Yet another delay in the long-awaited global growth acceleration

It is hard to imagine this weakness in growth was expected, given the huge consensus preference for underweighting fixed income relative to equity at the start of the year. Indeed, the combined drop in G10 and EM growth surprises was among the largest in the now five-year-old global expansion.

Global growth should pick up. Looking ahead, we expect the trend in global growth to improve from the sub-par pace at the start of the year. Figure 1 shows our global growth forecast, while Figure 2 looks at the details by region and country. Two points are worth highlighting.

First, we expect Q1 to mark the low point for growth for our full forecast horizon. While the Q2 run rate is still likely to be subpar, we expect the pace of global growth to average 4% in H2 14; this would be the strongest six-month pace of growth since the end of 2010. Second, the growth pickup should be well diversified.

The long-awaited US recovery should finally take hold. After an above-trend 3% in Q2 (payback after the weak Q1), we expect US growth to average a solid, if unspectacular 2.5% in H2. Growth in Europe is expected to remain steady, if still modest. Even so, the improvement in European growth relative to the past two years is expected to be the single biggest contributor to stronger global growth in 2014. Finally, China’s growth is expected to improve sharply in H2 as government efforts to boost the economy begin to bear fruit.

Overall, we expect the next 6-18 months to mark a turning point of sorts for global growth. After more than two years of decidedly sub-par growth, there should begin to be a higher level (though still modest compared with pre-crisis levels) and a broadening of growth, including an eventual improvement in emerging markets.

Risk asset performance since 2011 is consistent with persistently weak growth. To understand what the strengthening and broadening of global growth would mean for risk asset allocations (assuming it happens, of course), it is worth reviewing in detail the trends in growth and growth assets in recent years.

It is important to recognize that the middle of 2011 marked a major turning point for the global growth cycle and asset prices linked to it. At the global level, the manufacturing cycle fell below par and has stayed there for much of the time since; during the second half of last year, it looked as though global growth was turning up a notch, but Q1 saw a reversion to the sub-par rate of growth.

The causes of this prolonged period of weak global growth are now well known: a 2-year recession in the eurozone, the start of a persistent slowing in China’s growth rate and a sizable fiscal tightening in the US in 2013 that prevented a more robust recovery.

The effect on asset prices typically linked to the global business cycle is also evident. Figure 3 looks at the relative performance of our generic basket of 19 growth-linked asset prices against the performance of the S&P500. From its summer 2011 bottom, the S&P has risen a remarkable 70% and now stands at a record high. During the same period, our generic basket of growth-linked assets – a mix of commodities, equity indices and FX rates – has largely been treading water.

Let’s look a bit more specifically at the link between the global manufacturing cycle and the basket of growth-linked assets. While these asset prices do gravitate between rich and cheap against the global business cycle (they look slightly cheap today), the link between the two has remained reasonably consistent over time. In other words, the poor performance of a diverse basket of growth-linked assets looks consistent with the lacklustre trend in global manufacturing over the past three years.

The relative trends in growth-linked assets tell an even more interesting story. While the overall level of global growth has remained persistently weak in the past three years, the relative performance has been more mixed.