Friday 10 June 2016 by Trade opportunities

World Bank adjusts growth expectations – we suggest an inflation strategy

The World Bank forecasts economic growth every six months. This year, like every year for the past seven, they have lowered their initial forecast quite dramatically

world bank

In January, their forecast for 2016 global growth was 2.9%, and now it is just 2.4%.

They cite “sluggish growth in advanced economies, stubbornly low commodity prices, weak global trade, and diminishing capital flows” as the cause for their downgrade.  Important to note is that when the World Bank downgrades forecasts, they tend to still err on the upside, potentially due to the alignment of their budgets with their sponsoring countries’ economic growth.

This pattern of lowering forecasts during the year has been a feature of the post GFC world where the economy’s stubborn resistance to stimulate have frustrated economists.  For those of you that have attended our smart income seminars or webinars, the below chart will look familiar: it shows that the IMF, like the World Bank, has suffered from this same pattern of overestimating each year’s growth.

The World Bank’s lowered forecasts comes at the same time as a slew of well respected global equities investors, namely George Soros, Carl Icahn and Stanley Druckenmiller taking very bearish positions in global equities, investing in gold and gold miners, setting themselves up for “an exhausted equities bull market” and “economic turmoil from any unwinding of Chinese investments as the credit bubble bursts”.

Ironically, despite some of these extreme statements of risks, the raft of downgrades to the global economy in recent months has also signaled that risks are falling.  In other words, there is an increasing probability of lower growth being the new normal, and the downside risks that were clouding the outlook are dissipating.  Europe is experiencing modest growth, the US is maintaining its “good but not great” momentum, China’s consumer and services sectors are holding up despite the credit fuelled volatility in their industrial sector and Japan is at least consistently flat.

Amongst the narrowing range of future forecasts is an outlook of very low inflation around the world, which has engulfed Australia now too.  Despite massive monetary stimulus that some feared would create excessive inflation, every major economy is struggling to create any meaningful inflation.

So what does that mean for bond investors?  One interesting strategy at the moment is to lengthen positions in infrastructure sector bonds, most of which have inflation linked returns. Inflation is unlikely to do anything meaningful in the next 3 to 4 years, so anyone holding nearer term infrastructure bonds, such as the Sydney Airport 2020s, could look to take advantage of any profits they have at present and trade into longer dated bonds of a similar credit risk but potentially better value.  Inflation pricing is very low right now, so any pick up in inflation that occurs after 2020 will be upside for investors. Probably more importantly, investors are locking in cashflow for a longer period than the 2020s would offer, increasing certainty of income.

For clients not wanting to lock in their cashflow that far out, look for higher yielding options with a similar timeframe, but ensure that you diversify across sectors given the relatively flat economic outlook.

Please contact your FIIG representative for further details on the Sydney Airport 2020 bond. Available to both retail and wholesale investors in minimum parcels of AUD$10,000.