European woes tiny part of brighter picture for global economy, writes Alan McChesney
Some investors will understandably be nervous over the renewed volatility in equity markets worldwide this year. Many markets have fallen to levels last seen at the start of the third quarter of 2009.
A correction of this magnitude should, however, come as no surprise. Since global equity markets began their strong recovery in March last year, question marks have persisted over the quality and durability of the rally.
This was highlighted earlier this year when many of the shares that led the recovery were trading at prices that required a near-perfect economic outcome to justify their lofty prices.
The developments in Europe sparked by Greece were the perfect excuse for markets to correct.
But while there are concerns that Europe's sovereign debt problems may impact the global recovery story, it is worth pointing out that Europe's contribution to global growth is surprisingly small.
The International Monetary Fund anticipates Europe's contribution to be just 3 per cent for the period between 2008 and 2012. This against China's 34 per cent and the US's 12.5 per cent.
This is in many ways for Europe a reflection of the Japanese story over the last 30 years.
Whilst still the world's second largest economy, Japan only contributes 1.4 per cent to global growth and has become largely insignificant to global markets.
The developments in Europe augur the shift in the axis of economic power globally. No longer does this axis lie between the US and Europe, but between the US and Asia.
Recognising this is important for long-term investment strategies.
All this market uncertainty is set against an improving global economic backdrop led by strong economic growth, particularly out of China and the rest of Asia.
The Asian economies have already experienced their own financial crisis in 1997 when similar issues forced the region into a not-dissimilar economic downward spiral.
The upshot was that this forced Governments in Asia to sort out their banking sector - which today is one of the most robust worldwide.
Even the US economy has turned the corner and in some areas - such as exports - is expanding swiftly.
Australia remains robust - though not without problems - whilst better economic times are looming for us in New Zealand with much improved dairy prices and a growing trade relationship with Asia.
Even some parts of Europe, such as the UK and Germany, are showing encouraging economic signs, in particular the exporters who are beginning to benefit from the low euro.
But the mountain of debt sitting primarily on the balance sheets of Western Governments will need to be financed and eventually paid off.
For most Western economies, this level of debt will act as an anchor on their potential level of growth as austerity measures to balance budgets set in.
From an equity market investment perspective, expect to see the indices consolidate rather than continue to surge higher.
This is a reflection of the high valuations of many of the stocks that make up the indexes and the reality check that has occurred last month.
There, however, remain very attractive returns to be gained from picking stocks from the plethora of attractively priced and undervalued companies that didn't participate in last year's rally.
These tend to be the medium-sized stocks that don't make up the major market indexes. Many of these businesses are under-researched, have cut costs aggressively and are generating very strong profits as activity picks up.
At the moment, we have a stronger weighting to funds investing in the mid-cap part of the market. Supporting this profit growth story is the continuing lack of signs of inflation in the major economies.
We favour exposure to the US market, as we believe profits in the US will continue to expand.
Cash flows are very strong and this will eventually lead to a robust recovery in new capacity and equipment investment.
This will be a positive growth theme for the US alongside the explosion that is occurring in exports.
These factors will offset other areas of weakness, especially in the banking sector.
China and the wider Asia region are also highly favoured. The Chinese property market has recovered strongly but the authorities in Beijing have moved quickly to tighten credit to prevent a bubble forming.
We would still expect China to grow at over 10 per cent this year even as stimulus is withdrawn from the economy.
Consumption growth in China is especially strong - and growing.
This has traditionally been an economy with very high levels of savings and very low consumption. With the Government putting in place a quasi-welfare safety net for healthcare and education, the need to save all household income is changing.
While the world works its way through a patchy economic recovery, strong returns are likely to come from the ability to pick the right stocks.
* Alan McChesney is principal of investment firm New Zealand Assets Management.
