Archive for January, 2015
That was the title of a 2015 outlook piece from a major American bank out earlier this month. The piece itself had its strengths as well as weaknesses but what is beyond doubt is that it stands foursquare behind the prevailing consensus. The US economy will soon be global growth leader (in the developed world at least) – awesome! The dollar will continue to appreciate on the back of this and the monetary tightening it will bring with it – woohoo! Stocks will go up, though let’s not get carried away here; there won’t be another 2013, but maybe we’ll get last year all over again (S&P 500: +11.4%).
At present these views are so unanimously held as to represent truisms. Wall Street has been bullish on Uncle Sam for some time, fuelled at first by the shale boom and projections of US energy independence, but today the positivity is much broader and universally shared. These bull views are not wrong, exactly, but it seems pretty clear that the case is now being enthusiastically overstated.
Let’s look at growth first. Yes, the average forecast for this year is for real US GDP to go up by 3.2%, outpacing Japan, Europe, the UK and elsewhere. Uncannily enough, however, 3.2% is exactly the level of the post-war trend. So what is being feted is a return to trend growth – not, in fact, as terrifically exciting a phenomenon as all that. And should the forecast prove correct this calendar year will be the first over which growth even reaches that trend level since 2005. Yee-haw.
This is not to be sniffy about American prospects. Some of the structural strengths identified in the note referred to at the outset (Goldman Sachs, since you ask) are absolutely valid, and important: the quality and global reach of the tertiary education sector, the connected vitality of innovation and so forth. But the market effect of these things is the very definition of “long run”, and they have been features of the landscape in the USA while markets and the dollar have got up to all sorts of things, not all of them good for investors.
No: the real point concerns sentiment. Only three short years ago there was still talk over the Atlantic of jobless recoveries; the autumn of 2011 was a time of near-universal pessimism and panic, even at the Fed; over the summer it emerged that growth had stalled; Congress was trying to appear to threaten to push the country into default; S&P downgraded the sovereign debt rating to AA+; and of course stocks crashed.
This was an excellent time to be buying American assets.
Sentiment is a tough thing to measure. But if you remember the 1990s you will recall that they really were a time of optimism – even “exuberance”, as one famous proclamation had it. Does the shale boom really measure up to the rolling out of the internet? Is a return to trend levels of economic growth really as “preeminent” an accomplishment as victory in the Cold War? And best, perhaps, that we don’t mention Clinton-era phenomena such as budget surpluses and consistent real growth of well over 4%.
The truth is that the circumstances in which the US finds itself today are good, but they are nowhere near as exciting as some appear to believe. There may even be tiny hints of caution in today’s GDP print (ever so slightly lower than expected) and the current earnings season (reported EPS for the S&P 500 are up only 3% on the previous year with almost half the index having declared).
It is idle to speculate too heavily on these kinds of outcomes. But just as sentiment provided investors in risk with a great opportunity in 2011-12, so now does it pose a potential threat. There is simply not all that much room for disappointment – should there be any, of course.
There are some who favour massively overweighting the US just now at the expense of what they see as conspicuously less gilded markets. It is not clear that this is sensible advice.
Much like last year, 2015 has got off to an exciting start. This blog identified interest rates as an important market theme, and though the Fed (and to a lesser extent the Bank of England) have been positioning expectations for a tightening of policy at some point it has been the new emergency monetary measures in Europe which have dominated attention thus far. Mr Draghi can take much of the credit for turning around sentiment on the sovereign debt malady in 2012, attracted further limelight last year by introducing negative deposit rates among other things and yesterday, of course, officially announced the start of quantitative easing in the eurozone. As with his other announcements this one has been taken well: the Stoxx 50 has risen by more than 10% over the last couple of weeks, bonds in Greece and elsewhere in the eurozone periphery have found some support and he will not mind that the euro, which has fallen by 3% against the dollar in the last two days alone, now stands at levels last reached in the summer of 2003.
Fears over the prospects for Europe are nowhere near as powerful as they were in the days of the Bond Market Terror when Draghi took the helm in November 2011. Today the fear is that the Continent will follow the “deflationary spiral” which sucked the Japanese economy under the waves for so many years, as people defer spending decisions, companies delay production, activity thus contracts (exacerbating the price effect) and the bells of doom generally begin to toll.
Or so the story goes. The Japanese experience was / is not actually like that. After the collapse of the 1980s economic and investment boom the stock market crashed in 1990, growth began to slow, and the Bank of Japan cut rates accordingly. The yen, however, was allowed to appreciate by over 50% on a trade weighted basis at the same time, more than compensating for this effect and ensuring a recession which saw growth move sideways for two years. Annual inflation, on the other hand, didn’t turn negative until 1994 – and in 1995-6 the economy motored along just fine. The first bout of Japanese deflation was therefore a symptom of the malaise, not its cause.
Then came the 1997 collapse of the Asian tiger economies, the Japanese banking crisis and another unwelcome period of massive yen appreciation. It was at this point that the zero-interest rate policy, “ZIRP”, came along. Then of course there followed the collapse of the TMT boom. So the level of Japanese real GDP moved sideways for five years this time (1997-2002). Although deflation did not begin in earnest until the 2000s, its association with Japan’s “lost decade” had become intractable, and the idea of deflation as a cause of her problems, rather than a symptom of them, an established part of the market narrative.
Looking at this another way, Japan is not the only economy to have experienced deflation in the recent past. Did you know that Switzerland, for example, saw a pronounced deflationary period from 2011 to 2013? Or that Singapore officially entered deflation a month before the eurozone? Nor is it only countries beginning with “S”: Israel has been deflating quite cheerfully since the autumn, joined last month by neighbouring Lebanon. None of these places are forecast to suffer Armageddon as a result.
One could also mention that “core” inflation in Europe remains positive … but by this stage the point ought to be well made.
Of course, a lot of market narratives can become self-fulfilling. For this, if for no other reason, it should come as a relief to see the latest round of “open mouth operations” at the ECB enjoying a positive reception.
As a last word on this subject – for now! – it also salutary to observe what happened to Japanese asset pricing during the first decade of this century. Ten year bond yields did not tend to trade at 0.4%, for example, even with deflation all around, QE in train and the policy rate at or near zero. Nor did equities experience a terminal spiral of death, or the yen perpetually depreciate. But all of that is a much longer story.