Archive for January, 2013
This morning saw the release of the preliminary UK GDP estimate for Q4 2012. A quarterly fall of 0.3% rounded off a year of perfect stagnation.
It could have been worse. And according to the ONS, without a series of one-offs linked to maintenance problems with North Sea energy production and the unwinding of the effect of the London Olympics from Q3, quarterly growth would have been ever so slightly positive.
Still, the underlying picture for the UK economy is undoubtedly weak. We have noted before that a measure of luck can be thanked for the country’s safe haven status. Our sovereign debt burden, whose gross interest payments each year already outstrip the entire defence budget, is a millstone round the nation’s neck. Until last year, rises in indirect taxation pushed inflation up to the point where real wages were being materially eroded, with the result that the household sector re-entered recession in Q1 2011 (almost a year before this was reflected across the economy as a whole). And the strength of the pound last year saw the current account deficit reach its highest level as a percentage of GDP for over 20 years.
Nonetheless, there are reasons to be positive as the new year unfolds. The health of the eurozone economy is extremely important to Britain. This week we saw consumer confidence and the PMI composite indicator of current activity over the Channel rise more convincingly than at any time since last spring’s panic. And growth in Europe as elsewhere is generally forecast to rise this year – albeit modestly – which as we know is only to be expected given its disappointing level relative to trend. Furthermore, sterling is already 3% weaker on a trade weighted basis year to date; that’s the amount it gained over the whole course of last year.
Which brings us on to another source of risk.
Currency weakness, while beneficial at least in the short term to exporters, is another source of inflation. Only a month ago, the Bank of England’s governor elect gave a speech in which he mooted the idea of ditching the inflation target altogether in favour of targeting nominal growth. Readers will know the Bank already has a growth target, which while technically secondary to the target for CPI inflation has been making a lot of the running when it comes to making monetary decisions. And those decisions have failed: despite a near-zero base rate over the last four years and £375bn of “quantitative easing”, growth in real GDP has averaged a measly 0.2% per quarter since the end of the slump in mid-2009.
We live in a world which over the past few years has seemed even more imperfect than usual. All too often, the only ideal answer to the problems of a western social democracy with too much debt on its books has mirrored the old joke about the driver who asks for directions, only to be told: “if I were you, I wouldn’t be starting from here.”
Over the past few weeks, markets in risk assets saw the sun shining and have been making hay. Let’s hope they are right. But we need to remember that a return to economic norms will bring with it the risk of inflation, which in turn entails a threat to growth either by being left uncontained (as here in Britain recently) or by provoking a policy response seen as aggressive.
2013 has barely begun. With major stock indices some 3-5% higher already for the year to date it is obvious that it has begun with a bang.
Confidence has been improving for some time, taking valuations with it. At the end of the year the MSCI World Index of developed-world stock markets carried a historic p/e ratio of 16x. At the same time, consensus earnings growth for the index (based on analyst estimates aggregated by Bloomberg) is forecast to rise by 23% this year. If that can be delivered, current pricing doesn’t look too demanding.
Turning to the US in particular, as of today 67 S&P 500 index members have reported earnings for Q4 2012. Share weighted EPS are up 31% on the previous year. All that growth comes from financials: ex-financial EPS are currently down slightly (-0.4%).
Overall, earnings are forecast to have grown 3.8% on Q4 2011 by the time the last index constituent reports. Unsurprisingly that number has risen slightly since the data began to come in, and if the pace doesn’t slacken too suddenly will be revised up again.
There are a number of reasons why we might expect company earnings to do well – and to do better than nominal American GDP. Most obviously, there is room for margin improvement. Some of this may be attributable to manager brilliance; some is certainly attributable to new lows for corporate interest rates (with the BoA ML US Corporate Index recently yielding a record 2.7%), and lower effective tax rates over the last few years.
Whatever the reasons, however, EPS growth of 31% is remarkable. It appears highly unlikely to be sustained at that level as more reports come in. But even if we do see “only” 3.8% on the year to Q4, and similar data this year, robust earnings growth for the US and for the developed world as a whole begins to look perfectly plausible.
There are risks out there, as always. The sudden optimism over US politics and Japanese growth may be premature. It seems as if the European crisis is being disregarded now too. Though it has yet to push pricing into uncomfortable territory, there is the scent of complacency in the air.
After the disappointments of recent years we wish the relief rally well. Whatever happens to sentiment, sustained earnings growth would give it important support.