David Rosenberg: U.S. Economy is Still Fragile

Tuesday, January 10th, 2012

David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates, talks about the outlook for the U.S. and European economies.

Source: Bloomberg, January 9, 2012.

Tags: Amp, Chief Economist, David Rosenberg, Economy, European Economies, Gluskin Sheff, Outlook, Stocks, Strategist
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Global Manufacturing PMI: Saved by the U.S.

Friday, December 2nd, 2011

The contraction in the global manufacturing sector continued in November. The global manufacturing PMI that I calculate on a GDP-weighted basis for the major economic regions was virtually unmoved at 49.6 from October’s 49.5. The relatively unchanged PMI masks significant changes in the individual countries and regions, though.

The global manufacturing sector was saved by a higher than expected showing in the U.S. as my calculations show the global PMI excluding the U.S. fell from 48.7 in October to 47.8 In November. The ISM Manufacturing PMI surged by 1.9 to 52.7 from 50.8 in October. Outside the U,S., South Africa, Russia, Turkey and India were the only other economies where manufacturing expanded. The contraction in Brazil’s manufacturing sector eased significantly.

The downturn in the Eurozone is gathering pace as the contraction in France and Germany, the two major economies in the region, is deepening. The Markit Eurozone Manufacturing PMI fell to 46.4 in November from 47.1 in October. After Ireland fell back into contraction, the manufacturing sectors of all countries in the Eurozone are now in recession while the contagion widened to emerging European economies. In both China and Japan the expansion ended abruptly. Elsewhere in the Far East the contraction in Taiwan continues and the contraction in South Korea has deepened.

Sources: Markit*; Li & Fung**; Plexus Asset Management****; ISM*****

Sources: Markit*; Li & Fung**; Plexus Asset Management****; ISM*****

The current state of the global manufacturing sector leaves global central bankers no other choice but to act aggressively to stop the rot. We should expect more announcements in coming weeks regarding lower reserve requirements for banks and interest rate cuts in countries where these cuts can still have a major impact on the economy, especially countries in the BRICS block.

Tags: Contagion, Contraction, Current State, Downturn, Economic Regions, European Economies, Eurozone, Gathering Pace, GDP, Interest Rate Cuts, Ism Manufacturing, Manufacturing Sector, Manufacturing Sectors, Markit, Masks, Plexus Asset Management, Pmi, Recession, S South, South Korea
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Emerging Markets Cheat Sheet (January 3, 2011)

Monday, January 3rd, 2011

Emerging Markets Cheat Sheet (January 3, 2011)

Strengths

• China’s total online population reached 450 million at the end of November, growing 20.3 percent year-over-year and up from 420 million at the end of June. Around 33.9 percent of the country’s population has used the internet, higher than the world average of 30 percent.
• The Chinese yuan strengthened beyond 6.6 per U.S. dollar for the first time in 17 years, bringing total appreciation for 2010 to 3.6 percent, ahead of President Hu Jintao’s state visit to Washington in January. Chinese authorities may have allowed this move to tame domestic inflation as well.
• Russian service industries accelerated growth this month at the fastest pace since May, according to HSBC. The Service Purchasing Managers’ Index (PMI) rose from 54.1 in November to 56.4. The survey based index indicates a contraction when it is below 50 and growth with a figure above 50.
• The Republic of Georgia attracted more than two million visitors in 2010, the highest figure since 2003. The number of visitors has increased since Georgia’s five day war with neighboring Russia, when tourism’s share of GDP fell to 3.6 percent. Georgia’s economy is projected to expand as much as 6.5 percent in 2010.
• Ten years ago, when the Economist Intelligence Unit calculated scores for countries’ sovereign-debt risk, the riskiest countries by some distance were Russia, Brazil and China, three of the four emerging-market BRICs. Now, some European economies look riskier, according to the Economist.

Weaknesses

• China’s central bank raised one-year benchmark lending and deposit rates by 25 basis points on Christmas day to better manage rising inflation expectations and preempt a usual surge in lending at the beginning of a new year. Short- term interbank liquidity has dropped significantly so far this month.
• The HSBC / Markit China Manufacturing Purchasing Managers’ Index declined to 54.4 in December from 55.3 November, the first moderation in five months, as both new orders and production eased.
• Hungary sovereign ratings by all three agencies are at the lowest level of the past ten years and all three agencies maintain a negative outlook. Controversial decisions include the financing of permanent tax cuts with temporary revenue sources, reversal of pension reforms and changes to the independent Fiscal Council.

Opportunities

• China’s real interest rate has become increasingly negative even after the most recent central bank hike and ranks among the lowest in G-20 countries. Adjusted for inflation, Chinese savers now would lose 2.4 percent on their one-year bank deposits. With the government’s resolve not to relax policy restrictions toward physical residential properties, Chinese investors, still deprived of investable asset classes apart from bank deposits, real estate, and stocks, are likely to allocate more liquidity in domestic equities next year.
• Savings and debt service payments take a relatively small toll on the average household budget in Russia, opening it for discretionary spending on goods and services. Renaissance Capital expects retail spending to grow 13 percent in 2011, with spending on consumer electronics exceeding 20 percent.

Threats

• The overall tax burden for the oil sector will rise as Russia begins to equalize heavy and light oil products. From February 2011, heavy and light product export duty will be set at 46.7 percent and 67 percent of crude export duty vs. 38 percent and 73 percent currently, respectively. From 2012, heavy and light product export duty will be set at 52.9 percent and 64 percent of crude export duty, and from 2013 the duty will be equalized for heavy and light products at 60 percent of crude export duty.

Tags: Basis Points, Brazil, BRIC, BRICs, China Manufacturing, Chinese Authorities, Chinese Yuan, Christmas Day, Debt Risk, Domestic Inflation, Economist Intelligence Unit, Emerging Market, Emerging Markets, European Economies, Hu Jintao, Inflation Expectations, Interbank, Markit, President Hu Jintao, Purchasing Managers Index, Republic Of Georgia, Russia, Russian Service, S Central, Sovereign Debt
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Latest from China

Monday, September 13th, 2010

More positive economic news is coming out of China – industrial production figures for August were up more than expected, and the latest retail numbers are also ahead of what the market was anticipating.

It appears that Beijing’s plan is working – pulling back on the overheated growth pace and putting in place policies that encourage growth at more moderate (but still strong) levels. Those who predicted a hard landing are looking wrong.

Romeo Dator, who co-manages our China Region Fund (USCOX), is among the more than 1,500 investment pros in Hong Kong this week for the 17th annual Investors’ Forum sponsored by CLSA Asia-Pacific Markets. This is one of the region’s biggest gatherings, with some 500 CEOs and CFOs also expected to attend.

Romeo sent back notes from the conference’s first day to the team in San Antonio – below are some of his thoughts and observations.

• Consensus from day 1 is that Asia will outgrow the West in 2011 but the main thing that held China/Hong Kong back was a wall of worry that China could not grow without vibrant U.S. and European economies.
• Eric Fishwick (CLSA chief economist) sees only 1.25% growth in GDP for the U.S. in 2011 and no growth for the European Union.  As a result, he thinks all countries will be stimulating their economies again in 2011.
• Chris Wood (CLSA chief equity strategist) sees deleveraging as the primary theme and he expects it to remain that way until the evidence shows otherwise.  Sees 10-year Treasury yield hitting 2% and 30-year hitting 3%.
• One area of continued growth expected to be the Internet. Another bullish area is gaming due to Macau and Singapore with the strength in Macau expected but Singapore doing much better than expected. In telecom, increased data penetration via netbooks and smartphones is foreseen.
• In the Philippines, Alfred Dy (top-ranked Philippines analyst) thinks 2011 will be a very good year as investors will give the new president a grace period.

ISI Group also had some observations about China today. It sees continuing U.S. pressure on China paying off with greater-than-predicted appreciation of the yuan against the dollar by year-end. And though inflation in August was above the 3 percent target, ISI says, the longer-term inflation risk is not likely to be a major policy concern.

Tags: Asia Pacific Markets, Ceos, Chief Economist, China, China Hong Kong, China Region, Dator, Dy, Economic News, European Economies, Good Year, Grace Period, Growth Pace, Investment Pros, Investors Forum, Isi Group, Netbooks, New President, Place Policies, Rsquo, Smartphones, Strategist, Uscox
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John Taylor: “Micro Booms, but Macro Slump”

Thursday, July 15th, 2010

This article is a guest contribution by John R. Taylor, Jr., Chief Investment Officer, F/X Concepts.

This week, the US equity market is starting its quarterly earnings ritual and the odds favor a strong performance for the closely followed investor favorites. Although the game is rigged as almost 50% of the corporate managements have adjusted their guidance in the past month trying to lower analysts’ projections down to levels that the companies know they can beat. Despite the opera buffa quality of the process, the S&P 500 companies will still produce a dramatic increase in earnings over the second quarter of 2009. The same can be said of the major European corporations. The increase in corporate earnings and the projection of further increases seems to be universal, and many argue that the positive outlook for thousands of individual companies must sum to an impressive economic recovery.

Despite these positive micro stories, they do not add up to a happy macro outcome. There are several reasons why this is the case, but the result is that the vast majority of the analysts that examine individual companies are bullish and almost all of the macro analysts are bearish, many like us, and dramatically so.

There is a very large segment of the US, Canadian, and European economies that is not part of theglobal equity system and this major fraction of the economies is not doing at all well. Even if theoptimists will retort that moaning about the depressed readings in the National Federation of Independent Businesses (NFIB) reports, the collapse in bank credit, and the sharp decline in the ECRI leading indicators are nothing but anecdotal examples, they should carry at least as much weight as the positive earnings numbers. These smaller businesses represent the lion’s share of the internal and retail economies, while the giants represent almost all of the export and global part of the economies.

The slowdown in the non-S&P sector of the economy is actually reflected in the sluggish increase in the major companies’ top-line revenue, but the tight cost controls that have allowed their reported earnings to keep climbing has exaggerated the decline hitting the independent businesses. The shrinking cost of goods at every Fortune 100 company represents the top line sales of many smaller companies and the take-home pay of thousands of employees. Because nominal GDP is growing more slowly than the outstanding national debt is compounding, it is becoming a more oppressive weight on the “non-S&P” economy, tightening the financial position of small businesses and the consumer.

The macro pessimists actually have academic research firmly on their side. Just two points must suffice here. Keynes famously noted that there was a savings paradox. As I would paraphrase it, if one family saves, it is good for the family, but if all families save, the economy will be ruined. This is happening everywhere. The S&P 500 companies are all saving, by cutting costs – and building giant worthless cash mountains (like they did in the 1930’s) – but this is shrinking nominal GDP as their saved costs are others’ lost earnings. The global economies are all trying to grow by increasing exports, which is the same as saving. If there are no countries stimulating consumption, the world economy will shrink. If all countries try to balance their fiscal books, they are clearly saving. The Eurozone, the UK, and the American states are dramatic examples of this. And if consumers build up their savings, we know what happens to retail sales and the GDP. On top of this the money multiplier comes into play. With the global banking system suffering under an extremely high load of worthless assets – whether recognized or not – and being forced to improve their capital allocation for risk by the Basel II and Basel III rules, banks must cut back the amount of credit that they make available to the economy. The multiplier will force global economies to shrink in the years ahead. Cash is now king, worthless or not, so buy dollars.

Copyright (c) F/X Concepts

h/t:  Zerohedge.com

Tags: Booms, Canadian Market, Chief Investment Officer, Collapse, Corporate Earnings, Dramatic Increase, Economic Recovery, European Corporations, European Economies, Individual Companies, John R Taylor, John Taylor, Leading Indicators, National Federation Of Independent Businesses, Nfib, Opera Buffa, Positive Outlook, Quarterly Earnings, Slowdown, Taylor Jr, Us Equity Market
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The Great Divergence

Tuesday, June 29th, 2010

This article is guest contribution by Bill Hester, CFA, Hussman Funds.

For a brief period during the last decade the developed economies around the world became one. Countries shared similar fiscal policies, interest rate policies, and spending patterns which resulted in uncharacteristically similar economic performances. Investors took their cues from these trends and sent financial market securities converging in price and yield. The range of bond yields tightened, the level of valuations became closely aligned, and trailing stock returns were remarkably similar. As the developed economies continue to recover from the world-wide credit crisis, and now face new pressures of over-levered sovereign balance sheets and the prospects for below-average economic growth, investors should expect financial market performance among countries to continue to diverge.

The convergence of financial market performance that began in the second half of the 1990′s – both in the bond and equity markets – was helped by three major forces. The first was the trailing effects of the period of The Great Moderation. Economic cycles stretched out and moderated during the 1990′s and early 2000′s, not only in the US but in most of the major European economies as well. Economic growth stabilized, inflation subsided, and exogenous shocks were fewer and came with less impact so investors pushed bond yields lower and stock prices higher on an expectation that the moderation would continue. The second trend fueling the convergence in financial market performance was very strong world-wide growth. World GDP grew at an average rate of nearly 5 percent in the three years through 2007, versus a longer-term average of 3.2 percent. More moderate economic cycles and investors’ perceptions that world growth would remain strong helped countries with weaker structural characteristics converge in valuation with those with better characteristics.

The third event that supported the convergence was the adoption of the Euro by the countries in the European Union. The hope of the single currency was to introduce a viable alternative to the US Dollar as a world currency and to make trade and the economies of Europe more efficient by lowering financial transaction costs. As soon as the Maastricht Treaty was agreed upon, European countries began to focus on the hurdles to enter the union, including lowering deficits and debt levels. This brought an alignment among Euro members in leverage characteristics, which over time misled investors into thinking that a monetary union meant singular economic outcomes.

These three forces proved potent in diminishing investors’ assessment in the differences in the characteristics of individual countries. The graph below shows the spread between the highest and lowest 6-month returns of the members of Morgan Stanley’s index of developed countries (the spread is smoothed to highlight the medium-term cyclical fluctuations of the series).

The large spread around 1990 highlights the weakness in the Nordic countries during this period as their stock markets collapsed as they battled their domestic banking crises. The peak around 2000 coincides with the peak in the world-wide stock market bubble where a few indexes that were over-weighted in telecommunication and technology stocks fueled strong relative outperformance. But even outside of those peaks, the graph shows that during the 1970′s and 1980′s it was typical for there to be large divergences between the best and worst performing countries – 40 to 50 percentage points difference was typical. More recently through 2007 the divergence in stock market returns among developed countries collapsed. There was very little value in making distinctions at the country level when individual country returns were so tightly centered about broad benchmark return levels.

These trends have shifted the last couple of years and the recent spread between relative performances continues to widen. Year to date, Denmark’s benchmark index is up 20 percent, while the Athens Stock Exchange index has dropped 33 percent. Country selection is beginning to matter again.

Bond Yield Divergences

One of the strongest benefits of the shared currency was that investors began to price government debt similarly across the Euro area. The countries of southern Europe and countries with smaller economies felt the greatest amount of benefit. Yields on Greek debt fell by more than half in less than 10 years. Ireland and Spain also directly benefited from a collapse in borrowing rates. This helped their economies prosper, fueled partly by lower bond yields and booming housing markets.

As the bottom right section of the graph above shows investors have returned to assessing individual country risk, and they are quickly re-pricing that risk. These trends are worth watching because they’ve mostly continued to deteriorate in the time since the ECB announced its $1 trillion rescue plan in May. Spreads between German bond yields and the debt of peripheral European countries have blown out to levels nearly as wide as immediately prior to the rescue. The spread between bonds issued by Portugal and Bunds are 8 times the longer-term average of the spread. Spanish bond spreads are trading at 13 times their longer-term average.

The widening spreads between the bonds of peripheral Europe and Germany are, of course, picking up both aspects of investors’ reactions. Bond investors are demanding higher yields from the debt of countries with less attractive leverage profiles and seeking out the safer debt of countries like Germany, widening spreads.

The risk is that the cost of borrowing money from bond investors for the highly indebted countries will rise substantially, offsetting any improvements they can make in their budget outlook by way of higher taxes or pushing through austerity plans. One important threshold has already been surpassed. Over the last couple of years the cost of borrowing money for longer-periods for the peripheral European countries has been below the average coupon rate of their existing debt. This was a result of low inflation and low policy rates worldwide. Recently though, the 10-year note yield for many of these countries has risen above their historical average cost of issuing debt. The yields on Portugal debt are now more than full percentage point above the average cost of its debt currently outstanding. The yield on the debt of Ireland and Spain are now also trading at yields above their own historical cost of borrowing.

Diverging bond yields might be one of the more important risks to the relative valuation between countries. The convergence of bond yields was dramatic near the middle of this decade and fueled a convergence in stock market valuations. Investors have likely already begun to factor in new levels of long-term discount rates in valuing worldwide benchmarks.

Economic Growth Divergences

The divergence in discount rates will likely be only part of the valuation readjustment process. The other part that investors will be factoring into their analysis is the expectations of future cash flows. These expectations are also diverging. Returning to the Euro area, during the first decade of the monetary union economic growth was mostly aligned among member countries. Economic growth was faster in the smaller, peripheral countries. But as a group, growth was widespread and stable among Euro-area countries.

Countries within the union used these years of favorable tail winds in different ways, points out David Marsh in his new book The Euro . Measures put into place during this period – like a containment of worker incomes and domestic investment – has helped Germany become the best-managed of the larger Euro countries in his view. And German companies have emerged with increased competitiveness. According to the Organization of Economic Cooperation and Development, Germany improved its competitiveness against all other countries by more than 10 percent in the decade through 2007, based on labor costs per unit of output in industry. Over the same period, Italy’s competitiveness position worsened by 34 percent.

It’s also clear that the leaders of European countries plan on pursuing different strategies in tending to their violations of the Maastricht Treaty (which included limitations on deficits and debt loads when measured in relation to GDP). For one brief moment in May, European leaders came together with one voice to announce their bailout plan. Since that time, the rhetoric has reverted back to the more typical disparate tone. Countries like Greece, Portugal, and Germany have announced that they are pursuing mostly strategies of austerity (sending the US-based Keynesians who architected the American bailout plan into a frenzy). The French leaders have mostly balked at this strategy. France’s Prime Minister Francois Fillon was quoted this week saying that “for the moment, we are trying to avoid austerity”.

The vastly different approaches to solving the sovereign debt problem in Europe are likely to produce a wide array of outcomes. And considering the amount of debt that has to be reigned in, across so many countries, leaves this as more of a hopeful experiment than a simple follow-through of a textbook economic theory. It’s becoming clear that investors are moving from a period where they were mostly focused on the strengths of a single currency to a period where they are concerned about the inherent weaknesses of the union. As they do, the growth forecasts for individual countries will come into greater focus. Over the last decade there has typically been about a 2 percentage point spread between the rates at which the fastest growing countries expanded at versus the slowest countries. This spread will likely widen. The expectations for economic growth over the next couple of years are currently much wider. The graph below shows the expected GDP growth in 2010 across a range of countries.

There’s almost 8 percentage points difference between the expectations for growth in Canada versus the expected contraction in Greece. And more than 3 percentage points difference in expected growth among Euro-area countries. The table also shows that the companies with the most challenging near-term debt loads – Italy, Portugal, Ireland, Spain, and Greece – also have the worst prospects for economic growth.

Benchmark Bank Weighting Divergences

The tremors that have been felt in US and European stock markets this year are less about sovereign debt risks then they are about the concentration of risks on European bank balance sheets. If Greece’s debt – along with the debt of Spain and Portugal – was more diversified among governments and institutions, then a default of the debt might cause fewer problems as the pain of a write-down would be more widely distributed. Instead, European banks hold a big slug of this debt. The Economist magazine recently estimated that foreign banks’ exposures to Greece, Portugal, and Spain combined comes to Euro 1.2 trillion and that most of this debt is being held by European Banks. German bank holdings alone account for almost a fifth of the total debt.

So investors are showing sensitivity to European bank stocks and indexes that have a large weighting of financials in their benchmark index. The graph below shows that there’s been a rough correlation between the performance of country benchmarks and their weightings of financial stocks.

The riskiness of European bank balance sheets may not be an issue that is quietly swept under the rug. That’s because the debt repayment schedules of the countries with the greatest amount of stress on their sovereign balance sheets are very much front-loaded. For the countries that are most often grouped together – Greece, Portugal, Italy, and Ireland, and Spain – about two-thirds of their total debt is due over the next three years. These aren’t risks that sit far out on the horizon. These are risks that come due in the next few years.

In addition to monitoring country risk, investors will likely be assessing broad benchmark risk by measuring the weight of each index that is dedicated to financial companies and which banks hold the greatest amount of debt from the countries with the highest leverage ratios. These differences will also likely fuel future divergences in benchmark returns.

International stock markets are undergoing a new level of analysis at the country level. It’s likely that investors are beginning to price in changes in their assumptions of futures cash flows and discount rates, informed by each country’s growth prospects, debt levels, inflation risks, and fiscal battle plans. If the first decade of this century was about the convergence of economic performance, bond yields, and stock performance in developed countries, the next few years may be about the growing divergences in these characteristics. If so, country selection will begin to matter again.

Copyright (c) Hussman Funds

Tags: Balance Sheets, Bond Yields, Canadian Market, Cfa, Credit Crisis, Economic Cycles, Economic Performances, European Economies, Exogenous Shocks, Fiscal Policies, Great Divergence, Growth Investors, Hester, Hussman Funds, Last Decade, Market Performance, Rate Policies, Stock Prices, Stock Returns, Strong World, World Gdp
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