Skandia cautiously optimistic on global outlook

Continuing instability in eurozone bond markets, coupled with a lack of improvement in US consumption data, has caused markets worldwide to remain volatile during the past few months.

The Chicago Board Options Exchange Volatility Index (Vix), which reflects investor estimates of future volatility — and is also referred to as the fear index — has traded up 35% since August.

“I am not sure if it is a good or a bad time to be coming out here because there are so many uncertainties, particularly on the political front, in Europe,” said Rupert Watson, head of the asset allocation team at Skandia Investment Group, a UK-based investment manager, at a briefing last week.

Billionaire investor George Soros shares those concerns, saying last week that the crisis will “push not only Germany, not only Europe, but also the whole world into conditions very reminiscent of the Great Depression in the 1930s”. Soros went on to make the case for Germany to step in to bail out some of the struggling European economies.

Last month, Spanish and Italian 10-year government bond yields fell significantly while French credit default swaps (CDS) widened. Watson said that the advantages for Europeans of a common currency have been oft-touted, such as the ease of holidaying across the continent without having to convert currency, but the downsides are only now setting in. “This is the key political challenge facing Europe today,” he said.

The purchasing manager index (PMI) in Europe, which measures the opinions of purchasing managers, has fallen to 50.7 in August from 58.2 in February. The new-order-to-inventory-ratio in the eurozone, an indicator of economic growth, has also fallen this year.

The outlook in the US is also bleak, according to Skandia. Recovery in US consumer spending so far has greatly lagged previous economic recoveries. Unemployment crossed 9% again in the second quarter of this calendar year, after falling to 8.9% in the first quarter.

The situation in Asia is better, with consumption in Japan recovering rapidly after the earthquake, and China looking on track to achieve a soft landing. “The Chinese economy will be able to generate growth this year and next year, and perhaps for some time,” said Watson, going on to compliment the Chinese authorities for managing the economy well. Watson is in agreement with a number of other economists in his view that emerging economies will continue to outperform developed countries for the foreseeable future, encouraging a bullish view on emerging market equities.

Watson cautiously recommends global equities and corporate bonds, on the assumption that the eurozone will be successful in sorting out its current fiscal challenges. “Broadly speaking we think that the global economy will continue to recover,” he said. “We are not expecting a return to recession, but at the same time we are not expecting particularly high growth either.”