TradingHelpDesk's  Instablog

The Global Economy

For some weeks now this weekly review has 'called' Q1 or Q2 2009 as the trough of the economic cycle. Initially there was much risk in the statement as the global and US recovery was by no means certain, but as the weeks have progressed the ongoing stream of economic data has increasingly supported this view. The consensus among market commentators has also moved towards our more optimistic pro-recovery stance and now a Q3/Q4 recovery is a mainstream prediction, rather than the hopeful rhetoric of the enlightened minority. Our view did of course fully consider the unusually bitter and sharp contraction in growth primarily caused by very poor leadership in the global banking sector, ineffective regulatory risk controls and appalling credit procedures in the mortgage and commercial lending market place. But whilst we accepted this scenario as depressingly and worryingly unique in modern times, with only the depression of the 1930’s having close similarities, we also reflected on the impact of the unprecedented wall of money flooding into the global economy via government and central bank stimulus packages and its effect on demand. The global economy has never enjoyed such internationally co-ordinated monetary easing or the simultaneous hard–cash injections by governments, to shore up the balance sheets of strategically important institutions. The consequences of this combined stimulus are already being seen in the price of commodities, including oil and gold. Looking beyond the current market-wide inflation data which does not yet fully reflect improving demand outside of the resource sector, we predict that deflation will not only fade from the vocabulary of pessimistic US economists, but that concerns over inflation will return with vengeance within 18 months. The real challenge for 2010 is not achieving stronger global economic growth, a scenario which looks inevitable relative to 2009, but how to restore stable economic growth without killing the US consumer spending recovery with sharp interest rate rises, the usual primitive remedy for rising inflation. We would stress this view is not implying the deep structural problems within capitalism are being fixed. A move away from a cyclical, debt based economic system would need to be implemented for that. Nor is it an equity market prediction, which is below. But we do think the US and global economy, in terms of Gross Domestic Product, is set for a significant improvement from its Q1/Q2 trough.

Looking at the most recent US economic news in more detail, revised data now indicates the US economy weakened less than initially estimated in Q1 contracting at a 5.7% annualised rate, rather than the 6.1% fall previously announced. Investor’s, prior to the announcement, had been even more optimistic and predicted on average, the figure to be revised to a 5.5% contraction. Also, for the first time in a year, US corporate profits after tax increased, albeit only by 1.1%. The figure is a vast improvement on the 10.7% slump seen in the prior quarter and surpassed the consensus Q1 forecast of a 7% fall. Dissecting the Q1 GDP figures more closely, weakness in exports more than off-set a stabilisation in consumer spending, which accounts for around 2/3rds of US economic activity. Interestingly, some very competent market analysts are putting their neck on the block and are predicting much shallower weakness in Q2 and a return to positive US GDP growth in Q3. Unfortunately, unemployment is a lagging indicator so the US economy is likely to suffer rising jobless claims for some time yet even when the wider economy has returned to growth. The current unemployment rate is 8.9% and looks set to reach 10%, with the car manufacturing sector and Michigan, its home, likely to suffer most.

The growing expectation of H2 2009 economic recovery, and the view that equities were grossly oversold, prompted the sharp appreciation of equity prices in the period from early March to mid-May. At the end of that 10 week rally we highlighted that in the short-term prices look stretched after such a short sharp spike and a pause in upward momentum was inevitable. 2 weeks later that pause appears to be coming to a conclusion and the next move in the S&P 500, the diversified large cap index, is imminent. Based on the current trend of improving economic data and index technical factors we suggest the next significant move is up. The S&P 500 is at 907 (at the time of writing) from a March low of sub 700 and a further rise to near 1,000 would likely complete the technical recovery from the manic depressive state in investor confidence that caused the oversold trough in prices seen in March. A summer lull in trading may interfere with the timing of this view, but the next major move for US equities, we believe, is up. Time will tell.

We briefly mentioned oil. It’s worth taking a closer look at the market as the recent price action, we suggest, is a fore-taste of further inflationary pressures to come in other areas of the global economy. Reflecting for a moment, a barrel of oil fell from $147 during mid-2008, to a little over $32 by December of the same year. Since then oil has pursued a near-relentless recovery to pass $65 on Friday, twice its cyclical low. Statements from OPEC members have reinforced the view that the current rally is not a false dawn for oil bulls. The Saudi Arabia Oil Minister, Ali al-Naimi, long respected for moderate and reasonable analysis of the sector commented the market is “ready” for $75-$80 per barrel prices later in 2009. His views are based on already firming Asian, Middle Eastern and Latin American demand, not pie-in-the-sky guess work. The start of the US holiday driving season also suggests we are more likely to see $80 than $50, next. From a technical view, the price of oil has crossed its 200 day moving average and a number of oil analysts are now suggesting $60 is the new floor in prices. Politicians who side-lined their pro-green sound bites through the worst of the recession will soon be marketing their renewable energy credentials again.

Before progressing on to the UK, let’s take a brief look at the Euro-Zone economy where investment ‘professionals&a... are still talking about deflation following release of May’s data which showed prices flat at 0.0% compared to the same month a year earlier. Readers will be forgiven for being confused. “Haven’t I just read oil prices have doubled and the global recession is definitely easing?” You did. But the Euro-zone is different to the US and other economies because the European Central Bank executed a monetary easing plan that was so mistimed (late) you would be forgiven for thinking they were trying to pre-empt the next recession, not cure this one. Not only were the box-tickers at the ECB too late in cutting rates, they unbelievably were still raising interest rates in July 2008 when corporate confidence had already stalled and seasoned financial sector analysts were busting blood vessels in stress as we approached the near-collapse of the global banking industry.

The UK Economy

In the UK, investors digested the Financial Services Authority stress test results for the banking sector. All the big banks; Barclays, RBS, Lloyds Group and HSBC passed the examination, though RBS and Lloyds would have failed were it not for the recent government bail-outs. The stress test was applied to ensure the banks were sufficiently financially robust to cope with a possible further deterioration in the UK economy and considered a scenario of a 6% fall in GDP, 12% unemployment, a 60% decline in commercial property prices and a 50% collapse in residential property prices. Observers quite rightly argued that the criteria could have been decided on the “back of an envelope” years ago and was hardly a doomsday scenario considering the falls in GDP and property prices already seen. Overall, welcome as stress-testing is, surely if it was that simple, it should have been done before the near collapse of the UK banking sector, not after. But politicians and bureaucrats are uber-skilled at closing the barn door after the horse has bolted whilst reciting cosy sound-bites, and at least they have their “back of the envelope” stress test in place for the next recession. Of course there is another side to the argument, maybe a practical one. The UK economy won’t collapse, thanks to monetary easing and government stimulus. If the stress test criteria was considerably more challenging and therefore some of the banks failed the test, the only party with deep enough pockets to fix the problem is the government (the tax-payer), who has already paid a heavy price. Maybe that’s why the exercise was less of a stress test, and more of a balance sheet tickling contest?

The writer holds no interest, direct or indirect, in any stock or financial instrument mentioned in the above article.