig 10: Equity Option Implied Volatility and Fixed Income Volatility Have Been Increasing

Fig 11: At Present Yields, Fixed Income Provides No Buffer Against A Small Rate Rise

We see no reason not to hold equities. With bond yields at current levels, equity risk premiums
for many markets are elevated and are above 1 standard deviation from long term
averages. This means that despite above average valuations for some markets, we are
sufficiently compensated for taking on equity risk (Fig 12).

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Fig 12: Equity Risk Premiums Are Elevated. High Risk Premium Means More Compensation For
Taking On Equity Risk

Conclusion.
We wrap up this update by reiterating that we see growth continuing at an incrementally
higher pace than last year. We should see boosts to consumption coming from lower oil
which would benefit oil importing countries. The US could take over the lead in global growth
once again which represents a structural shift in the world economy. Be mindful that we will
face higher volatility in markets this year as a result of Fed policy but there should be ample
liquidity given divergent monetary policy from the various central banks.

IMPORTANT NOTES: This report is provided for the information of the intended recipient only and should not be
reproduced, published, circulated or disclosed to any other person without the prior written consent of GYC. The
information and opinions expressed herein reflect a judgment of the markets at its original date of publication and are
subject to change without notice. GYC does not warrant the accuracy, adequacy or completeness of the information
herein and expressly disclaims liability for any errors or omissions. The information is given on a general basis without
obligation and on the understanding that any person acting upon or in reliance on it, does so entirely at his or her own
risk. Any projections or other forwardlooking statements regarding future events or performance of countries, markets or
companies are not necessarily indicative of, and may differ from, actual events or results. Neither is past performance
necessarily indicative of future performance. You should make your own assessment of the relevance, accuracy and
adequacy of the information contained in the information provided and make such independent investigations as you
may consider necessary or appropriate. Accordingly, neither GYC nor any of our directors, employees or
Representatives can accept any liability whatsoever for any loss, whether direct or indirect, or consequential loss, that
may arise from the use of information or opinions provided.

GYC FINANCIAL ADVISORY PTE LTD 1 Raffles Place #1501 One Raffles Place, Singapore 048616
Tel: (65) 63491441 | Fax: (65) 63491440 | Email: enquiries@gyc.com.sg | Co Reg: 199806191K
Website: www.gyc.com.sg

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