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Global Macroeconomic Update - Improving Leading Indicators

In recent months, the news coverage was dominated by the U.S. presidential election and other important global political and economic events were almost ignored. Now is the time to review recent developments and anticipate what next year will bring. In coming weeks the talks about how to deal with the upcoming so called fiscal cliff will probably grab a lot of attention but most likely some sort of compromise will eventually be made. For global markets more important influences will come from other economic developments. We have to face the fact that globally things today don't look too good. Europe continues to a big problem and it remains uncertain whether some of the weaker member states can remain in the Eurozone long-term; especially Greece still looks to be a big problem. In September, unemployment in the Eurozone climbed to 11.6% and there seems no change in sight. Also in other major economies, such as Japan or China, growth is slowing. Are there any signs yet that this might be the bottom or are things getting worse going into next year?

In our view, some encouraging signs are there already. Looking at leading indicators globally, it seems as if global growth could accelerate next year. While the slight improvement in U.S. leading indicators in the recent months seems vulnerable given the possible impact from higher taxes next year, we think it is highly important to realize that conditions seem to be improving in other important markets such as the BRIC states. Other countries such as Mexico, Indonesia and Turkey are showing even stronger signs of recovering. China remains the big question mark but even here we are now seeing signs of stabilization and further stimulus is likely in coming months. Even most European countries seem to be poised for a slight improvement next year; albeit a marginal improvement and most European countries are still likely to see little to no growth. In this context it is very interesting to mention that export activity in the troubled European states is picking up strongly (approx. +15% y-o-y). The weakest countries in Europe, such as Greece or Spain, will see another year of negative growth in 2013. However, on a global scale, this is only having a minor impact as long as the situation in other areas is improving.

And what about the situation in the U.S.? While some economic data has shown an improvement in recent months, we don't think that the U.S. economy is out of the woods yet. We have often argued that the main issue is not so much the possible negative impact coming from higher taxes and spending cuts next year but the general uncertainty surrounding the situation. Few things in business and life are worse than having uncertainty regarding the future. Without at least some visibility, businesses are not going to invest and hire and private households are not going to spend. In the U.S. the presidential election as well as the fiscal cliff were and are very important factors to consider in that context. Now at least the presidential election is behind us but the uncertainty has not gone away. Economically speaking, the fiscal cliff issue is more important and we think it is absolutely critical to get a deal/compromise there soon. The longer this situation remains unresolved, the bigger the damage will be. We do not know how a possible compromise could look like. If we see the most negative scenario, assuming no compromise is reached and all tax increases and spending cuts take place, we believe that this would be enough to push the U.S. back into a recession (costing about 3% of GDP). This would be the extreme but unlikely scenario. A more realistic scenario is that we see a compromise that still has a negative impact on GDP but certainly a more moderate one. The key is that policy makers don't wait much longer with this, it is critical to increase visibility for businesses and the people. We can only hope that the two major parties are doing what is in the best interest of the American people and that is to get together and find a solution fast. Fighting each other for the sake of fighting results in another, indirect but costly extra tax for people. Assuming that a potential compromise would be made somewhere in the middle, then it is still possible for the U.S. economy to grow at around 2 percent next year, assuming that the ongoing recovery in other major market continues.

In the job market, growth might still be too slow to create enough new jobs to bring down the unemployment number. We think it is unrealistic to expect much of a change there in the first couple of months in the new year, but we could see a gradual improvement thereafter. Looking at similar scenarios in the past, it is important to understand how quickly momentum can build sometimes, positively and negatively. Four years ago, when president Obama was first elected, he took office in a very difficult time when the global banking crisis was still fresh. In early 2009 the global banking system was under serious distress and confidence in financial markets was at record lows. Exactly at a time when many believed that the worst was yet to come, the global economy and with it global financial markets were starting to recover. Equity investors saw record returns in 2009 and 2010 and the situation today might be similar. We continue to have concerns about the longer-term picture and the potential negative consequences of cumulative attempts to reflate the global economy, but on a short-term horizon (12-18 months), we still think there could be an impressive equity market rally ahead of us.

The future is uncertain, again, and the developments in the first couple of months next year will be critical. For the global economy to recover, we need to see more signals and indications that conditions are improving. The U.S. situation is very important but globally other regions/countries are important as well. For now the somewhat more positive economic data is helping but without more of the same in coming months, it is hard to believe that global markets have much further upside.