A Snapshot View of the Global Economy

The second estimate of UK gross domestic product in the first quarter of 2010 was this morning revised upwards to 0.3%, as was widely expected. This represents the fourth quarter in a row that real input data has proved statisticians to be relatively conservative in their estimates, and the first quarter figure could still be upgraded further as the true underlying performance is likely to be more robust than current data is letting on. Today's figure brings the UK's annual rate of economic contraction down to 0.2% from the previously-estimated 0.3% decline.

Going forward, the coalition government's emergency budget in late June as well as factors further afield will dictate the investing environment. With around 60% of UK exports ending up in the eurozone, the sovereign debt crisis and governments' austerity measures will have a substantial impact on economic growth going forward. To cast our net further afield, following are excerpts from a recent article on Morningstar.com.au.

Outlook for Investment Markets
The Greek/eurozone debt problems have cast a pall over growth assets and reawakened a rush into safe-haven assets (high-grade bonds) and currencies, causing suffering for the euro and sterling. The outlook for Greece in particular remains problematic even after a massive rescue package, although the risk of contagion appears to have been contained. Markets will understandably be wary until these issues become clearer. It's worth noting, though, that recent economic data out of the US, Japan, China, Asia in general have been quite positive. If financial crisis issues diminish, growth assets may come to reflect this strengthening global activity.

International Property - Review
Although quite buoyant up to early May on signs of better-than-expected economic activity, global property shares slumped in line with world shares after the Greek debt issues surfaced.

Most global property markets are down by around 10% for the past month, although Japan's 6.6% fall was a bit less than the average. Unsurprisingly, property markets in troubled eurozone economies were particularly weak, with Greece dropping 16.3% over the past month and 30% over the past three months.

International Property – Outlook
At the Morningstar Australia Investment Conference at the end of April, the asset allocation session had some difficulties with the outlook for domestic (Australian) property, given the reduction in choice within the sector and the dominance of a single name, Westfield. With yields not especially competitive with lower-risk alternatives such as Commonwealth bonds, and property stocks exposed to potentially weak consumer spending overseas, the feeling was that the outlook for the sector as a whole was not especially promising.

International property investors are getting a more volatile asset class than they would from global shares, as the buoyancy of March/April followed by large falls in May showed. The latest stresses in financial markets are clearly bad news for global property, which, with its legacy levels of debt, is particularly exposed to any renewed tightening of credit. Global economic recovery will ultimately work for the sector, but the interim looks hazardous.

International Fixed Interest – Review
There was strong demand from worried investors for prime government debt over the past month, and the JP Morgan Index of global government bond prices rose by 1.6%. This carried the entire fixed-interest asset class, the Barclays Global Aggregate Index, up 0.9% for the month. Conversely, yields on the less creditworthy eurozone countries' debt rose, in Greece's case to 12.2% in early May before the European Union/International Monetary Fund rescue package, compared to around 6.0% at the start of this year. High-yielding (low-quality) corporate debt was another casualty of the turmoil: both US and European high-yield bond prices fell 4.2% over the month.

International Fixed Interest – Outlook
Fixed interest markets remain unsettled. The rescue package has not definitively allayed default worries. This is especially the case for Greece, whose debt is trading at 5.0% over German yields, indicative of ongoing concern about Greece's repayment abilities. (Markets are also concerned about Ireland and Portugal, although less so about Italy and Spain.) The risk of Greek or other defaults has even led to speculation about a second phase of global financial crisis and renewed risk of a "double-dip" global recession. In these circumstances high-grade government and corporate bonds are likely to be the beneficiaries until these risks are resolved. Short-term interest rates will stay very low as governments remain alert to downside risks to their economies and financial systems. On a longer-term perspective, however, cash and bond yields are exceptionally low, and on the other side of current uncertainties are likely to return to more normal levels.

International Equities – Review
World shares have had a very volatile ride. They reached a temporary high on April 15, but sagged thereafter largely on sovereign debt worries, aggravated on May 6 by what appears to have been mistakenly large automated selling. The news of the Greek bailout was at first greeted warmly, and shares rallied substantially, but this did not last long. Worries re-emerged about the more indebted eurozone economies, aggravated by a poor reaction to the German ban on short-selling various securities. At the time of writing, sharemarkets appeared to be steadying, but the end result is that the MSCI World Index was down 10.4% in overseas currency terms for the past month, European shares faring worse than the US, Japanese, or Asian markets.

International Equities – Outlook
Greek and other eurozone debt problems are likely to remain front and centre for investors in the short term. Although Greece is taking the sort of austerity measures it needs to, there is no great optimism that the country will find its way through its problems and continue to service its debts, although the contagion risks, such as losses on the balance sheets of banks holding Greek debt, appear to be lower after the European Union package. Other eurozone economies also appear to have more credible prospects of managing their issues, both Portugal and Spain moving to improve their fiscal accounts (Ireland had a draconian Budget in late 2009). Debt and financial issues are therefore likely to remain a downside risk until Greece's position, in particular, crystallises one way or the other. These debt issues could trigger renewed short-term economic weakness, especially in the eurozone, where consumer confidence has unsurprisingly been falling.

On a more medium-term view, however, data on global economic activity has been more positive. In the US, in particular, employment is well on the mend (290,000 extra jobs in April), an especially encouraging sign as this tends to be one of the later indicators to improve after a recession. Japan, one of the laggard major economies, has also picked up, with latest numbers showing an annualised rate of growth of 4.9% in the March quarter. The Asian region as a whole continues to grow very strongly, with China likely to have grown in the March quarter at an annual rate of 10%-11%, despite official moves to dampen overheated sectors, notably property. Current debt market difficulties could go either way, but if resolved without too much delay or damage, world sharemarkets may start to reflect more of this improved economic outlook.

Performance periods refer to the month and three months to 22 May 2010.