All eyes are on economic data emanating from the US since it remains the single largest economy in the world and has remained resilient to the eurozone crisis thus far. When America sneezes, the world catches a cold.
Positive surprises have emerged from the US economic data pertaining to the final quarter of 2011. Today, in the US, more jobs are being created than expected (US unemployment rate fell from a peak of 9.2 % in the summer of 2011 to 8.5 % in December, while unemployment in the eurozone is on an upward spiral), new jobless claims were the lowest since just
after Bear Stearns failed, unemployment is down, consumer confidence is up, and car sales are on a roll.
The manufacturing purchasing managers? index (PMI) surveys for December add to the evidence of a sharp divergence between the US and eurozone economies during the second half of 2011.
The US Institute for Supply Management (SMI) jumped to 53.9 in December, up from 50.8 only two months earlier. By comparison, the eurozone PMI increased only marginally in December, and at 46.9 it still points to a deep recession.
There are good reasons to believe the US may be able to ride out the eurozone crisis without being dragged into a recession itself. Most importantly, the US banking sector has limited exposure to Europe, is well capitalised, and the Federal Reserve is well placed to stave off a liquidity crunch. For the five biggest US banks, total exposure to Greece, Ireland, Italy, Portugal and Spain (net of hedges) ranges from $16 billion at Citigroup or 14% of core capital, to $2.5 billion at Goldman Sachs or less than 4% of core capital.
Also, only 19% of US exports now go to Europe, down from 28% in 1980, suggesting that the correlation between the two economies may have fallen in the past decades.
Economic growth is not the only determinant of asset prices, and, in fact, there is little or no correlation between growth figures and shares over the past 100 years. Still, the recent recovery in equity markets is predicated in large part on the apparently improved prospects for the economy.
It is never easy for economists to identify major turning points in the global economic cycle as they are happening in real time. Economic data at these stages of the cycle are inevitably noisy, and it is easy to miss major inflection points, even several months in arrears. Yet, active investors have little choice but to attempt to take a view on this critical matter. By the time that economic data have clearly confirmed a turning point in global activity, asset prices will already have fully discounted the news.
One way of trying to handle this difficulty is to examine monthly changes in global leading indicators, including business surveys. As Chart 1 shows, these real-time data have traced out a clear turning point in global activity since the middle of last year.
In retrospect, the path for world oil prices probably proved decisive for the mini-cycle in global activity in 2011. Leading indicators bottomed in July/August, shortly after oil prices peaked. Global activity improved slightly in September and October, but at that stage, only the US proved robust to the increasingly grim economic data emerging from Europe and China. There seemed to be a significant risk that the eurozone crisis would cause a renewed recession not just in Europe, but in the world as a whole. But the economic data for November and December do not seem to have justified these fears.
The eurozone is, of course, already in a shallow recession, and this will inevitably worsen markedly in the peripheral economies as fiscal policy tightens by about 2% of GDP this year and banks continue to delever. But the large demand shock which is under way in the crisis economies of the eurozone will, on its own, reduce global GDP by no more than 0.2% this year. Even assuming that the eurozone shock drags the core economies like France and Germany into recession, which is likely but not certain, the impact on global GDP would be only about 0.4%.
This is manageable, given the 3.3% growth rate which the US economy seems to have recorded in 2011 Q4. Admittedly, part of this apparent strength in the US may well be illusory. There are grounds for believing that seasonal distortions have exaggerated the strength of the American economy in recent months. And fiscal policy is scheduled to tighten by about 0.75% of GDP this year, much the same as last year. Besides, in the absence of much greater contagion from the eurozone, recession risk in the US seems much smaller than it was in mid 2011.
So how might trans-Atlantic contagion occur? By far the most worrying channel is via stress in the eurozone banking sector. Consider Chart 2, which shows financial conditions indicators in the US and the eurozone.
The tightening in the eurozone FCI has now been about half as severe as that which hit the European economy at the end of 2008. That is enough to cause a recession, but it would have been far worse if the ECB had not taken enormous steps to support the financial system, and the integrity of the euro. In the process, they have come much closer to full-scale quantitative easing, along with bailing out of eurozone governments, than they have been willing to acknowledge in their rhetoric.
Since the end of 2008, all categories of US private-sector debt have fallen relative to GDP. Financial-sector debt has declined from $8 trillion to $6.1 trillion and stands at 40% of GDP, the same as in 2000. Nonfinancial corporations have also reduced their debt relative to GDP, and US household debt has fallen by $584 billion, or a 15% reduction relative to disposable income. Two-thirds of household debt reduction is due to defaults on home loans and consumer debt. With $254 billion of mortgages still in the foreclosure pipeline, the US could see several more percentage points of household deleveraging in the months and years ahead as the foreclosure process continues.
Besides, the US household debt ratio could return to its long-term trend in 2013 (see Chart 4) which would be further favourable.
Not everything is rosy, of course. Last week?s Philadelphia Federal Reserve?s business survey was disappointing, in contrast to the surprisingly strong New York regional survey. There are only the most tentative of signs of a recovery in housebuilding. And the US Christmas sales were disappointing for retailers.
Admittedly, since 1980, there has been only one previous year during which GDP in the eurozone economies contracted while the US continued to grow ? but that was in 1993 in the wake of the collapse of the ERM and German reunification.
The manufacturing PMIs also showed a slight improvement in December for most of the major emerging economies and for Japan. But in all cases they still point to weak manufacturing growth or outright contraction. Moreover, the manufacturing PMIs in the four Bric economies, the eurozone, Japan, the US and the UK are all well below their levels in January 2011.
As a result, the global manufacturing purchasing managers? survey also increased in December, to above the 50-mark which supposedly divides contraction from expansion, but it too ended the year well below its reading in January 2011.
Given the bleak outlook for the eurozone and the continued fiscal austerity in the US and elsewhere, I do not think the upturn in December will be sustained for long in the new year. Overall, I expect global GDP growth to drop from just below 4% in 2011 to 3 % this year?well below the average growth rate of over 4% during the pre-crisis years from 2000 to 2008. In short, the relatively encouraging end to 2011 should not detract from the not so rosy outlook for 2012.
Despite its ability to withstand a euro break-up, I expect US growth to edge down to around 1.5% this year from 1.7% in 2011, whereas the consensus forecast is for growth of over 2%. This is largely for domestic reasons, the most important being further fiscal austerity
and continued weakness of the housing and labour markets. And if the eurozone crisis spins out of control more fully and rapidly than we currently expect, then the US just like rest of the world, would not be so immune.
The author is CEO, Global Money Investor
