In Sir Arthur Conan Doyle's 1902 novel, The Hound of the Baskervilles, Sherlock Holmes famously pointed to the dog that did not bark. A modern Sherlock, looking for clues about the future of the stock market, might examine the positive trends that don't make the front page. Specifically, while the whole world is transfixed by the Dogs of War, barking their views about Syria this week, it might pay dividends to listen to the older mutts that are no longer barking - yesterday's biggest fears that suddenly fell silent.
In particular, whatever happened to the major headlines (and excuses) for the stock market's corrections over the last four years? For instance, we endured three straight Greek crises in May of 2010, 2011 and 2012, but the Greek dog did not bark in 2013. In addition, we endured eurozone crises in Italy, Spain and Portugal preceded by terrible financial crises in two north European islands, namely Iceland and Ireland.
Then there was the fear of a China slowdown or a Japanese collapse or an overall global recession. What happened there? Did China ever slow down? Did Japan collapse? Did the world economy grind to a halt?
Based on the latest series of purchasing managers indexes (PMIs), the world economy is doing fine. The overall JPMorgan Global Manufacturing PMI rose to 51.7 in August, up from 50.8 in July, delivering the tenth straight monthly gain and the highest growth rate since January, according to economist Ed Yardeni.
The MSCI World stock composite is up 16.9% this year through September 10, just shy of the S&P 500's 18.1% gain. This rise is fueled by global earnings. Earnings for the MSCI World Index are expected to rise by 7.8% this year and 10.9% next year. MSCI World revenues are expected to grow 3.4% this year and 4.6% in 2014. Revenues in the once-hot (and still-warm) MSCI Emerging Markets are forecasted to grow 6.5% this year and 7.2% next, while revenues in once-tired Europe are expected grow 3.4% in 2014.
The World Economy: A Kennel Full of Relatively Contented (Non-Barking) Dogs
When the world was expected to slow down sharply, that fear earned Page 1 headlines. But the stories of recovery are buried on page 10 of the business section - if they are covered at all. Good news is boring.
Here's the latest news from yesterday's problem children - in case you missed the small-print coverage:
The Eurozone has finally emerged from a long (six-quarter) recession. Last week, Markit's Eurozone PMI Composite Output Index rose from 50.5 in July to 51.5 in August, the fastest growth rate in over two years. Real eurozone GDP rose 1.2% last quarter. The two largest economies, Germany and France, rose the fastest, 2.9% and 1.9%, respectively, while formerly-morbid Spain reported exports rising at a 24.1% annual rate. Overall eurozone exports rose by 6.6% last quarter, leading Europe out of its long recession.
The United Kingdom is performing even better, due in part to government spending cuts launched by the Conservative/Liberal coalition led by David Cameron since 2010. Last month, British manufacturing output and new orders surged at their fastest rate since 1994. The UK's Economic Sentiment Indicator hit a lofty 108.5 in August, the highest level since October 2007, and well above most eurozone nations.
China's "slowdown" was like a race car slowing down from 200 to 140 miles per hour in the turns. China is now heading back to the straightaway. On Tuesday, China's National Bureau of Statistics said that industrial production rose 10.4% (year-over-year) in August, beating economists' expectations of 9.9%. In the same report, we learned that China's retail sales were up 13.4% in August. Last Friday, we learned that China's exports rose by a larger-than-expected 7.2%, while imports rose 7.0%. In addition, China's manufacturing PMI rose to a 16-month high of 51, while the competing HSBC PMI finally rose above 50.
Part of the confusion revolves around the definition of "slowdown." Slow, compared to what? India has "slowed" to a four-year low of 4.4% growth in the second quarter - a rate that would be considered boom times in the United States or Europe. An even more ridiculous use of the term "slow" is China's latest "slowdown," to a 7.6% growth rate in the first half of 2013, the strongest growth rate in the world, yet relatively weak by Chinese standards. (China averaged over 10% annual growth from 1992 to 2012.)
Japan is finally emerging from its decades-long malaise. Japan's second-quarter GDP, released Monday, rose at a 3.8% annual rate, up sharply from a preliminary 2.6% estimate and nearly matching the first quarter's 4.1% annual growth rate. Capital spending last quarter rose at a 5.1% annual rate, the first increase since 2011 and well above the 0.4% annualized decline originally estimated. Exports (+12.4%) rose twice as fast as imports (+6.2%). In addition, Japan's Nikkei 225 index is up 35% year-to-date, the best performance among major markets. To justify these gains, analysts expect a spectacular 64.8% earnings gain this year on 8.5% revenue gains. In addition, Tokyo won the bid to host the 2020 Olympics.
Latin America: Speaking of the Olympics, Brazil - host of the 2016 Olympics and the 2014 World Cup soccer tournament - grew at a 3.3% annual rate in the second quarter, slower than previous years, but not bad. According to The Economist, the latest quarterly GDP gains in the other major nations of South America are in the same range: Chile (+4.1%), Argentina (+3.0%), Colombia (+2.8%) and Venezuela (+2.6%).
Australia is growing at acceptable rates (+2.6% in the second quarter), but Sunday's election of Prime Minister Toby Abbott, who ran on a program of cutting taxes to boost growth, promises some of the same type of recovery we've seen in Britain since the Cameron coalition took power in 2010. With the recent recovery in many commodity prices, resource-rich Australia may also benefit from a commodity tailwind.
What Does All This Mean for the U.S. Stock Market?
Before turning to the U.S. market, let me take just one paragraph to put all this growth into perspective.
In 1945, Germany and Japan were bombed back to the Stone Age, but they recovered strongly and are now at peace. China was under brutal Maoist control from 1949 to 1976. Before 1949, China cowered under a series of warlords, followed by a brutal Japanese occupation and a 15-year civil war. India's economy was virtually dead for most of the 20th Century. Meanwhile, Europe was split by two World Wars and then a 45-year Cold War. The British economy was dead from 1945 to 1980. In the 1980s, you couldn't drive goods from one end of Europe to the other without onerous border crossings and constant currency exchanges. The fact that Europe and Asia are growing (and at peace) is a cause for celebration.
Here in the U.S., our economy depends in part on global economic health. The world needs to be wealthy enough to afford our exports, and vice versa. For example, auto sales rose in August to a new cyclical peak of 16.1 million (annualized) units, the best month since November 2007, in part because imports like BMW, Honda (HMC), Toyota (TM) and Nissan (OTCPK:NSANY) reported annual sales growth of 36%, 37%, 23% and 22%, respectively.
The S&P 500 has recovered well in September and is now flirting with the August 2 peak of 1710. Still, we haven't seen anything like euphoria. In fact, in the last four weeks, bullish sentiment fell from 51.6% to 37.1%. But if the world continues to grow, we could see 2000 on the S&P 500 in 2014. All we need is a rise to $130 in S&P earnings next year, multiplied by a fairly modest price/earnings ratio of just 15.5.
Bear market fears will always grab the headlines and make for more compelling TV, just like the barking dog commands attention. But I prefer seeking out that friendly fellow in the corner, wagging his tail.