The debate rages on regarding whether the global business cycle has started to stabilize, with most of the green shoots arguments based on softer data such as Purchasing Managers Indices (PMIs) appearing less bad. Although this is not the same as good, one should be aware of the fact that a bottoming process of the economic cycle has commenced. Importantly, different countries will experience dissimilar rates of recovery that, in turn, will impact asset allocation decisions.
An interesting analysis by the Goldman Sachs Global Economics team suggests that every major economy has possibly already seen its worst rate of GDP decline, either in Q4 of last year or Q1 of this year (see graphs below). Emerging markets are likely to see a return to trend growth about six months, on average, before advanced economies. Similarly, emerging markets on average will close their output gaps - the difference between actual growth and trend growth - about two years before advanced economies, said the economists.
Although the Goldman team are not under the elusion that they will be entirely correct on the timing of these events, they do feel more confident about the relative order in which countries/regions will reach the above milestones. The analysis leads them to the following market implications as summarized in the report:
• Equity markets have most likely bottomed and volatility should start diminishing.
• Countries that get back to trend growth sooner will tighten monetary policy sooner.
• Countries that get back to trend growth sooner should see their currencies strengthen.
• As the output gap will take many years to close, there should be limited pressure on prices and wages. Deflation will still be a greater concern in the short term than inflation.
• Emerging markets, particularly Asia, should offer more opportunities for outperformance for equities and forex, and could support commodity prices, especially industrial metals.
Source: Peter Berezin and Alex Kelston, Goldman Sachs - Global Economics Weekly (via Fullermoney), May 20, 2009.