Going Pear-Shaped

On markets I’m sounding a bit like an old gramophone and haven’t really changed views in recent months as most developments have been just the arrival of forecast events rather than the arrival of new information. I do think that there are so many moving parts in play at the moment that clarity is indeed difficult to achieve. However we must have a view, so where is sustained recovery coming from?

Starting with Japan it is indeed difficult to see Japan as the engine of global growth with its demographic and deflationary issues lurking in the background. Most of Asia is still too small to make a difference on a global scale, and too fragmented to assume a global role in the near future. China is quite rightly focusing on its domestic market but that process will take a decade or more. Africa- no; Latin America- no; Russia oh no, so that leaves us with the developed economies the most significant of which are beginning a de-leveraging process that realistically may take a decade to conclude. This puts both the consumer and the corporate sector under some pressure: it’s not easy to see where profit growth is coming from (domestic demand falling and cost of capital rising) or what sustains consumer demand (wage pressures, lack of credit availability, rising tax burdens). Having said this, the Consensus Forecast is for profit growth! Japan around 8% pa going forward; the UK around 8.5%; but lower, and then declining, expectations in both the US and core-Europe. Perhaps this tells us something about various attitudes to printing money and profits in real terms. The good news is, of course, currency depreciation may help boost export markets which, in aggregate, could be the developed world’s saviour as the change in terms of trade would suggest growing and broader based demand from EMs.

So is Europe the engine of growth? With prospective growth of 1.4% in 2011, a recent currency crisis and the wrong demographics, probably not. Having said that Europe now has a cheap currency and the ability –if it wants to take it- of recreating some highly competitive satellites capable of, on the margin, boosting aggregate growth within Europe while the cheap euro precipitates an export-lead German recovery. Sounds good but the banking system won’t be (despite Stress Testing) in a position to help, so no it’s not Europe.

So that brings us to the US and the posed question. My answer is one should be optimistic but mindful of the very real downside risks. For example,  there are more future mortgage resets to come in the US. These numbers show a situation that is very similar to the situation in mid-2007 and poses the threat of a further contraction in consumer demand. Resets will continue to rise peaking in 2013/4.

The US does have a history of reinventing its economy through renewal. Although the problems of bank intermediation and leverage misuse were arguably first felt here, equally the US will probably emerge well ahead of the others (again a theme expressed by Michel over the last year or so). There is plenty to go wrong- strong currency; unemployment; the banks. But on the other side of the coin there remains a de facto dollar bloc covering much of the world; a propensity to work (rather than languish on benefits) and very low interest rates across the term structure. The US’s main export markets are all doing well. The US is probably well positioned due to its (potentially) overvalued currency and substantial non-paper reserves (gold) to go ahead with a further round of QE to tide them over the waves of forced debt restructuring predicated by the recapitalization of the banking system. So, on balance a pretty awful situation, but with get-outs. Not sure that the get-outs extend to Europe or the UK. I’d put money on the US and hope.


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