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By Peter Buchanan
research.cibcwm.com
Observers have been paring their projections for the global economy, as illustrated by the OECD’s forecast cuts this week. At the same time, they have been reducing the odds on the more extreme outcomes that had figured in the summer’s upwelling in market risk aversion. US double dip anxieties have subsided appreciably in the wake of August’s “less bad-than-expected” payrolls report. That showed private sector job creation not falling outright as some had feared, though still far well below levels needed to dent crippling unemployment.
Fears of a stumble also appear to have eased in another key player, China, feted just weeks ago as the world’s new number two economic power. The just-released August trade data pointed to a continued recovery in the important export sector from year earlier weakness tied to the global downturn. That’s good news for the economy, though not perhaps for trade tensions with the US.
China’s 40% share of global industrial metals demand has made it an enormously important arbiter of price trends, especially for non-energy resources. The health of the economy there will become clearer over the weekend when a further deluge of data is released. Back in June (see “Reading China’s Tea Leaves”, June Economic Insights), we wrote that reports from China were consistent with a controlled downshift in momentum from white hot levels, as opposed to the free fall some had feared. The more recent data to this point, have lent added support to that assessment. The latest PMI readings are consistent with a year on year rate of growth of about 9% in GDP in Q3. That would represent a downshift—but not a too radical one— from the preceding quarter’s pace.
Housing price inflation, a key policy concern earlier in the year, is also showing some signs of abating. Those prices were up 9.3% on the year in August nationally, down from April’s peak of almost 13%. Other evidence suggests however that the government may have to take further action to cool what has been the economy’s hottest sector in recent quarters. Housing transactions jumped in a number of key urban centres in August, rising by a steep 84% on the month in the Shenzen area near Hong Kong.
Given renewed concerns that China’s housing market may still have too much momentum, investors will be paying particularly close attention to the pending monthly inflation numbers. A reading above July’s 3.3% print could reinforce worries that more tightening may be needed, weighing on commodity markets.
Will the Bulls Keep Running?
By Peter Buchanan
research.cibcwm.com
Besides Pamplona, the bulls were out in some force this week on Wall Street, after a lengthy absence. Whether they continue to roam quite so freely will depend in no small part on the upcoming S&P earnings season, which begins Monday.
Market eyes will also be on China. That country, a centre of slowdown fears that have battered commodities, reports Q2 GDP on Thursday, becoming the first major economy to do so.
Investors and companies have had their plates full of market moving developments lately. Eurozone contagion fears dominated the headlines during the spring. More recently, concerns have shifted to the US economy itself. Forward-looking data is always more critical in interesting times. Analysts are expecting a year-on-year rise of 23% in earnings for the S&P 500 in the quarter ended. How well firms do against that target will as always be of significance. But even more important, given the fast-changing backdrop, will be the clues provided in the guidance of what to expect down the road. Announcements from some firms have suggested that meeting last quarter’s targets may not prove so difficult. However, the year-on-year comps will get more challenging from here as the earnings recovery matures. Given that fact, a loss of fiscal support and drag from the higher dollar, investors will be more interested in firms’ views on their ability to validate the 27% and 31% earnings gains pencilled in for Q3 and Q4, based on the Thomson data.
Double-dip recession fears appear to have eased a bit in recent days, contributing to the improved tone. That’s not so surprising. While the housing data has been abysmal, two broader gauges of the US economy’s health are still some way from recessionary territory. The yield curve has only flattened by about a fifth as much as it did before the last two recessions (Chart). The ISM index, while softer, is still 14 points above the level typically associated with a broad economic pullback.
The IMF’s upgrade of its forecast for 2010 global growth also helped to ease gloom on Thursday. Part of the story there was China. With fiscal retightening set to slow growth in the indebted developed nations to a crawl of 2% or less next year, the global recovery’s prospects will rest even more on the shoulders of emerging market businesses and consumers. China’s GDP report will indicate whether those in one key market are up to the task.
Implications of the Greek crisis
At this time it is important to put the Greek situation in perspective. Will we be talking about Greece 12 months from now? Clearly, no one can predict how the stock and bond markets will react in the coming weeks to developments in Europe. After all, as we all know, in this kind of situation the market is driven by emotions (panic?), not fundamentals.
It is not enough to say that the impact of the crisis will be limited due to the fact that Greece is an insignificant player in the global economic arena. After all, Thailand which originated the Asian debt crisis of 1997 is not exactly an economic giant. The more important focus should be on the shape of the global economy at the eve of the crisis. And in this context note that the crisis is occurring in an environment of a recovering global economy while the EU’s bailout of Greece implicitly guaranteeing the debt of larger economies such as Spain and Italy.
The drivers of global growth now include China and India, which are less vulnerable to Europe’s downturns. At the same time, Latin America and Southeast Asia enjoy much stronger government finances and more moderate exchange rate. These factors reduce their sensitivity to economic shocks. Furthermore, Greece, Portugal and Ireland don’t have the trade or capital market gravity of their larger European neighbors. The Greek crisis will end up being an important event in the history of sovereign debt, but its impact on the global economy will be minimal.
More important focus should be on the fact that the crisis is an exaggerated preview of what we should expect to see down the road from other countries. After all, Greece is not the only country that is facing a mountain of debt. Yes, the magnitude is different but the direction is the same. In Greece, they call it austerity measures, in North America it will be called reduced spending and higher taxes.
The point is that fiscal policy will work as a clear negative for overall economic growth. In Canada, for example, a government that was responsible for no less than 40% of overall economic growth during the past decade will start acting as a negative for economic growth in the second half of 2010 and beyond. The fiscal drag in the US will be much more significant. Accordingly, while the Bank of Canada will probably proceed with its plans to raise rates come June or July, the upcoming fiscal challenge suggests a very gradual approach. As for the stock market, any significant sell-off in the coming weeks should be seen as a buying opportunity.
Benjamin Tal
Senior Economist
Benjamin Tal
Senior Economist
The Toronto stock market advanced Monday afternoon after solid manufacturing data from the U.S. and China sent commodity prices higher.
The S&P/TSX composite index was off early highs as losses mounted in the telecom and tech sectors on the first trading day of 2010. But the main index was still ahead 76.8 points to 11,822.9 as the Institute for Supply Management’s U.S. manufacturing index rose to a better-than-expected 55.9 last month from 53.6 in November.
A figure above 50 indicates expansion and the bigger the difference, the faster the expansion.
Other data showed China’s manufacturing sector expanded at its fastest rate in 20 months in December.
The monthly purchasing managers’ index – a key gauge of activity – for the 16 countries that use the euro rose to a 21-month high of 51.6, while the equivalent survey for Britain rose to a 25-month high of 54.1.
“I think you have all the pieces,” said Kate Warne, Canadian markets specialist at Edward Jones in St. Louis.
“The news is better than expected on the economy and certainly in the U.S. and China, which are both global growth drivers. And I think that’s what everybody is watching, so we have commodities higher and no surprise the TSX is up as well.”
The Canadian dollar jumped 0.99 of a cent to 96.14 cents US – its highest level since mid-October – as the data pushed the American currency lower.
The economic reports follow an impressive end to the 2009 trading year that saw the main Toronto index up 31 per cent – its best one-year gain since 1979. The Dow Jones industrials ran ahead 19 per cent, the tech-heavy Nasdaq 44 per cent and the S&P 500 index jumped 23 per cent as investors hope a solid economic recovery is taking place.