A cursory glance at the global economic outlook for 2014 might lead to the conclusion that the distress of the worldwide financial crisis is finally over. GDP growth looks set to rise to 3.7 percent from 2.9 percent this year. Developed economies, in particular, are showing meaningful pickups in economic activity, with domestic demand growing in Europe, Japan and the U.S. Growth in the euro zone, Japan, the U.K. and U.S. is set to nearly double from 1.1 percent to 2.1 percent next year, compared to a more modest rise from 4.7 percent to 5.3 percent in emerging markets.
And yet. Look a little more closely, and it’s hard to get overly excited, difficult to shake the sense that the recovery’s foundation is not exactly rock-solid. The euro zone might only manage to grow 1.3 percent, and youth unemployment in the region remains crushingly high. While that’s a clear improvement over the two-year recession that recently came to an end, deflation remains a serious threat in the region, as well as in Japan. Indeed, inflation remains low in much of the world, a reflection of the fact that many economies aren’t running anywhere close to maximum capacity. In fact, the potential growth of developed and emerging economies alike is eroding, not improving, as populations age and workforces shrink nearly everywhere except Africa.
So what’s an investor to do? For now, Credit Suisse’s team recommends that investors assume that the investment environment remains similar to 2013 and position themselves to profit from strong financial markets and a continuing economic rebound in the developed world. That means overweighting equities and, within fixed income, risky credit assets. But investors should also watch carefully for signs of disappointing growth. As Credit Suisse analysts said in their 2014 outlook note, “Closer to the Top, Further From the Exit, “We do not expect returns to rise in the event of stronger-than-expected activity but think that they will fall if activity weakens.” Heads, we sort of win, tails we lose. These is not great risk-reward, but it is the situation at hand.
Central Banks Lead the Way
Five years after the crisis, the world’s largest central banks – the Bank of Japan, Bank of England, European Central Bank and the Federal Reserve – are still playing a historically disproportionate role in the global economy as well as the capital markets. “The balm of central bank liquidity has offered material comfort first to bonds and now equities,” Credit Suisse analysts wrote in the outlook note. None of the Big Four banks appears likely to hike interest rates next year. But since rates are already near zero, any monetary efforts to juice economies that still need it will require some creativity. The European Central Bank, for example, is contemplating introducing negative deposit rates. Credit Suisse believes the Bank of Japan, which pledged in April to double the size of the monetary base by the end of 2014, will likely increase monthly bond purchases by an additional 30 to 40 percent next year as well as buying billions of dollars in equities.
Just as further stimulus seems a near-certainty, so too is the fact that fears of that very stimulus drying up will likely be the primary source of headaches for investors in 2014. That will be a repeat of 2013, when concern that the Fed would begin reducing its $85 billion monthly asset purchases sparked a summer swoon in emerging market stocks and bonds while also playing havoc on spreads elsewhere. Simply put, concerns about when and how much incoming Federal Reserve Chair Janet Yellen tapers will drive returns in nearly every major asset class over the next six months or more.