What would you think if you surfed over to the home page of the Wall Street Journal tomorrow and saw this headline:
Malaysian Recession Threatens US Economic Expansion
How about this one?
Oman Facing Depression – World Economy At Risk
Or this one?
Ghana Prime Minister Resigns, US Investors Await Formation of New Government
Or finally, how about this one?
Could Venezuela Go Bankrupt?
Oh, wait, that last one is real.
I don’t know about you but I’d wonder what the headline writer was smoking before he wrote those headlines. Could a recession or even depression in Malaysia or Oman or Ghana or all three for that matter really be a reason to worry about US growth? If you don’t think the US should worry too much about economic concerns in these countries, why is everyone so worried about Greece, Italy and Portugal? Our exports to Malaysia are approximately the same as our exports to Italy. Oman is about the same as Greece and Ghana only slightly less than Portugal. Venezuela, which has been an economic basket case almost since Hugo Chavez seized power, has a GDP about the same size as Greece. The decline there has been going on for a decade and yet the effect on the US hasn’t made headlines to my knowledge.
The fact is that Italy, Greece and the other periphery economies in Europe really don’t matter much to the US economy. Now, I understand that the concern over Europe isn’t about our direct trade with the periphery countries. The concern is about contagion through the banking system and a nasty recession in all of Europe and yes, if Europe enters a recession as bad as 2008-2009, then, Houston we might have a problem. Our trade with the EU fell about 20% in 2009 and a similar drop now would amount to just 0.3% of US GDP which is not enough to push the US back into recession unless we’re already on the way there. And just as the periphery isn’t that important to the US economy neither is it that important to the rest of Europe. With the possible exception of Italy, none of the other countries commonly believed to be in trouble have been significant sources of growth for the rest of the EU for some time.
The banking problems are a source of concern but even there one cannot help but wonder if the fears are a bit overblown. Private sector loan growth in the EU was still growing at a 2.5% annual rate as of October despite the debt crisis and the threat of higher capital requirements. Europe’s banks are restructuring by selling off foreign loan books and writing down loans to sovereigns. In other words, Europe’s banks are pulling back from the rest of the world to concentrate on home markets. The stronger European banks, such as Santander, are buying along with US banks. In other words, assets are passing from weak hands to strong as should happen in a capitalist system. I’ve read recently of concerns that weaker European banks will mean less lending in emerging markets but that would seem to assume that well capitalized US banks aren’t interested in filling the gap. I find it hard to believe that JP Morgan, for instance, won’t be interested in gaining market share in Asia as the European banks pull back.
I don’t want to sound too pollyannish about the potential fall out from the European debt crisis. The developed world has a debt problem and growth will surely be affected in the short term by deleveraging. In countries such as Greece, Ireland, Spain and Portugal the pain is, and will continue to be, significant as budgets are adjusted to the new reality of reduced access to credit. But the fate of the global economy does not depend on economic growth in the PIIGS countries. A mild recession in Europe – as ECB chief Draghi predicted recently – does not mean recession in the US. There are plenty of reasons to worry about the US economy but who replaces Berlusconi in Italy or who becomes the next Prime Minister of Greece aren’t among them.
Of greater importance to the US economy – and Europe for that matter – is US economic policy and whether China can engineer a soft landing. On the first point, there is little expectation of better policy but with low expectations comes the potential for upside surprises. Will the super committee produce some form of corporate tax reform? It seems possible and any positive change at the margin could produce big results. I hasten to add that I’m not investing on that outcome but investors should always prepare for the consensus to be wrong. As for China and the possibility of a soft landing, that remains to be seen but I would point out that they have ample room to ease, both fiscally and monetarily. In addition, many emerging market countries have already started easing monetary policy. Will the global economy avoid renewed recession? I don’t know but the outcome will likely be determined in Washington and Beijing, not Athens and Rome.
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Retail sales are firm, mortgage applications for purchase and refinance are rising, inventories are lean, trade continues to expand, jobless claims are under 400k and falling, import and export prices are coming off the boil and consumer sentiment is rising. That’s what the economic data looked like last week and what’s not to like? Like many observers, I’m not all that confident about the future of our economy but the present condition – while leaving a lot to be desired – continues to defy the pessimists’ predictions of doom and gloom. Whether that continues to be the case is something I can’t predict – and neither can anyone else by the way – but an unemotional review of the available data reveals, if anything, slow but steady improvement over the last few months.
Goldman and Redbook both continue to show fairly steady improvement in retail sales of about 3% year over year. While that surely isn’t boom territory, it isn’t recession either. Will the steady growth continue? Again, I can’t predict the future but with debt service no more onerous now than the mid 90s, it seems so. Of course debt service payments as a percent of disposable income are low because interest rates are also low so anything that caused a spike in interest rates would be cause for concern but if the Fed is to be believed, that won’t be a concern for some time.
Wholesale inventories shrank last month (-0.1%) while sales rose (+0.5%). The inventory to sales ratio at the wholesale level is a relatively lean 1.15. That’s a bit of a negative for coming 3rd quarter GDP revisions but overall a positive for profits, potential employment and future production. Barring a sudden drop in sales such as we saw in 2008, inventories are no cause for concern.
Mortgage applications rose 10.3% on the week with purchase apps rising 4.8% and refi apps rising 12.1%. While this is the third solid increase, the level of applications still remains quite low. Part of that is due to the increase in cash purchases by investors but it is also due to the low level of home sales, particularly new homes. Real estate and construction continue to be the weakest part of the economy but this too shall eventually pass. When it does, history tells us – unless this time is different – the rebound will be fairly swift.
The trade deficit improved slightly in September to -$43.1 billion. John Chapman has a detailed report on the trade numbers which can be found here. As John points out, what really matters is the total volume of trade and on that front we see good news with nominal trade volume hitting a record in September. That is particularly encouraging considering that both import and export prices have been falling the last few months. Import prices were down 0.6% and export prices down 2.1% in October. Of course, as John points out, both of these metrics are still showing very high year over year changes (11% for imports and 6.3% for exports).
The difference in the rate of price changes also shows emphatically the futility of trying to “solve” our trade deficit by devaluing the dollar. Our biggest import is oil which is almost immediately impacted by a falling dollar. Our exports do not adjust in price so quickly so devaluing the dollar tends to increase the trade deficit until oil prices reach the point where they cause recession. The only way devaluing the dollar “solves” the trade deficit is by causing recession which surely shouldn’t be the goal of economic policy. The only way to eliminate the trade deficit – if that were a worthy goal – is to increase domestic energy production dramatically. Counter-intuitively, a higher value for the dollar might also positively affect the current account.
Jobless claims continue their slow march downward, dropping last week to 390k. That’s the lowest level since April but still too high to support robust job growth. I have said for months that we need to see weekly claims fall below 350k and considering the depth of the recession, a number closer to 300k would be preferred. Nevertheless, it cannot be denied that the trend is getting better. The drop may be affecting consumer sentiment which rose to 64.2. If sentiment can continue to improve, spending is likely to follow.
Markets had a wild week with all eyes on Europe. Stocks ended the week higher with the S&P 500 up 0.85% but the path to that gain was littered with the corpses of bulls and bears alike. The rest of the world was mixed with Europe mostly higher by the end of the week and emerging markets mostly lower. Commodities were also slightly higher on the week. One area of concern to our muddle through economic outlook is the continued rise in the price of oil which is right back near the $100 mark. Oil prices had fallen to around $75 during the summer recession scare but are back on the rise again no doubt in expectation of more monetary easing around the world. We’ve seen this picture before and it doesn’t end well.
Over the last two months we’ve worked down our cash levels and raised our risk profile. I must say, it wasn’t the most comfortable position when the market dove last Wednesday but we continue to believe that markets have more than compensated for the potential fallout from European recession. The US economy continues to improve slowly and the emerging markets are entering a monetary easing cycle. Assuming the blowback on the US banking system from the European mess is limited, we think the combination of slow US growth and continued growth in emerging markets will be sufficient to keep global growth on a 3-4% path. Earnings growth and profit margins continue to surprise to the upside and we see no indication that is about to end. At current valuations, stocks appear cheap relative to potential earnings growth. We remain vigilant in analyzing the incoming data but for now, we remain cautiously bullish.
For information on Alhambra Investment Partners' money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: jyc3@alhambrapartners.com
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# Retail sales are firm, mortgage applications for purchase and refinance are rising, inventories are lean, trade continues to expand, jobless claims are under 400k and falling, import and export prices are coming off the boil and consumer sentiment is rising. #
one thing forgot to mention… at what cost ?
do you know that in 2011-oct GROSS US DEBT increased by 200 bln.. its over $2 trln per anum..?
do you really think US fed goverment is gonna print 10% of GDP for good ?
keep on living in ivory tower and wearing pink glasses alx
Alex,
The weekly review is exactly that – a review of the stats from the previous week. The fact is that the statistics have been improving over the last couple of months. That says nothing about the future but I think it is important to report where we are right now.
These weekly reports are focused on the short term picture and are often at odds with our longer term view. For some time now, we’ve posited that the likely outcome of the current set of policies is stagflation. In fact, one could say that we are already in that condition with headline CPI rising faster than real GDP growth. But the economy can traverse a lot of territory in the short term and since markets respond to it, we must as well. Better economic performance in the US will require better fiscal policy which in turn would allow the Fed to adjust to a better monetary policy. Absent major fiscal changes that expand the supply side of the economy, we don’t believe there will be significant improvement in the economy.
As for your ivory tower comment, I’m not sure what you mean. We are an investment advisory firm and we are judged on our results of which we are quite proud. In fact, it is you that is viewing the economy through an ivory tower lens. Your belief that the economy is being supported by government spending is a standard Keynesian (academic) view which we reject. We believe government spending has been a drag on growth and that we would be in a better position now if the “stimulus” had not been enacted. Reducing government spending will surely reduce GDP since it is a part of the calculation, but it will have a positive effect on the private sector. Whether the economy contracts in the short term is something we can’t predict since we don’t know how the adjustment will be structured.
Thank you for your comments.
Joe Calhoun
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