Economic Outlook - January 2012
16 Jan 2012
The start of a New Year should bring with it renewed optimism for the year ahead. However, with continued concerns over Europe can 2012 see significant improvements in the fortunes of global economies and markets? John Greenwood, Chief Economist at fund group Invesco Perpetual, shares his thoughts on the year ahead.
Three key questions for 2012
The fate of the world economy, and the prospects for financial markets in 2012 and 2013, depend primarily on the answers to three key questions: Will the eurozone crisis be resolved in a timely and effective manner? Will the US economy maintain its recent better performance? And will China avoid a deep recession in 2012?
Unfortunately, the answers to these questions are not all favourable. The outcome of the eurozone debt crisis remains very unclear, with another escalation during 2012 a distinct possibility, in my view. As for the US economy, the partial improvement in economic performance we have seen recently is likely to be held back in 2012 by many of the same obstacles that occurred in 2011. Finally, the Chinese economy remains overly dependent on external demand for its goods and hence acutely vulnerable to the deepening economic downturn in Europe.
Crisis in the eurozone: still no solution
While European leaders have brought forward a permanent rescue fund for struggling economies and introduced greater ‘fiscal discipline', stock markets are likely to require even more tangible measures, in my view. The problem is that while these actions may help to avoid the next crisis, whenever that may be, they are not capable of solving the current one. Stock markets have good historic reasons to be sceptical on issues of fiscal discipline. The previous Stability and Growth Pact was persistently broken, above all by Germany and France in 2003-04 when they each refused to pay the penalties incurred. Even though the latest measures from the European Central Bank will help alleviate bank funding, it is by no means clear that these measures will be enough.
The plan devised so far by EU leaders contains no vision or clarity on the final destination. Proposals to revive growth are notable only by their absence. Furthermore, there is no attempt to address the underlying problem of the loss of competitiveness in southern Europe as reflected in the trade surpluses in the north European countries (principally Holland and Germany) and the deficits in southern Europe (countries such as Greece, Spain and Portugal). What does this mean for the investor? Essentially, that the eurozone debt crisis will persist through 2012 and even beyond. In financial markets that spells heightened uncertainty and increased volatility. Among the major currencies, the euro is beginning to lose its appeal, and in my view, will decline further against the US dollar, the yen and the pound. With interest rates in the developed world remaining very low for an extended period, I believe the search for quality assets that generate safe and sustainable yields will continue.
Will the US economy keep on improving?
Since the summer, when stock market falls were triggered by a downgrading of US sovereign debt, the reported economic data have started to improve. However, major obstacles to economic recovery still exist, in my view. Most notable amongst these are the continuous efforts by households and governments to reduce their debt burden. Balance sheet repair, as it is known, one of the main headwinds to hold back the economy in 2010 and 2011, is likely to continue to be a major pre-occupation of the household and financial sectors over several years to come. We should therefore moderate our expectations of any sudden snap-back to economic normality.
A second major obstacle in 2010 and 2011 was the adverse shift in the terms of trade - the price of exports relative to the price of imports. Specifically, this took the form of strong rises in imported energy, metals and food prices driven largely by demand in China and India, as well as by other emerging economies. The principal effect was to drive up consumer prices from an average of 1.6% in 2010 to an average of 3.2% in 2011, eroding nominal wage and salary growth, and causing the consumer to feel worse off in inflation adjusted terms. This phenomenon was by no means restricted to the United States, and was evident in many other developed economies. The good news is that in 2012, I expect the rise in commodity prices to ease, with some prices declining - particularly under the influence of the recession in Europe and the slowdown in China.
The continuing slump in the housing market remains a problem for the US economy. It is still the case that over 22% of mortgage borrowers are in negative equity, implying that their ability as consumers to spend freely in the shopping malls is constrained by the need to pay down their debts. Equally, the large overhang of unsold homes means that house prices have remained under downward pressure for much of 2011. While affordability has started to improve, access to credit remains difficult.
Balance Sheet Repair Continues
Source: Datastream, as at Q3 2011.
China: growth will slow but no deep recession
The Chinese economy has been losing economic momentum in 2011 and, I believe, will weaken further in the first half of 2012. There have been two main contributors to the slowdown: weaker domestic demand as a result of progressively higher interest rates and a distinct slowing of export growth as key overseas markets such as Europe and the UK have edged closer to recession.
Overall, I expect Chinese economic growth to slow to between 7% and 8% in 2012, but if the authorities take the view that the slowdown is becoming more serious - perhaps because of a recession in the eurozone - then they will have no hesitation in introducing further stimulatory measures. As in 2009-10, these would be likely to succeed thanks to the fact that balance sheets in China remain in good shape, and households, firms and local authorities are therefore still willing to borrow and spend.
Chinese Exports Suffer Distinct Slowdown (%)
Where John Greenwood has expressed views and opinions, they are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals and may not necessarily reflect those of TQ Invest.
