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New York, October 2, 2012, Advisor Update®
Is it possible that policy makers and investors have already enjoyed all the good news and rising asset prices they are going to get from recent Central Bank action? After all, every major macro issue of the past few months: ECB open ended bond buying (with conditions), ESM approval by the German Courts, Dutch elections, Fed going for unlimited QE3, even the Apple I phone 5 roll out, went about as well as one could hope. As a result, fear gave way to complacency and risk assets worldwide rose 10-15% off the May-June lows, with Spanish and Italian stocks rising 30% plus while their bond yields plummeted. Unlike in QE 1 and 2, when stocks fell hard in the months prior and then rallied on the news, maybe we have already had the party?
Complacency extends to policy makers as well. Congress has adjourned without even a thought to address the looming “fiscal cliff,” confident in the unelected officials at the Fed. In Europe, the Spanish Government suggests it won’t seek a bail out unless it is the absolute last option, a reasonable course of action if the objective is political survival as opposed to economic revival. In Asia, economic policy twists in the wind as China struggles with transitions to both its growth model and its political leadership.
What does the Fed see that we, investors and policy makers alike, don’t? Why does it feel compelled to act in such an aggressive manner, directly targeting jobs, American jobs? Maybe it’s this morning’s Q2 GDP report showing a deceleration in growth from 4% in Q4 2011 to 2% in Q1 to an anemic 1.3% growth rate this past quarter. Perhaps it’s because the political class has utterly abdicated on jobs and growth? As Wall St begins to discount an Obama victory, the early word is that a fiscal deal will be put on the table within days of such a win. Other areas such as immigration, education reform are flagged for second term focus — yet there is no mention of the two words that should be front and center for both investors and policy makers — growth and jobs.
Where is economic and corporate earnings growth to come from? I believe the Fed sees real and rising risk of a 2013 recession, fed by fiscal cliff uncertainty and driven by regional slowdowns in the US, Europe and China morphing together to create a global slowdown. Herein lies the rub for equities: 2013 S&P earnings forecasts at 12% seem way too high. Earnings growth (now at risk) has been a principal underpinning for the stock market since 2009.
Thus the question, where does growth come from? Investors have already given up on the idea that money-printing leads to economic growth — the Fed has bought close to $2.5tr in assets in the past 4 years and the US seems stuck in a 1 – 2% growth profile. Europe is in recession as politically imposed austerity measures combine with overly indebted sovereigns and bank systems to ensure a downward spiral that gathers pace as we speak. Conditionality is pro cyclical and ensures that Europe will remain in recession for the foreseeable future. Time is not Europe’s friend.
Well, we can always count on China to boost global growth can’t we? We could in 2009 but sorry to say we can’t in 2012 and it is unlikely in 2013. Why one asks? First, China’s ability to finance a major stimulus package is unclear with bad debts rising rapidly from past stimulus efforts. Second, China knows it needs to move away from an investment led, export driven economic growth model to a more domestic demand driven, consumption led model. That shift is already overdue; generating another major stimulus program while tactically appealing is strategically dangerous. Third, the leadership transition makes the timing very tricky.
China highlights two important issues: first, its economic woes suggest that its growth model is broken, a situation I believe is shared by both the US and Europe. Second, the very poor performance of Chinese equities over the past few months, down close to 10% in Q3 vs. global stocks up about the same, leads one to question whether Chinese equities are leaders or laggards? If leaders, might their performance be an early warning signal for other parts of the world? If laggards, then perhaps they suggest China will make one last big stimulus push, in which case Chinese equity could be a big winner in the months ahead.
Are there other big picture insights we can tease from recent macro action? If one accepts that the growth models for all three major regions: the US, EU and Asia are broken, one has to wonder where growth comes from. Furthermore, if one accepts that since 2008 economic policy has been led by monetary policy then the Fed’s actions might suggest we are coming to the end of this phase as well… After all what more can the Fed do? Investors still hold strongly to the belief that Fed action can boost risk asset prices; should that belief break, investors will be left with little to hang onto.