Research

23 October 2013

ASSET ALLOCATION AND FX RESEARCH

Who benefits from an acceleration in

global growth?
Investor expectations have been slow to incorporate the improvement in global
business confidence, and the persistent pessimism presents an opportunity to be
long assets that will benefit from an acceleration in global growth.

We determine country- and sector- level spill-over effects by combining two

models: one to measure cross-country spill-over effects and another that links
the final demand for goods and services with their intermediate uses at the
sector level across 40 countries (plus the rest of the world).

Our findings show that the strongest spill-overs from an acceleration in growth
in the majors (US, Japan, China and Developed Europe) are felt by Eastern
Europe, followed by Western Europe, Asia, and the Americas. At the sector level,
cyclicals such as construction, basic metals, and machinery tend to outperform in
a positive spill-over.

Further, we find that a positive growth shock to developed Europe has a larger
effect on most economies barring the large centres (the US, Japan, and China)
than even the US.

Our framework implies that the improvement in global business confidence since
June 2013 (Figure 1) is especially positive for growth in emerging and developed
Europe and cyclical sectors. European equities have generally bounced since June
but the cross-country performance does not match the predictions of the model.
The performance of cyclical equity sectors is more in line with the model, suggesting
they are a better vehicle to express views of further business cycle strength.
FIGURE 1
Changes in analysts growth expectations (2013-15) vs. business confidence-based
GDP growth (since June 2013)
%
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
Japan

China

Change in growth forecast (2013-2015)

US

Euro area

UK

Change in business confidence-based GDP indicator

Note: We run regressions of quarterly real GDP growth on the country measures of business confidence. Source:
Bloomberg, Barclays Research

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 9

Aroop Chatterjee
+1 212 412 5622
aroop.chatterjee@barclays.com
Guillermo Felices
+44 (0)20 3555 2533
guillermo.felices@barclays.com
www.barclays.com

Barclays | ASSET ALLOCATION AND FX RESEARCH

FIGURE 2
Manufacturing confidence has rebounded across the
developed world

FIGURE 3
G4 growth matters for small open economies

Index

US

Japan

% GVA

65

China

Euro Area

7%

United Kingdom

60

6%

55

5%

50

4%

45

3%

40

2%
1%

35
07

08

09

10

11

12

RoW
AUS
BEL
IDN
IND
TWN
KOR
CHN
BRA
MEX
CAN
GRC
LUX
IRL
MLT
GBR
CYP
PRT
ITA
JPN
DEU
DNK
FRA
AUT
SWE
NLD
ESP
FIN
TUR
BGR
POL
LVA
SVK
LTU
SVN
HUN
ROU
CZE
USA
RUS
EST

0%

30
13

G4
Source: Haver Analytics, Barclays Research

Note: We measure the aggregate long-term effect of a 1% GDP shock in the US,
Developed Europe, Japan and China on each country using the impulse
responses from a VAR model (details in the Appendix).
Source: OCED, WTO, Barclays Research

The global manufacturing cycle appears to be entering above-trend growth for the first time
since 2011 and there appears to be room for markets to be surprised to the upside. Looking
beyond the recent concerns about the strength of the US cycle, manufacturing confidence
in the main four regions (the US, Europe, Japan, and China) are accelerating (or at worst
stabilizing, eg, China, Figure 2).
Although it is still unclear whether the acceleration, which began in June 2013, will last,
analysts growth expectations have been slow to capture this improvement, especially in the
US and China (Figure 1). This persistent pessimism means that there is scope for asset
prices that are linked to growth to outperform as those expectations are revised up.
Admittedly, some amount of re-pricing has started already in markets such as EM Asian
equities (MSCI EM local currency returns are up more than 9% since end June 2013) and
some risky currencies such as the AUD (up more than 6% over the same period).
If the positive growth momentum in those large economies persists, further gains are likely
and investors should be paying attention at the regions and sectors that are likely to benefit
the most. In particular, we seek to answer the following questions:

Which countries should be the main beneficiaries of stronger growth in the major
economies (G4)?

Which large economies matter more for the smaller ones?

Which sectors should benefit from stronger G4 growth?
Are markets pricing the recent pick up in G4 growth?

Beneficiaries of G4 growth
We identify the winners and losers from an acceleration in global growth by looking at the
spill-overs of a 1% shock to GDP growth in the US, China, Japan, and developed Europe
(G4). We gauge the effect at the country level by running a statistical (vector auto
regression or VAR) model that measures growth spill-overs between large and small
economies over the long run. We determine the sectoral implications of the spill-overs using
an input-output matrix from the OECD and the WTO that links the production of final goods
23 October 2013

Barclays | ASSET ALLOCATION AND FX RESEARCH

FIGURE 4
Growth spill-overs from Europe are bigger than ones from
US (effect on output, proxied by GVA)

FIGURE 5
Japan growth matters more for EM Asia than for other small
open economies (effect on output, proxied by GVA)

% GVA
4.5%

% GVA

4.0%

1.6%

3.5%

1.4%

3.0%

1.2%

2.5%

1.0%

2.0%

0.8%

1.5%

0.6%

1.0%

0.4%

0.5%

0.2%

0.0%

0.0%

USA

RoW
AUS
BEL
IDN
IND
TWN
KOR
CHN
BRA
MEX
CAN
GRC
LUX
IRL
MLT
GBR
CYP
PRT
ITA
JPN
DEU
DNK
FRA
AUT
SWE
NLD
ESP
FIN
TUR
BGR
POL
LVA
SVK
LTU
SVN
HUN
ROU
CZE
USA
RUS
EST

RoW
AUS
BEL
IDN
IND
TWN
KOR
CHN
BRA
MEX
CAN
GRC
LUX
IRL
MLT
GBR
CYP
PRT
ITA
JPN
DEU
DNK
FRA
AUT
SWE
NLD
ESP
FIN
TUR
BGR
POL
LVA
SVK
LTU
SVN
HUN
ROU
CZE
USA
RUS
EST

1.8%

DevEurope

Note: We measure the long-term effect of a 1% GDP shock in the US versus one
in developed Europe on each country using the impulse responses from a VAR
model (details in the Appendix). Source: OCED, WTO, Barclays Research

Japan

China

Note: We measure the long-term effect of a 1% GDP shock in Japan versus one
in China on each country using the impulse responses from a VAR model (details
in the Appendix). Source: OCED, WTO, Barclays Research

and services with their intermediate uses at the sectoral level across 40 countries (plus the
rest of the world). A detailed discussion of the methodology is available in the Appendix.
Figure 3 shows the effect of a 1% shock to G4 growth on various economies gross value
added (GVA, a good proxy for GDP growth); these numbers refer to the long-run effect of a
growth shock, ie, taking into account both direct and indirect effects. The results show that
the shock to G4 growth leads to at least a 2% pickup in GVA growth globally. The strongest
spill-overs are felt by Eastern Europe, followed by Western Europe, Asia, and the Americas
(LatAm + Canada). The large effect on emerging Europe is not as surprising when one
considers the fact that these are small open economies (hence, direct effects are large) and,
additionally, see large indirect effects. In particular, US growth matters more for Europe than
vice versa, so EM Europe benefits from this indirect effect (see Figure 13 in the appendix).

Europe is more important than many think

Although it is often believed that the US cycle is a bigger source of global growth shocks, our
estimates suggest otherwise. Figure 4 shows the effect on GVA following a 1% increase in
aggregate demand in developed Europe and the US. Against conventional wisdom, a positive
growth shock to developed Europe has a larger effect on most economies barring the large
centres (the US, Japan, and China). In fact, the importance of developed Europe goes beyond its
European trading partners. In particular, our model predicts that growth spill-overs to EM Asia,
and even to some countries in LatAm, are at least as large as those from US growth.
As one would expect, growth in Japan matters more for EM Asia than other small open
economies (Figure 5). A similar pattern emerges with a shock to China, the main
difference being that Chinese growth seems to matter less for developed Europe than in
the case of Japan.

Winners and losers by sector

The OECD-WTO input-output table allows us to capture the effect of shocks to aggregate
demand on various sectors across countries. Figure 6 shows the estimated effect of a 1%
shock to G4 growth on each of these sectors globally. This has important implications for
equity markets, as it highlights which sectors may have greater earnings potential as a
result of G4 growth acceleration. As one would expect, cyclical sectors such as
construction, basic metals, and machinery are at the top of the list.
23 October 2013

Barclays | ASSET ALLOCATION AND FX RESEARCH

FIGURE 6
Effect of a 1% increase G4 GDP on sector output (gross value added)
%chg GVA
Construction
Basic Metals and Fabricated Metal
Machinery, Nec
Electrical and Optical Equipment
Renting of M&Eq and Other Business Activities
Wood and Products of Wood and Cork
Transport Equipment
Mining and Quarrying
Public Admin and Defence; Compulsory
Manufacturing, Nec; Recycling
Education
Other Non-Metallic Mineral
Health and Social Work
Pulp, Paper, Paper , Printing and Publishing
Wholesale Trade and Commission Trade,
Other Supporting and Auxiliary Transport
Rubber and Plastics
Sale, Maintenance and Repair of Motor
Textiles and Textile Products
Inland Transport
Chemicals and Chemical Products
Retail Trade, Except of Motor Vehicles and
Real Estate Activities
Leather, Leather and Footwear
Other Community, Social and Personal Services
Electricity, Gas and Water Supply
Post and Telecommunications
Private Households with Employed Persons
Agriculture, Hunting, Forestry and Fishing
Air Transport
Coke, Refined Petroleum and Nuclear Fuel
Financial Intermediation
Food, Beverages and Tobacco
Hotels and Restaurants
Water Transport
0%

2%

4%

6%

Note: We measure the effect of a 1% GDP shock in the US, Developed Europe, Japan and China on sector output using
the impulse responses from a VAR model and the world input-output matrix (detailed in the Appendix). Source: WTO,
OECD, Barclays Research

Are markets differentiating according to potential growth spill-overs?

As we argued in the introduction, our sense is that there is excessive bearishness about the
outlook for the main economies, in particular China and more recently the US. This
contrasts with the actual pickup in the manufacturing cycle, which provided a strong
undercurrent to cyclical assets. In our view, this helped cyclical assets to bounce after a
sharp sell-off driven primarily by tapering expectations.

23 October 2013

Barclays | ASSET ALLOCATION AND FX RESEARCH

FIGURE 7
Growth implications of the uptick in G4 business confidence since June 2013
% GVA
4.5%
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
RUS
EST
ROU
LTU
LVA
CZE
BGR
SVN
POL
HUN
SVK
TUR
FIN
AUT
NLD
ESP
BEL
SWE
DNK
DEU
FRA
ITA
CYP
PRT
MLT
GBR
LUX
IRL
GRC
KOR
CHN
AUS
IDN
IND
TWN
JPN
CAN
MEX
BRA
USA
RoW

0.0%

Effect on output (% GVA)

Source: Barclays Research

What would our framework predict given the size and distribution of improvement in G4
activity since June 2013? Figure 7 shows what the increase in G4 business confidence
implies about output growth for the various economies over the long-term. The strongest
boosts are for those in emerging Europe, followed by developed Europe, Asia and then the
Americas. Running a similar exercise on the sector level, we find the increase in G4 business
confidence to be driving increased activity in industrial and material sectors such as basic
metals, construction, and machinery.
But to what extent have assets caught up with the cyclical improvement? We look at
country/sector equity index and currency (vs. the USD) returns since June 2013 and
compare these with the implied effect on country growth owing to global spill-overs. We
find that at the cross-country level, asset prices (country equity indices and currencies, to a
lesser extent) do not reflect the improved growth prospects particularly closely (Figure 8).
The relationship is marginally stronger for FX rather than equities, which vary according to
their sector concentrations, as well as other idiosyncratic factors. Elevated uncertainty
brought on by fears of a Fed exit (and, in some cases, poor market liquidity) has led to
sharp/idiosyncratic moves for assets of countries with large external vulnerabilities (mainly
FIGURE 8
Country equity market and currency returns vs. the growth
implications of better G4 bus. confidence since June 2013

Asset return

Asset return
35%
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
-15%
-20%
0.0%

FIGURE 9
Developed and EM equity sector returns vs. the growth
implications of better G4 bus. confidence since June 2013

Equity

Currency vs. USD

12%
y = 0.2368x + 0.0572
R = 0.2851

10%
y = -0.0326x + 0.0788
R = 4E-05

8%
6%

y = 0.1658x + 0.0514
R = 0.0761

4%
y = 0.6614x + 0.0057
R = 0.0652
1.0%

2.0%

3.0%

4.0%

5.0%

Effect on output (% GVA)

Source: MSCI, Bloomberg, Barclays Research

23 October 2013

DM equity sectors

2%

EM equity sectors
6.0%

7.0%

0%
0.0%

5.0%

10.0%

15.0%

20.0%

Effect on output (% GVA)

Source: MSCI, Bloomberg, Barclays Research

Barclays | ASSET ALLOCATION AND FX RESEARCH

FIGURE 10
Country equity market returns compared with the growth
implications of better G4 bus. confidence since June 2013

FIGURE 11
Developed equity sector returns compared with the growth
implications of better G4 bus. confidence since June 2013
% change

% change
35%
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
-15%

JPN
USA
BRA
MEX
CAN
TWN
IND
IDN
AUS
KOR
CHN
GRC
IRL
GBR
PRT
ITA
FRA
DEU
DNK
BEL
ESP
AUT
FIN
TUR
HUN
POL
CZE
ROU
RUS

20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%

GVA, by country

Equities

Note: We rank countries left to right using the size of the effect on country GVA.
Source: MSCI, Bloomberg, Barclays Research

GVA, by sector

DM Equities

Note: We rank sectors left to right using the size of the effect on sector GVA.
Source: MSCI, Bloomberg, Barclays Research

in EM). This intuition is reinforced by the stronger correlation between improved growth
prospects and equity sector returns (Figure 9), with a closer correspondence of DM equities
with increased sector output than for EM.
The sizes of the under-/outperformance of various country and sector equity indices versus
the effect on output (GVA) are shown in Figures 10 and 11. By and large, equities in
European countries (especially in the periphery) show up as significant outperformers
versus the spill-over effects on output, reflecting the improved sentiment that seems to
have formed regarding the euro area since mid-2013. On the other hand, country equity
indices for EMs (Hungary, Indonesia, Turkey, etc.) have significantly underperformed,
reflecting their idiosyncratic vulnerabilities. At the sector level, manufacturing growthrelated sectors (materials and industrials) have underperformed, whereas telecom and IT
have outperformed.
Overall, European equities have generally bounced since June but the cross-country
performance does not match the predictions of the model. The performance of cyclical
equity sectors is more in line with the model, suggesting that they are a better vehicle for
expressing further business cycle strength. Our sense is that investors remain bearish
despite the recent improvement, especially given softer data and political uncertainty in the
US. We continue to see scope for these spill-over effects to be priced in, a view that is
consistent with the September Global Outlook.

Appendix: Measuring spill-overs of G4 growth to smaller

economies
Understanding the global implications of an acceleration in G4 growth on smaller
economies and sectors requires a lot of information on how goods and services are
produced globally, by type of good and by location, as well as where those goods end up
being consumed or invested. A combined effort by the OECD and the World Trade
Organization has put this information together using national input-output tables for 35
sectors across 40 countries (plus the rest of the world) based on purchases and sales of
goods and services globally up to 2009 (see FX mid-quarterly update: How does China
matter for FX? for more details).

23 October 2013

Barclays | ASSET ALLOCATION AND FX RESEARCH

While powerful, the concept is quite simple, as illustrated in Figure 12. Each sector in a
particular country uses other goods and services as intermediate inputs, adds some value
by using capital and labour, and produces a final unit of good or service. These intermediate
inputs may come from the same or other sectors, domestically or from the rest of the world.
For example, machinery may be needed to produce other machinery in China, along with
other goods and services, such as electricity, rubber and plastic, that may come from China
or any other country. The final goods produced may be used for private consumption,
investment or government use either domestically or in other countries.
By assuming fixed proportions in the use of intermediate goods and in final uses (demand),
one could ask how global production has to change to effect a change in demand globally.
Notice that Figure 12 can be easily expressed linearly as a system of equations representing
the resource constraints for each sector in each country:
X = A*X + B*Y
In this equation, X is a vector listing the final output of each of the 35 goods in the 41
locations (40 countries plus the rest of the world), and Y is the final use (consumption,
investment, government spending, etc) by each country. The resource constraints simply
state that whatever is produced in each location must be used either as intermediate input
of production for other goods or for final consumption or investment, public or private.
The resource constraint shows the complexity of the global allocation of production. A has
information of intermediate uses for 1435 items (identified by sector and country), while B
contains information on the type of demand by country.
Assuming changes in the elements of Y that correspond to G4 countries, we can examine
how the global production of goods and services (X) responds, as well as the value added
by each sector. Value added could be expressed as (I-A)*X, which is the final gross value of
output minus the cost of intermediate inputs used in the process, a proxy for GDP.
Gauging how gross value added, (I-A)*X, responds to changes in final demand is straightforward. However, the fact that the production technology in the input-output matrix is in
fixed proportions means that adjusting, say, US demand while keeping the demand of other
countries constant is unrealistic.
To make the technology more realistic, we adjust the matrix according to our own
estimates of the effect of shocks to GDP growth in G4 on other countries. The
determination of true spill-overs is a challenging exercise. For one, business cycles may at
times be responding to common factors that are driven by correlated domestic factors,

Country A

Country B

Rest of World

Industry Industry Industry

FIGURE 12
Schematic outline of a World Input-Output Table with three regions
Country A

Country B

Intermediate
Industry

Intermediate
Industry

Intermediate use of
domestic output
Intermediate use by
A of Exports from B
Intermediate use by
A of Exports from
RoW

Rest of World

Country A

Country B

Rest of World

Intermediate
Final domestic
Final domestic
Final domestic
Total
Industry
Intermediate use by
Final use of
Final use by B of Final use by RoW of
Intermediate use by
Output A
RoW of Exports
domestic output
exports from A
exports from A
B of Exports from A
from A
Intermediate use by
Final use by A of
Final use of
Final use by RoW of
Intermediate use of
Output B
RoW of Exports
exports from B
domestic output
exports from B
domestic output
from B
Intermediate use by
Intermediate use of Final use by A of Final use by B of Final use of domestic
B of Exports from
Output RoW
domestic output exports from RoW exports from RoW
output
RoW

Value added

Value added

Value added

Output in A

Output in B

Output in RoW

Source: OECD, WTO, WIOD, Barclays Research

23 October 2013

Barclays | ASSET ALLOCATION AND FX RESEARCH

rather than the true spill-over effects of an external shock. An additional challenge is
determining how countries are ordered in terms of spill-over process; for example, it is hard
to expect a shock in a small open economy having a contemporaneous effect on a large
open one.
We follow the methodology of Bayoumi and Swiston (2007) and estimate a statistical
model (a Vector Auto Regression, or VAR) that takes into account the contemporaneous
and lagged effects of a growth shock in one country on growth in other countries. To make
the estimation tractable (we are using annual GDP data since the 1980s onwards, so
measuring spill-overs among 41 countries is not feasible), we group countries together on
the basis of the geographical proximity. These are the US, China, Japan, Developed Europe,
EM Asia ex-China, Americas, EMEA and the rest of the world (ROW).
Identifying shocks using the historical data is a tricky exercise since assumptions have to be
made about how countries are ordered. Shock identification is done using Cholesky
decomposition and allows for uncertainty in the ordering ie, we separate the country
groupings into two classes a primary class for the majors (US, China, Japan and
DevEurope) and a secondary class for the remaining ones. A shock to the secondary ones
does not affect the primary ones contemporaneously. Within each class, we assume a flat
prior over the orderings; ie, we assume that there is an equal probability of one country
being ahead of another one.
The estimated spill-overs for a 1% GDP shock using this methodology are shown in Figure
13. We find that a US-specific shock has the widest spill-over: a 1% increase in GDP leads to
a 0.3% increase in Chinas GDP, 0.7% in Japan, 0.7% in Developed Europe and so on. On the
flipside, shocks from each of these countries have a smaller effect on US GDP: 0.1%, 0.3%
and 0.1% due to an increase of 1% in China, Japan and Developed Europe GDP.
There are other interesting results in terms of the effect on various EM economies. For
example, EM Asia ex-China is much more sensitive to Developed Europe, China and Japan
growth than the US. EMEA is unsurprisingly extremely sensitive to Developed Europe;
however, it is more sensitive to US growth and relatively unaffected by China and Japan. The
Americas are equally sensitive to US and Developed Europe and about half as much to
China and Japan.
FIGURE 13
Effect of a 1% GDP shock
GDP shock from

Responses of

USA

China

Japan

DevEurope

USA

1.0

0.1

0.3

0.1

China

0.3

1.0

0.3

0.3

Japan

0.7

0.1

1.0

0.6

DevEurope

0.7

0.1

0.4

1.0

EM Asia ex-China

0.1

0.3

0.4

0.8

Americas

0.4

0.2

0.2

0.4

EMEA

0.9

0.4

0.2

2.5

ROW

0.0

0.3

0.5

0.1

Source: Barclays Research

We can directly plug in these spill-over estimates to shock the final demands in the InputOutput matrix to determine how production would potentially adjust on a country and
sectoral basis. However, this would imply making the assumption that a shock to GDP or
aggregate demand is felt equally by the different components (consumption, investment,
23 October 2013

Barclays | ASSET ALLOCATION AND FX RESEARCH

government expenditure, etc). There is a body of literature, (see, for example, Uribe (2013)
for a discussion) that has found that the components of aggregate demand can be more or
less volatile than the aggregate. For example, consumption in affluent countries tends to be
about 15% less volatile than aggregate demand, while investment is more than 3 times as
much. There is also heterogeneity across countries in terms of the volatility of the
components of demand. For example, consumption and investment in emerging countries
tend to be significantly more volatile than in affluent ones, potentially reflecting the fact that
credit constraints may be more binding. We incorporate estimates of Uribe (2013) on the
effect of a shock to aggregate demand on its different components for developed and
emerging countries.
Finally, we take spill-over estimates of aggregate demand along with estimates for how the
different components of demand respond to the overall shock to derive the final demands
for our 41 countries. We can now look at the cross-country effect and sectoral effect of the
shock using the I-O matrix to see the effect on value added.

References
1. Bayoumi, Tamim and Andrew Swiston, 2007, Foreign Entanglements: Estimating the
Source and Size of Spillovers Across Industrial Countries, IMF Working Papers 07/182,
International Monetary Fund
2. Uribe, Martin, 2013, Open Economy Macroeconomics, Columbia University

23 October 2013

Analyst Certification
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