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World update: China's growth and Europe's challenges

August 07, 2013

It's been an eventful summer in many corners of the globe. We checked in with Jonathan Lemco, a principal and senior sovereign debt analyst in the Vanguard Taxable Credit Research Group, to get his view of events in Europe, China, and the Middle East—and their impact on world markets.

How is the situation in Europe? Is any improvement in sight?

Jonathan LemcoThe macroeconomic fundamentals for much of the region remain awful. Yet, although growth remains poor, the region is showing tiny signs of economic recovery. Private-sector business activity has jumped a bit, suggesting to many economists that we will see a very small amount of economic growth in the third quarter of 2013 across the 17-nation Eurozone.

At least it seems that, from a fixed income perspective, no meaningful fiscal deterioration has occurred this summer. More important, the risk that the European currency union could disintegrate was sharply reduced during the second quarter. As a consequence—and despite the poor economic prospects for much of the region—interest rate spreads for many of the countries of peripheral Europe have tightened of late.

Are any Eurozone countries still in the critical danger zone?

Portugal had been undergoing political turmoil as recently as late June. However, its short-term challenges seem to have been addressed successfully at this point. Of course, Greece remains in deep financial trouble.

How has the market reacted to China's uncertain economic outlook?

The broader markets have been showing a bit more concern recently about China's growth prospects for 2013 and 2014. We're hearing a renewed debate about whether the Chinese economy will experience a soft or hard landing. The broad consensus is that economic growth in China will slow to a pace between 7.0% and 7.5% for 2013, but the market has obvious concerns.

How widespread is China's economic impact?

The country's economic health matters, in part because it buys so many commodities from both emerging and developed markets worldwide. And recently China instructed all of its government agencies to cut spending 5% by the end of the year in an effort to reduce domestic debt and conserve resources. The Chinese government has been signaling to the market for more than a year that it was prepared to slow down the economy somewhat to address its domestic fiscal issues. However, I would stress that China's government is somewhat ineffective at conveying this message to those market participants who care about the Chinese economy.

China's slowing growth is also notable because, in light of Europe's present challenges, China should be one of the world's two major engines of growth, alongside the United States. But as long as its annual growth numbers don't dip much below 7%, which is still considered a soft landing for its economy, the markets should bear the pain.

Should investors be concerned about the impact of Middle East violence on their portfolios?

On the fixed income side, Vanguard mainly invests in Israel, Qatar, the United Arab Emirates (UAE), and Turkey. That said, it is our view that Qatar and the UAE are relatively unaffected by the turmoil in the region. Israel is a special case—on the one hand, it has by far the most dynamic economy in the Middle East as well as a political democracy with a competitive party system. On the other hand, it is not immune to the negative spillover effects of violence close to its borders.

With all these sources of instability internationally, how can investors manage the risks?

Here's where clients benefit from a portfolio that's broadly diversified worldwide, takes a long-term perspective, and focuses on low costs. Vanguard believes a diversified portfolio is the best way to spread the risk of geopolitical uncertainty.

Notes:

  • All investments are subject to risk, including the possible loss of principal.
  • Investments in stocks or bonds issued by non-U.S. companies are subject to risks, including country/regional risk and currency risk. Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
  • Stocks and bonds of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.
  • Diversification does not ensure a profit or protect against a loss.
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