Archive for the ‘Global Economy’ Category

There have been times in the past when the markets got it into their collective head that it was time for buying, even though there were good reasons to think it was really a time for panicking. Take 2007: in that year, the Dow Jones passed a new all-time high, and the FTSE 100 came close to passing its all-time high.

These promising stock market peaks occurred after the run on Northern Rock; after the phrase ‘credit crunch’ crept into popular parlance. Back then the markets were in the mood for interpreting all news – good or bad – as if it was a reason to buy. Their logic went like this: if the news was bad that meant interest rates might fall, so buy; if the news was good, they bought because, well… because the news was good.

There have been times since when it felt a bit like that all over again, but this year, it has been rather odd.

The Dow Jones began 2013 with a score of 13,104, peaked at 15,409 on May 28 (the previous all-time high was 14,164 set in 2007). The index then fell back, falling to under 15,000 and at the time of writing stands at 15,135.

For the FTSE 100 things were a lot more volatile. The index began 2013 with a reading of 5,897, peaked on May 22 with a reading of 6,804 (against an all-time high of 6,930 set on December 30 1999), before falling back to 6,029 on June 24, and at the time of writing is at 15,135.

In Japan things have been more even extreme. With the Nikkei 225 rising from 10,401 on January 1, to 15,627 on May 22 and then 12,834 a week or so ago.

It is not hard to find an explanation but it is harder to find one that makes sense.

Because the news out of the US has been so good, the Fed is now talking about reining-in QE, and upping interest rates in 2015.

The markets do not like it.

The jury is out on how much QE has had to do with equities surging so high. QE has driven asset prices upwards, but then valuations to earnings, especially in the UK, do not look excessive.

One of the worries is that while the US economy may boom, the more indebted regions of the world simply cannot afford higher interest rates.

The Bank of England and the ECB recently went out of their way to emphasise that they have no plans to tighten monetary policy and that what they do is not dictated by the Fed.

But, supposing interest rates rise in the US, and money therefore flows into the US from the rest of the world. In response and to stop currencies falling too sharply against the dollar, we may see other central banks up rates. To make matters worse, the Central Bank in China seems to be tightening monetary policy. This may be a good thing for China, and indeed for the global economy in the long term, but for much of the world the timing is not good.

Some have had a nasty attack of déjà vu. When the Fed upped rates in 2004, one eventual consequence was money flooding out of South East Asia into the US, which led to the Asian crisis of 1997.

But then again there are differences this time. In Asia, especially among the so-called ASEAN countries of Malaysia, Indonesia, the Philippines and Thailand, internal savings are much higher and the countries are less reliant on overseas credit.

Across the world some countries are more vulnerable than others. Brazil may be the most vulnerable of the BRICS; Turkey seems to have high exposure, and worryingly – given the political situation – so does Egypt.

Many countries in emerging Europe seem exposed, as do the PIIGs – of course, and so do Sweden and the Netherlands. Household debt and house prices are high in Canada and Australia, and then there is the UK. See: Is that a sword of Damocles hanging over the UK housing market? 

Interest rates seem set to rise in the US, and for other reasons they may rise worldwide. See: The Great Reset 

This is down to good news, and is largely positive, but for some countries, companies and people, the news is not so good – not at all.

© Investment & Business News 2013

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Among the more positive news coming out of the US of late, there was one piece of darkness. While US consumers grew more confident, more jobs were created, and house prices rose, the darkness drew all eyes. The darkness was otherwise known as Purchasing Managers’ Indices, or PMIs, with the PMI for US manufacturing in May pointing to contraction, for example. Things looked quite different today, and altogether lighter, however.

The latest PMI for US manufacturing, this time for June, stood at 50.9 from 49. Any score over 50 is meant to be consistent with growth, so that was a relief.

There was more good news. The sub-index tracking new orders rose to 51.9, and the new export orders index rose to 54.4 from 51 in May. So far so good. Alas the PMI for employment stood at 48.7 – suggesting job losses. So while the news was bright, some darkness remained.

In Europe, the news was brighter, but only in the sense that navy blue is brighter than black, except that is for Spain. For once the news on this country looked promising; a kind of dark grey.

The PMI for Spanish manufacturing rose to 50 in June, a new 26 month high. Okay, 50 suggests growth is flat, but flat is better than contracting, and that is approaching the best piece of economic news for a very long time for Spain.

The PMIs for French, Italian, and Greek manufacturing also saw big improvements – 16, 23 and 24 months highs respectively. But then in each case the index was below 50, so that was darkish news.

To the surprise of many, the PMI for Germany fell sharply – down to 48.6, which was a two month low, and at odds with other more encouraging data that has seen the light of day recently.

Looking further afield, in China the PMI was down, but given that a major credit crunch is underway in China, the fall was not as sharp as many had feared. PMIs were also either below 50 or very close to 50 in Brazil, India, Taiwan, South Korea and Vietnam.

Australia is more interesting. The manufacturing PMI has been below 50 since 2001, but in June it rose to its highest level since February 2011. Although at 49.6, it still points to contraction. In Australia talk of recession is beginning to dominate. New Prime Minister Kevin Rudd looks as if he is trying to present himself as the man to lead Australia through and out of recession. With household debt high, house prices apparently overvalued, and with the slowdown in China sure to hit Australian commodity exports, the economy appears to be at its most precarious balanced for some time.

© Investment & Business News 2013

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During the height of the euro crisis, politicians in Europe, and indeed central bankers, blamed the markets and credit ratings agencies. Yesterday an official at the Fed followed that tactic too.

Richard Fisher, president of the Dallas Federal Reserve, told the ‘FT’: “I do believe that big money does organize itself somewhat like feral hogs. If they detect a weakness or a bad scent, they go after it.”

He also took the opportunity of being interviewed by the ‘FT’ to remind us all about George Soros – the man who shorted sterling in 1992, beat the Bank of England and hastened the UK’s departure from the ERM. He likened today’s feral hogs to Mr Soros, but is that right?

Being a messenger is never a good place to be, not if you bring bad news anyway. When Eurozone politicians blamed credit ratings agencies, and what they called bond vigilantes for the woes in Europe, they were surely deluding themselves. They had fooled themselves into thinking the crisis was less serious than it was, and they thought they could talk until the cows came home. The markets went some way towards correcting their complacency.

By hastening the UK’s departure from the ERM, George Soros probably did the UK a favour.

But what about this time?

Markets are selling because there are fears that interest rates are set to rise. The Fed has said as much, and even in China there are signs of monetary tightening.

But don’t forget that the news out of the US has been good of late. To remind you of two of the highlights: US banks’ profits were at an all-time high in Q1, and US households have cut debt substantially since 2007.

As things stand, the Dow remains substantially up on its start of year position as does the Nikkei 225 in Japan. And that makes sense.

Markets probably overdid their exuberance in May, but both the US and Japan are in a better place now than they were at the beginning of the year.

As far as equities are concerned, in addition to fears about the Fed tightening monetary policy, some are nervous about the possibility that US profits to GDP are set to fall. But in the long run, profits to GDP falling and wages to GDP rising is surely good thing.
Even higher interest rates are a good thing, if higher rates are symptomatic of the economy returning to normal.

But higher interest rates will be bad news for those with high debts, and for that reason the UK and – more so – the Eurozone may lose out.

The FTSE 100 has not performed as well as US markets this year. Unlike the Dow, it never did pass its all-time high. And unlike the Dow, the FTSE 100 has now fallen to within a whisker of its start of year price. That is probably about right.

But at least the UK has its own central bank, free to print money and buy bonds via quantitative easing.

The countries of the indebted Eurozone do not have such a luxury, which is why Europe may yet be the biggest loser.

Image: Pig In Pen by Kim Newberg

© Investment & Business News 2013

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The IMF is a critic. It reckons the US has hit the brakes too fast, and wants to see more stimulus measures. As for the UK, it wants to see more short term borrowing to fund investment into infrastructure. The Bank of International Settlements (BIS), often called the world’s central bank, is a critic too, but for almost the opposite reasons.

Time to stop doing whatever it takes.

In a report out today, the BIS began by referring to Mario Draghi’s famous words when he said: “We will do whatever it takes to save the euro.” The BIS said: “But we are past the height of the crisis, and the goal of policy today is to return to strong and sustainable growth. Authorities need to hasten structural reforms so that economic resources can more easily be used in the most productive manner. Households and firms have to complete the repair of their balance sheets.

Governments must redouble their efforts to ensure the sustainability of their finances. And regulators have to adapt the rules to an increasingly interconnected and complex financial system and ensure that banks set aside sufficient capital to match the associated risks. Only forceful efforts at such repair and reform can return economies to strong and sustainable real growth.”

This is pure austerity economics, right out of the Austrian school of economics.

Then the BIS laid into what are often called the zombies.

It said: “Productivity gains and employment in the major advanced economies have sagged in recent years, especially where pre-crisis growth was severely unbalanced. Before they can return to sustainable growth, these countries will need to reallocate labour and capital across sectors. Structural rigidities that hamper this process are likely to hold back the economy’s productive potential. Both productivity and employment tend to be weaker in economies with rigid product markets than in ones with more flexible ones.

Similarly, employment rates tend to be lower where labour markets are more rigid.Conversely, countries with flexible labour markets recover more quickly from severely imbalanced downturns. They also create more jobs. Reforms that enhance the flexibility of labour and product markets could be swiftly rewarded with improved growth and employment.”

So what is it really saying?

Firstly, that QE has run its course, and monetary policy needs to return to normal. Secondly, that we need to see more creative destruction; let businesses fail, because the vacuum that is created can be filled by more efficient firms, and productivity will start to improve.

But is that really right? The BIS might be saying that QE has done its job, and now it is time to go back to normal, but frankly it never was a fan of QE in the first place. It may say that now is the time for governments to pay back debts, but then it also said that last year and the year before.

It is suggesting that as the economy changes, now is the time to implement the changes that it wanted to see implemented even before the economy had changed.

Do we really need to see create destruction? Take one sector, as an example, the UK High Street. This has seen rather a lot of destruction to date, precious little creativity has followed.

Then again, the recovery does appear to be starting in the US, and say one thing for the US, it does have an extraordinary ability to reinvent itself.

Being a cynic is fun. It is a good laugh, finding the flaws in any hint of optimism. And many have had a ball of a time laughing at the argument that it is good news on the US economy that lies behind the Fed announcing plans to ease back on QE.

But actually, there really has been good news coming out of the US of late. And with signs that US manufacturing is finding new opportunities, even that 3D printing may create new jobs, we could even be at the early stages of seeing something of a reversal of what we have seen in recent years of the trend of growing inequality.

The BIS might be right to say we are approaching the time when the US needs to see monetary policy return to normal – but that is happening anyway.

But the euro needs is own version of QE, proper QE that is, not Draghi playing with words. Japan’s experiment in Abeonomics needs to be given more time, and QE needs to be used more imaginatively to directly fund investment in the UK.

History tells us, that monetary policy has often been reversed too soon while an economy recovered from a depression recession/depression. Right now, there is a real danger that monetary policy will be tightened too soon. And the BIS seems to be oblivious to this risk.

© Investment & Business News 2013

Yesterday was a day for selling. But it is noticeable that while gold fell to a 34 month low, and US government bonds to a 22 month low, on the whole equities merely fell to a one month low.

At the time of writing gold is trading at $1,295. To put that price in context, back in September last year it was going for $1,778. The last time it was so cheap was September 2010.

Some say they are puzzled by the falls, but gold really is one of those riddles wrapped in an enigma – a golden enigma, in fact.

Gold rose in the aftermath of the finance crisis, and then again in the aftermath of the aftermath, because many feared a major meltdown as countries raced to devalue, and it was being said that QE created the danger of hyperinflation.

Talk of QE creating hyperinflation always was nonsense. As this column has said before, what matters is the broad money supply, and at a time when banks didn’t want to lend, while households were trying to repair their balance sheets, there was little chance of the broad money supply rising significantly, whatever central banks did.

Now the US economy is showing signs of real recovery, and the Fed chairman Ben Bernanke has suggested QE will be easing up soon and interest rates are likely to rise in 2015, everything looks different.

When real interest rates are negative, the fact that gold offers no yield is a trivial concern. But now that rates seem set to rise, that lack of yield seems to matter a great deal.

As for bonds, the yield on US 10 year treasuries has risen from 1.38 per cent last July to 2.39 per cent at the time of writing.

Markets are moving away from so-called safe harbour assets. During the era of QE, many feared currency wars, as loose monetary policy pushed down on the dollar, and other countries tried to devalue so as not to lose their competitive edge. Now the era of loosening is approaching an end; currency wars have moved to currency peace, and the new fear is that some currencies are in danger of becoming too weak.

As for equities, they too have fallen sharply, but just remember that the falls are not as drastic as recent rises. The FTSE 100 started 2013 on 5,898, rose to 6,840 last month, going close to the all-time high set in 1999, before falling to 6,159 last night.

Look at how equities have fallen since the end of May, and the sell-off looks drastic. Look at equities this year, and the market still looks attractive.

Above all, just remember that it is good news on the US economy that lies behind markets selling.

As rates rise, there will be losers, and for a while the markets may even punish those with strong fundamentals, but a resurgent US consumer is a good thing, and once the dust has settled we will see plenty of winners. But watch the Eurozone, emerging Europe, and maybe Brazil, for the real woe.

© Investment & Business News 2013

“I guess I should warn you,” once said Alan Greenspan, chairman of the US Federal Reserve before Ben Bernanke held that position, “If you think I am making myself clear, that probably means you have misunderstood me.” Ben Bernanke doesn’t say things like that. When he took over at the Fed he vowed to say it straight, tell it like it is, and avoid launching into jargonese whenever possible. And that is how it has panned out. Take monetary policy, for example.

Ben had spelt it out in terms a child could understand, (well at least a child that had studied economics): monetary policy would be tightened under certain circumstances. He then defined what those circumstances were and they now appear to be emerging. This is not new; the data had already been set before us in the full light of media scrutiny. Mr Bernanke has reacted the way in which he always said he would, and the markets react as if the Fed chairman has grown two heads, or taken on an alter ego.

As has been pointed out here many times, the news out of the US has been good of late. Notwithstanding the fact that in Q2 the US is likely to see less growth than in Q1, signs are afoot that the US economy is slowly returning to normal: to pre 2007, or even pre 2004 type conditions.

This is not bad news. It is good news. The US consumer, so long the central hub in the global economy, looks set to be moving back to the centre stage. Companies that export their wares to the US, and US companies that sell their wares to the US consumer can celebrate. There may be a knock on effect too, as companies benefit from a resurgent US themselves see growth rise, giving their suppliers reason for hope.

What do the markets do? They panic.

They panicked because when Ben Bernanke announced that the Fed will be forking out $85 billion a month purchasing bonds – otherwise known as QE – (QE3, or maybe 4, depending on how you define these things), he said that once the economy improves, and unemployment falls to a certain level, the QE campaign will be cut down, and eventually stopped.

They panicked because Mr Bernanke confirmed that he hasn’t changed his mind and that if things carry on improving, QE will be reduced later this year (September being the expected month).

He also confirmed that if things carry on improving next year and the year after that interest rates may rise in 2015.

Certain things in life are predictable, Mr Bernanke’s comments yesterday, or at least their inference, falls in this category.

But the markets are nervous. They fear that in a world where interest rates are higher and US consumers have less debt, more jobs and spend more, certain assets – propped up as they are by bubble-like money flows – may fall or even crash.

The obvious candidates for such falls are US and UK bonds; equities too, but to a lesser extent. The markets themselves are worried about emerging market debt.
Why they are worrying now, over something that was always inevitable is a puzzle. It just goes to show that the markets are as wise as a wise man who has had a lobotomy.

And talking about wise, the latest wisdom out of the Eurozone is that the crisis is nearly over.

Certainly the latest PMI, produced by Markit, suggests the region is now merely in recession, as opposed to being in deep recession.

But here is a tip to the wise; maybe as bond yields rise, as QE comes to an end, it will be indebted Europe that suffers the real woe.

Of course if the ECB launches QE when the Fed stops, that may just be enough to allow the euro area to follow the US into recovery (two years or so behind, but follow nonetheless).

But the ECB is far too wise to do that. Remember Mario Draghi once said the ECB will do whatever it takes to save the euro. But just in case you think Mr Draghi was making himself clear, just remember that he actually said: “Within our mandate, the ECB will do whatever it takes to save the euro.” The markets probably misunderstood what that meant.

© Investment & Business News 2013

Sometimes data is too good to ignore, and the latest Economics Review from the ONS contains such data. It shows that the star of the recession of 2008 was Canada. In Q1 of this year, Canadian GDP was no less than 5.1 per cent up on the pre-recession high.

US GDP was 3.2 per cent up, German GDP 1.3 per cent up, but French GDP is still 0.8 per cent below the pre-recession peak. In Japan GDP is now 1.3 per cent below peak, and for poor old Blighty, GDP is still 2.6 per cent below peak. Within the G7, Italy has suffered the worst performance, with GDP currently 8.6 per cent below peak.

Japan saw the steepest rate of decline during the recession, however, and at one point GDP was 9.2 per cent below peak before its recovery began.

So far, all is good for Canada. Just bear this mind, however. Levels of household debt in Canada seem high; they have risen since 2007, and are now even higher than in the UK and much higher than in the US. Meanwhile, Canadian house prices to both income and rent, relative to their historic average, seem excessive.

There are parallels between Canada today, and the US and the UK in 2007.

© Investment & Business News 2013