Renaissance Capital Global economics outlook 27 January 2011
Fighting one’s destiny can be a great storyline, as fans of Star Wars’ AnakinSkywalker to Shakespeare’s Macbeth will tell you. But in a captivating story, it justcan’t be done. Such is the situation for developed nations. When crises such asthose witnessed in 1973-1974 or 2008-2009 hit after a generation of risingindebtedness, the consequent problems of economic mayhem and collapsingconfidence require highly stimulative policies to counter them, policies thatthemselves store up new problems for the future. The Fed could no more resist QE2in late 2010 than it could resist loosening policy in late 1975. The short-term resultsare clear: markets are up and the US economy should grow by 3-4% in 2011. If theFed tightens policy in late 2011 as it did in late 1976, it might be too late to stopinflation’s gradual rise through 2012 and its more significant rise in 2013.Equally irresistible is the attraction of fast-growing low-debt emerging market (EM)economies relative to slow-growth highly indebted developed market (DM)economies. From 1975 EMs boomed and unsurprisingly the same thing ishappening again. To meet global demand for EM assets we can assume currencieswill strengthen alongside more issuances of external debt, local bonds and equities,with only grievous policy errors or surprisingly successful macro-prudentialmeasures likely to stand in the way of these developments.This is not to say that every EM asset will outperform the S&P 500 in 2011 – globalinvestors have arguably priced in a good chunk of this story already, particularly inAsia and Latin America, while the S&P 500 was priced for a possible double-dip – but we do believe there is a good case for EEMEA and the frontier markets to be thebest EM performers this year. Largely unloved in 2010, they are cheaper than theirEM peers and, as our country sections show, with growth of 5-11% goodopportunities abound. We favour countries with low private-sector debt that have theappetite to borrow, and preferably have the funds to self-finance a rise in lending,which leads us to favour a number of countries in EEMEA and Sub-Saharan Africa(SSA).What could alter the plot in 2011? Evidently, a continued rise in EM inflation is athreat. But assuming we have a good harvest in August, the inflation risk associatedwith soft commodities should dissipate. For other commodities, the likelihood thatgrowth fears will occasionally resurface, or that OPEC might pump more oil, couldprevent excessive price rises for these assets.A second threat is China slamming the brakes on its economy, although if new loansare ‘only’ an additional trillion dollars this year it would still look fairly positive forChinese demand. China could instead choose to significantly revalue its currency asJapan did in 1976-1978 – the yen appreciation then would be the equivalent ofChina moving to around CNY3.8/$1 in 2013. Not only would this sharply cutinflationary pressure in China, but other countries in the region could then followsuit. It is too contrarian even for us to seriously forecast CNY3.8/$1 in 2013, butCNY5.4/$1 in 2012 is the base case of this report.We doubt Europe will be a more significant target for the occasional risk-off trade in2011 than in 2010, as we share the consensus view on Portugal (IMF soon) andSpain (maybe IMF later), with restructuring of some peripheral eurozone debt likelyto occur when it is affordable, presumably not before 2012.What else lies out there? Oil much above $90/bbl would be a problem, particularlyfor countries like Turkey and perhaps Kenya, and within the EEMEA space, but thisis not our base case for 2011. But that’s enough of the risks. Today we have a newhope, to quote Star Wars: Episode IV, and we should enjoy it.