Global Optimism Amid Disinflation

Market Optimism Rises Amid Disinflation Sentiments

Global equities saw a positive trend last week, as hope for a mild economic downturn in 2023 strengthens. Gains in the stock market have extended beyond large-cap companies to mid and small-cap sectors. The Russell 2000 index, mostly comprising small caps in the US, experienced a rise of about 8%, outpacing the 4% increase in the NASDAQ 100. Europe also recorded similar growth, signalling a shift in investor confidence from challenges to opportunities, thus warding off a potential recession.

Emerging markets commenced June on a high note after a subdued May, despite the setback associated with China. The second-largest global economy and a significant part of MSCI’s EM index has been grappling with high expectations for a while now. In a bid to stimulate the economy, Chinese authorities are urging banks to reduce interest payments to depositors and prepare for equity market support. Valuations in China are currently attractive due to low investor confidence, paving the way for a potential upswing if the government’s plans succeed.

The anticipated further easing of China’s policy should benefit not just China, but also other economies. However, central banks worldwide will continue to hike interest rates until inflation in developed countries stabilises. Both Canada and Australia have recently surprised markets by increasing rates by 0.25%. The US Federal Reserve might follow suit at its Open Market Committee meeting this week, with another rate hike expected either this week or in July. Despite signs of employment growth in May, other economic areas are struggling, and unemployment is up at 3.7%. The Fed’s efforts to replenish its current account after the debt ceiling resolution might pull funds away from strained US regional banks. Increasing rates at this stage could further strain the economy, potentially causing more bank failures.

Market gains last week underscored the predominance of optimism over pessimism, suggesting that even the gloomiest investors might struggle to foresee a catastrophic event during good times.

Japan’s Promising Dawn?

Japan has been outperforming over the past quarter, with its stock market outpacing all other major regions. The Topix hit its highest point since 1989 in mid-May and has continued to grow in June. After three decades of near-zero inflation, Japan saw a record high of 4.3% in January, which then reduced to 3.5% in April. Investors are now hopeful of an upcoming wage growth. The current positive market sentiment towards Japan is the strongest it has been in decades.

While most western economies are battling inflation, Japan, which has long struggled with deflation, welcomes it. Deflation had been encouraging excessive saving and limiting investment and growth. Japan’s inflation has surpassed the Bank of Japan’s (BoJ) 2.0% target for over a year now. This controlled inflation gives the BoJ more flexibility than its international counterparts, maintaining its interest rates below 0%. The BoJ’s balance sheet has been showing signs of growth, bolstering the perception of Japan as a reliable investment hub for foreign investors.

However, caution must be exercised. Japan’s economy has historically underperformed following initial hype. Critics suggest Japan’s inflation is driven by global factors rather than domestic ones. They also argue that Japan’s profitability is merely due to a weak yen and not a reflection of actual economic improvement. Such a view oversimplifies the situation, as the increase in profitability extends beyond exporters to the entire economy. The falling yen has also made Japanese exports more appealing. If this continues in tandem with domestic corporate growth and economic optimism, it will only further solidify Japan’s position as an attractive investment destination. Japan tends to thrive when it is globally integrated, a fact that its policymakers seem to have acknowledged.

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This article is for information purposes only – should not be perceived as financial advice. We recommend you should always speak to a financial adviser before making any investment decisions.

Please note, past performance is not a reliable indicator to future returns. Your investment may fall as well as rise, and you may not get back what you put in.