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So if earnings are still forecast to grow, stocks are historically cheap, sentiment is extremely negative and interest rates are forecast by those who set them to stay low, then what is missing? The key unknown really becomes the trajectory of economic growth. Clearly the view being reflected by investors is that the global economy is on the verge of a breakdown. But what does the evidence say?
Europe is at the epi-centre of the bad economic news. While southern Europe is clearly now in recession (Italy, Spain and Greece are all shrinking and need to apply fiscal austerity as well in order to reduce their debt burdens and they still have to re-capitalize their banking systems). While Germany and France are doing better, they are not immune to the problems with their neighbours and have seen slowdowns in order growth and consumer sentiment. However, growth has still stayed positive in the rest of Europe (although only marginally) and the financial condition of the EuroZone as a whole is still better than the U.S. or Japan. The bottom line for us is that the problems in Europe will not be going away in a hurry, but we don’t think they will get much worse from here. Monetary conditions have been loosened and governments are starting to realize they need to act to correct the financial situation and encourage growth. Also, Europe has not been the engine of growth for the global economy for decades. It might be close to 20% of the global economy but it has also been one of the slowest growing regions in that global system for many years. The global economy has been expanding at over a 4% annual rate over the past decade, while Europe has been growing at only slightly over 1%. Slower growth in Europe should not undermine the global economic picture, and we still expect 3-4% growth for the global economy this year.
The U.S. has also slowed down in the past two quarters after seeing resurgence in growth in the back half of 2011. Part of this is due to the European situation, part is from slower growth in China and some is from the tepid expansion of jobs as corporations are still reticent to expand. But the U.S. is also seeing a real recovery in its housing market for the first time since 2007. The inventory of unsold homes is coming down, home building indicators such as housing starts and ‘CaseShiller Home Price Index’ have shown sharp recoveries in the past six months and prices have even started to move higher in some regions. Moving U.S. housing starts from the 500,000 annual range to the 800,000-1,000,000 range will add substantial stimulus to U.S. growth. The U.S. economy should show growth in the 2.5-3.0% range for the next few years. That’s hardly robust growth, but much better than the stock market seems to be anticipating.
The most important question for the global economy right now is the outlook for China. Investors seem to fear that the substantial growth in China is coming to an end and the economy is heading for a ‘hard a landing’. The slowdown fears were exacerbated by the weak economic numbers from Europe, a key destination for Chinese exports. While growth has clearly slowed in China, we are staying away from the “China hard landing camp.” First, most of the recent economic downturn and the cooling housing market are the intentional results of the harsh tightening cycle in 2010-11, where the government intentionally slowed growth in order to reduce inflation, which had accelerated to a 6% annual rate. With the urbanization ratio just crossing 50% last year, the powerful secular urbanization trend is still the friend of the China bulls and will continue to be for a long time. Second, the Chinese government still holds lots of potential to stimulate the economy now that inflation is back under control. Growth is the mantra of the policy-makers and we expect more of a focus on that going forward. While second quarter growth will most likely come in lower than the 8.1% rate of the first quarter, it will only be marginally lower and we expect that to also be the low quarter for 2012. Third, now that the Chinese government is convinced that the economic downside risk is higher than inflation risk, they might begin to adopt a more aggressive easing agenda.
We don’t see a recession coming for global growth. The chart below shows the index of global manufacturing over the past 8 years. While growth has clearly stalled due to some of factors mentioned earlier, we can see that the data is not nearly as dire as it was during the financial collapse in 2008. We tend to look at this as more of a ‘mid-cycle’ slowdown and expect that the data should once again start to improve in the second half of this year as Europe stabilizes, housing firms further in the U.S., and China resumes its focus on economic growth.
