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High uncertainty, low volatility

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Uncertainty is high, while volatility is low. How to resolve the contradiction?

Uncertainties
The uncertainties are related to the high level of global debt, low productivity growth, extremely expansive central bank policies, the divisive forces in the EU, the surge in political populism and the uncertain answer to the question of which macro-economic state the global economy is currently in or will be in in the future (lowflation, deflation or inflation).

The future is uncertain, that’s for sure. Particularly in times when many developments are new compared to the recent past: the Great Recession has been a turning point. But when we look at more recent trends, the picture we get is a bit more optimistic.

Global growth favourable
In its new World Economic Outlook, the International Monetary Fund projects the global economy to grow by 3.1% in 2016, following 3.2% growth in 2015. The forecast was not revised down compared with the July estimate, which is a fact that can be considered positive in itself.

Industrialised nations disappoint
Admittedly, the 2016 growth forecast for advanced economies has been marked down compared with the July estimate (by 0.2 percentage points to 1.6%); last year’s growth was still 2.1%. However, highly significant indicators such as industrial production and survey indicators are at least pointing to growth stabilising at this level, which corresponds to the reduced potential growth.

Emerging markets doing surprisingly well
In contrast to the industrialised nations, growth in emerging markets and developing economies is expected to pick up in 2016 (by one tenth of a percentage point to 4.2%), which marks an increase of 0.2% compared with 2015.

The difference in growth between the industrialised nations and the emerging markets is therefore expanding, with the dynamics taking place in the emerging markets. Russia and Brazil are recovering from recession, and commodity prices and currencies have stabilised. Economic policy in China is enabling the gradual slowdown of its growth rates and a rebalancing of its economy as a whole, while admirable structural reforms are being implemented in India, with the economy showing robust growth.

Favouring emerging markets
This development is reflected in Asset Allocation. Firstly, we favour government bonds in emerging markets both in local and hard currencies. Secondly, we overweigh emerging markets in country equity allocation.

To summarise, three risks can be deduced from the dichotomy between high uncertainty and low volatility.

TINA
The global economy is growing remarkably evenly, i.e. with low volatility. Relatively small confidence shocks, such as that experienced after the Brexit referendum or that was triggered by the depreciation of the Chinese currency, can be overcome by expansive central bank policies. The related uncertainties have relatively little impact on direct growth. However, market prices do not reflect these uncertainties. The TINA (There Is No Alternative) approach is dominating. As long as the risks do not turn into realities, risky securities classes continue to be purchased since secure government bonds only promise very low yields.

The liquidity trap
The cycle of crisis – central bank intervention – stabilisation and/or improvement – disregarding of risks – new crisis could be broken since central bank policies are becoming ineffective or even counterproductive. The Bank of Japan is one example. It is highly committed to overcoming the deflationary trend, but its measures taken last September (implicit promise to continue to lower real yields into negative territory) seem somewhat desperate.

Policy mistakes
Monetary and economic policy might be based on false macro-economic assumptions. When important global markets are in secular stagnation, it means that prolonged negative real yields are required to ensure growth. (More substantial) interest rate hikes in the USA or a reduction in the bond purchase programmes in the Eurozone could trigger a recession or lead to market turbulence. Furthermore, government aid for systemically important, failing banks could be granted too late. Additionally, protectionist action taken by a President Donald Trump might result in a trade war.

 

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This document is an advertisement. All data is sourced from ERSTE-SPARINVEST Kapitalanlagegesellschaft m.b.H., Erste Asset Management GmbH and ERSTE Immobilien Kapitalanlagegesellschaft m.b.H. unless indicated otherwise. Our languages of communication are German and English.

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The fund prospectus, Information for Investors pursuant to § 21 AIFMG and the key investor document/KID can be viewed in their latest versions at the web site www.erste-am.com or www.ersteimmobilien.at or obtained in their latest versions free of charge from the domicile of the management company and the domicile of the custodian bank. The exact date of the most recent publication of the fund prospectus, the languages in which the key investor document/KID is available, and any additional locations where the documents can be obtained can be viewed on the web site www.erste-am.com or www.ersteimmobilien.at .

This document serves as additional information for our investors and is based on the knowledge of the staff responsible for preparing it at the time of preparation. Our analyses and conclusions are general in nature and do not take into account the individual needs of our investors in terms of earnings, taxation and risk appetite. Past performance is not a reliable indicator of the future performance of a fund.

Gerhard Winzer

Gerhard Winzer has worked at Erste Asset Management since March 2008. Up until March 2009, he was Senior Fund Manager in Fixed Income Asset Allocation; he has been Head Economist since April 2009.

He holds a degree from a polytechnical college and studied economics and business at Vienna ...

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