My world economic “to do” list, with emphasis on the US
This is my checklist of the major economic problems produced by the financial crisis, and where I think we now stand:
1. world trade. Trade finance is more or less back to normal. Areas outside the US and the EU which have not been infected by our banking problems have stabilized faster than expected and are beginning to grow again.
China is perhaps the best example. But the Reserve Bank of Australia has recently announced that it has completed the process of bringing short-term interest rates up from their emergency low early in 2009 to a neutral level. Singapore is the latest to declare that its economy is looking up again.
Unlike Japan during its heyday, China is taking an active role in world economic affairs, not only by purchasing assets in other developing countries but also dispensing foreign aid. This serves a dual purpose–spreading China’s influence abroad, as well as shrinking its gigantic pile of US$ reserves.
2. global economic growth
The economic consensus is that 2010 will be a year of “above trend” economic growth around the world. Taken by itself, this is a pretty meaningless statement–sort of like saying that things could be looking up for the New Jersey Nets basketball team (now 3-30).
After an economic low point and the application of expansive monetary and fiscal policy, there’s always a bounceback. For economies like China, India or Brazil, economists seem to be predicting a return to business as usual. But the forecasts for the US and EU, which appear clustered around 3% real growth for the year, are above trend but only by a tiny bit. They’re not much more than half the level one would expect in the typical economic rebound.
If the US and EU forecasts are economists’ best guesses and not an attempt to guard against printing a number that may be too high, they are predicting that it will be years before the developed world shakes off the negative effects of the financial crisis.
The estimates have some common-sense plausibility. Typically, consumer rebounds are driven by renewed purchases of homes, cars and other household durables. With 25% of homeowners holding mortgage debt that’s more than their homes are worth and with 10% unemployment, will spending have the typical oomph to it? Maybe not. On the other hand, economists have always underestimated the resilience of the American consumer.
3. confidence in the US$.
–Are foreigners continuing to buy Treasury securities?–yes, especially at the short end, where the potential for currency losses is smallest.
–will the US do what is necessary to protect foreign creditors from a decline in the real value of their Treasury holdings? that is,
———-will the Fed raise short-term interest rates from their emergency lows to neutral?–yes (remember, short rates will probably go up by 175-200 bp before the Fed is through)
———-will Congress create a sound fiscal policy that will guard against dollar depreciation?–probably not. I don’t think anyone expects fiscal responsibility from Congress, though. That’s why buyers are sticking to short maturities and why the Chinese are so eager to reduce their dollar holdings. My guess, though, is that the world expects at least some action by Congress, other than creating inflation, to narrow the budget deficit. What Congress actually does could be a source of either positive or negative surprise. I’d lean more toward protecting against the negative than benefiting from the positive.
4. financial companies. A lot of progress has been made, but significantly more remains to be done.
–trade finance is back to normal
–business lending. High yield issuance is booming, as large firms are seeking the greater certainty of the bond market. This is true in Europe, where companies have traditionally been much more reliant on bank financing, as well as the US. Smaller firms seem to be waiting for final word on what their health care costs will be before spending on expansion.
–regional banks. Many are up to their eyes in construction loans, not an enviable position to be in. So they’re not lending either.
–consumer lending. Good luck trying to get a loan. High losses on derivatives, mortgages and credit cards have made all banks squeamish about new commitments.
–stock finance. It’s booming in emerging markets…not so much in the US and Europe.
–investors. Data from the Investment Company Institute, the trade association of the investment management industry, seem (to me, anyway) to show that individuals are continuing to act in the same vein they have for about a year. That is, they are:
-reducing money market holdings
-reducing domestic equity mutual fund holdings
-buying exchange traded equity funds instead
-buying taxable bond funds
rearranging their equity holdings to reduce their exposure to the US and increase it to foreign markets, especially emerging countries.
(One way of making sense of this is to say investors are following a barbell strategy, balancing what they perceive as very risky assets (emerging market equities) against ultra-safe ones (bonds). Or you might say they’re buying everything but US stocks. Personally, I don’t get it all, but only time will tell whether this is a prudent strategy or not.)
5. US industrial firms. Overall, US business have shown strong profit growth in the second half of 2009, mostly as a result of cost-cutting. Larger firms have begun to indicate that sales are either stabilizing or improving and that they intend to start purchasing new equipment and rehiring workers in 2010. Temporary help is already on the rise. Sales to non-US buyers are an area of particular strength, at least in part due to the weakness of the US$.
Smaller firms, on the other hand, appear to be more cautious. Several reasons:
–they tend to have little overseas exposure, where economies are stronger,
–many are suppliers to larger US firms, and their revenues tend to lag on the way up, as a result,
–some are concerned about the effect new health care legislation will have on their profits.
It’s probably also important to distinguish between manufacturing and service companies. On the manufacturing side, many publicly-traded industrial companies produce consumer durables, an area I tend to worry about. IT companies, on the other hand, appear to be doing exceptionally well. (See the very interesting, if somewhat specialized, blog by tech veteran Daniel Nenni, who points out that semiconductor companies are anticipating an unusually strong first quarter during what is typically a seasonal lull.)
Service companies are, I think, in better shape than manufacturers. They are also the area where the US has a true competitive advantage over foreign firms–although “creative destruction” is heavily rewriting the formulae for success in entertainment and publishing.
6. The US consumer. It’s a mixed picture.
a. the positives
–Housing prices probably bottomed sometime in late spring or early summer.
–Layoffs are slowing, and the labor situation may reverse into net hiring in the next few months.
–Holiday spending appears to have been better than (low) expectations.
–Almost two years of recession would imply considerable “pent-up demand” for consumer durables.
b. the negatives
–Consumers are continuing to trade down, implying they are still not feeling very confident
–Banks are still severely rationing credit to consumers, as well as dramatically raising the cost of maintaining credit card balances
–companies may have discovered during the downturn that they can operate with fewer workers than they thought. If so, unemployment may remain higher for longer than in past recoveries. For perhaps different reasons, I think this is the consensus expectation.
c. past patterns
The timing of US business cycle recoveries has been unique, in that the American consumer has typically picked up first and industry has followed later on. The opposite is true in the rest of the world. Perhaps the most dangerous words in all of investing are, “It’s different this time.”, but, like the economists forecasting a sub-par recovery, I wonder…
That’s it for this post. Next, I want to write about what stock markets have been doing and what their performance seems to be implying for the future. Then I’ll write about where I see the possibilities to profit this year from the current lay of the land.