A loss of recovery momentum
Mike Lenhoff – Chief Strategist
Brewin Dolphin
Investment Research
6 June 2011
Not only was last week’s economic news disappointing but also, in being so widespread, it confirmed the loss of recovery momentum behind the global economy. Great news for the bond markets.
Not great news for the UK, where exports have been a relatively strong feature of the economy. If anything, the doves on the Bank of England’s Monetary Policy Committee - the MPC meets later this week - will likely read the latest Purchasing Managers’ Surveys from Asia to Europe and the United States, all of which came in below expectations, as a vindication of their view.
Nor will the ECB, which meets later this week too, let the news flow dissuade it from thinking that the risks for inflation remain on the upside and that the need for vigilance remains critical. The ECB has other things to worry about, like the new aid package for Greece. The last thing the ECB wants on its hands is another banking crisis which is why its line to date has been motivated by a concern that even the slightest alteration in the terms of Greece’s loans would be seen as a default, no matter how camouflaged.
However, an accommodation is being reached on ‘voluntary’ participation by investors in bond rollovers and this appears to have the support of the ECB. Greece’s Prime Minister has promised further austerity measures for this year as well as for subsequent years and an accelerated privatisation programme has been agreed. Thus, as had been hoped, a plan now awaits approval – first through Greece’s Parliament and later this month at a European Council meeting. Equity markets should certainly feel cheered by this.
While the suddenness or abruptness of the loss of recovery momentum revealed by last week’s disappointing news all round may not be easy to explain, its widespread nature suggests that behind it lies a common denominator.
Given that the developing world and China especially were instrumental, along with the US, in leading the global recovery, the tightening of monetary policies throughout the emerging economies can be singled out, as can elevated levels for commodity prices, oil especially in the developed world and food stuffs along with oil in the developing world. The disruption to supply chains resulting from Japan’s Tsunami/earthquake may be relevant as is fiscal restraint, particularly in the eurozone. Depending on your view of causality as to what leads or lags, so may the limited availability of bank credit in the developed world.
On the other hand, the uniform loss of momentum apparent across May’s Purchasing Managers’ Surveys may be accounted for by May’s loss of momentum in the US non-farm payrolls. Or rather, when combined with this year’s US slowdown, the much weaker than expected job figure helps make the point that while China is the new and powerful global player, America’s influence over the global economy is still overwhelming.
As the chart below shows, global industrial output has been slowing for a number of months after what has been an unusually rapid rebound following a deep recession. That loss of momentum has transferred to the corporate sector where, as the chart also shows, earnings growth is now moderating.
This helps account for why equity markets have had trouble sustaining any progress this year. Equally, the commitment by the Federal Reserve to maintain its easy monetary policy combined with the determined efforts on the part of the ECB, EU and the IMF to avoid a Greek default help account for why equity markets have been reluctant to give up much ground. Certainly, the degree of volatility so far this year has been far lower compared to last year.
May’s extended sell-off into this month has left the FTSE All-World Index less than 5 percent down from its recent top - hardly worthy of a buying opportunity. Tactically, equity markets may see a bit more selling as they have yet to reach anything resembling an oversold condition. More downside then is likely to bring in the buyers, especially those who share our view that the widespread loss of momentum is likely to be par for the course in a global economy that is moving from recovery to sustainable expansion.
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Tactically, equity markets may see a bit more selling as they have yet to reach anything resembling an oversold condition.