In the business of economics and investment, there are plenty of people who profess to have crystal balls through which they glean the shape of the future. I have never owned a crystal ball, and have always been sceptical of the consensus view.
Looking back at the first six months of 2011, we have, among other things, experienced the Arab Spring, the ongoing drama of the euro zone, the tragedy in Japan, the slowdown in the world economy, and China overtaking Japan to become the second largest economy in the world. These are unpredictable times, and from my 30 years in the financial markets I have learnt that when there is uncertainty people fear the worst.
For me, uncertainty over the direction of markets means that we have to focus our attention on where the pockets of value still remain given the big picture macro themes we believe in. The story of the growth markets remains central to my near- and long-term thinking. It’s interesting to look back to the Maastricht criteria and see which countries within the euro currently satisfy them and compare that to the world’s growth markets.
Within the euro only one country meets Maastricht—Finland. Meanwhile, the Bric (Brazil, Russia, India and China) countries and the four other growth markets of Mexico, Indonesia, Korea and Turkey all satisfy the original criteria. How long will it take investors to accept that the growth markets are actually fiscally more prudent and financially in better shape than the Western world? Again, let’s look at the big picture: Bric countries are already among the 10 biggest economies in the world and could represent four of the world’s five largest economies by 2050. Together with the four other growth markets they could contribute 60% of the world’s gross domestic product (GDP). From this perspective, it seems crazy that so many in the Western world obsess about Greece. This year alone, China will create GDP of more than three times the size of Greece, and its import growth is likely to be as big as the entire Greek economy.
In terms of the current loss of momentum for the world economy, the main factors behind it are, in my view, the recent spike in commodity prices and the disruption in the supply chain following the Japanese earthquake. There are some signs that the negative impact of these events is now dissipating. A more fundamental question is whether a strong recovery can be sustained once these factors go away, particularly given the fiscal tightening in the emerging world.
Looking ahead to the second half of the year, Chinese inflation seems to me the single-most important issue. This year, China’s growth momentum has softened, and the policy of the Chinese government is now explicit about the quality rather than the quantity of growth. Most significantly, during his recent trip to Europe, China’s Prime Minister Wen Jiabao struck an optimistic note on inflation. Beyond the cyclical benefits in controlling inflation, China’s moderation could also provide relief for commodity markets, both in the near and long term, and improve the outlook for equities.
Inflation has also been a concern for India and at the start of the year India looked expensive relative to the other three Bric countries. However, I am in the camp that believes India’s inflation is close to peaking and if that is true, it should help the market to rally. In addition, India has remarkably positive demographic features, its structural story is strong, with investors keen to capitalize on huge planned infrastructure projects and as smart policies allow the remarkable underlying story to unfold, the market could come into favour during the rest of 2011. In future, India has the potential to grow at a faster rate than China.
In the so-called developed world, the US has been hit by continued uncertainties about the state of the labour market, housing and the budget. Financial conditions are likely to remain at very accommodating levels in the US, and as a result we can expect higher inflationary pressures. The key structural challenge for the US is domestic consumption. The simple fact is that the US consumer cannot support growth—domestic or global—to the extent that he has done in the past. However, while domestic consumption has decreased in importance for the US, there has been a rapid rise in the share of growth markets in US exports. If this rise is sustained it is not inconceivable that the improvement in the US current account could partly offset the decline of the domestic consumer.
Given the medium-term challenges facing the US, the global relevance of the growth markets have never been greater to the world economy. I come back to the big picture: the challenge for all of us is to remove ourselves from home market bias and try to see the world for what it really is—a world in which the growth markets underpin every major investment theme and opportunity. Understanding and responding to that new world is a challenge that goes way beyond the second half of 2011.
Jim O’Neill is chairman, Goldman Sachs Asset Management, and the coiner of the expression Bric
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