When we first launched our shorter business cycle theory back in 2010 we highlighted 2011 and 2012 as years where statistically the developed world would likely risk returning to recession. The main strand of the argument being that the total policy flexibility (monetary and fiscal) that had allowed the "Golden Age" between 1982-2007 to see long business cycles was over. As monetary and fiscal policy became compromised by the zero bound (and a liquidity trap) and by the need to reduce the pace of accumulation of Government debt, we would likely return to normal length cycles as the authorities would be powerless to fight economic nature. So this return to the normal historical pattern would perhaps very broadly consist of 2-3 years of growth and maybe a year of recession. This pattern we saw repeating for at least the next decade. This remains one of our core views and yesterday the UK became the latest country to return to recession as GDP (-0.2% vs +0.1% expected) disappointed. Of major Western developed countries, the UK now joins Greece, Italy, Portugal, Ireland, Belgium, Denmark, Holland, Czech Republic, and Slovenia as being in recession. By the time the data comes out next week its likely to be followed by Spain and remember German GDP was negative in Q4 and is expected to be flat in Q1 so its not impossible that they will also follow. Most other countries in the West are currently not far off recession so more may join the pack this year. Perhaps the furthest away from recession is the US and it is no co-incidence that of the countries in our sample they have the combination of having a high deficit and one that is reducing by far less than virtually all their peers. Those in recession either have a much lower annual deficit or have seen their deficit shrink more aggressively.
So if you had an argument against our shorter business cycle theory for the US then you might state that they don’t yet have a fiscal straight jacket and therefore still have flexibility to avoid a recession. Back in 2010 we thought it was unlikely that they could survive through to 2013 without a recession but clearly much depends on fiscal and monetary policy going forward. The election in November could be key here. Has the US been proved right and everywhere else proved wrong? Or is it just that the US has more international financial credibility that allows it to run higher deficits than other countries? If others copied the US then maybe a debt crisis would have occurred. Which to be fair is what has happened in many areas.
However if you wanted to be optimistic for those in recession, could we eventually look back on this week as being a pivotal one where the authorities finally realised that austerity without unconditional monetary support at this point in the structural cycle is detrimental to growth? One of the things we mentioned on our conference call earlier this week (replay details at the end) was that amongst the current renewed evidence of renewed economic weakness and political turmoil (in Holland and France) then maybe Europe would finally start to appreciate that they have the wrong policies in place to keep the crisis at bay. So its possible that we may get a different political agenda in Europe emerging. Indeed Merkel caught the mood yesterday as she suggested that austerity alone will not resolve the crisis and added that “we need growth in the form of sustainable initiatives, not simply economic stimulus programs that just increase government debt”. However its all very well saying that you want growth but its another thing achieving it. We’re not sure what can be done in a deleveraging world to actually get decent growth outside of increasing Government spending which isn’t going to happen for obvious Sovereign crisis avoidance reasons. Maybe a slower pace of cuts helps but it doesn’t mean growth will be aggressively high. We can’t help thinking a much weaker Euro would be the best thing for growth on the continent. However that probably only happens with a much more aggressive, unconditional and consistently intervening ECB. If we had that maybe Europe could get higher growth.
So maybe we may be starting to see the origins of a different political emphasis emerging towards growth but we’re scratching our heads as to how you actually get that. If it were that easy wouldn’t every government always have a bias to promote it anyway?? As discussed the US stands apart for the time being and yesterday FOMC meeting showed again a slightly more upbeat economic assessment from the Fed. The Committee noted signs of improvement in the housing market and the decline in unemployment rate although inflation has picked up somewhat. The first rate hike forecast date was brought forward a bit with only four members projecting that it would come after 2014 (previously 6). What got the market excited however was another dovish performance from the Chairman. Bernanke said that “we remain entirely prepared to take additional balance sheet actions if necessary”. So further easing is certainly possible if data flow starts to turn south. In the past our economists have suggested that the Fed is from Venus and the ECB from Mars. While this gap between the planets has narrowed in the last 6 months we still think it is a fairly good reflection of the DNA of the respective institutions. As we mentioned above an unconditional ECB is probably what Europe needs now given the austerity drive.
The S&P 500 (+1.36%) rallied further with the help of the Fed and the Apple earnings boost from the day before. It was generally another good day for earnings (EPS beat:miss of 74%:24% (2% in line), revenue beat:miss was 62%:38%) with the market cheered by IBM’s efforts to increase its share buyback program. On the other side of the pond we saw the CAC, DAX and IBEX gain +2.02%, +1.73% and +1.70%, respectively.
The overnight markets are mixed with equity market gains seen in Hong Kong (+0.51%), Korea (+0.25%) and Australia (+0.48%) while the Shanghai Composite (-0.2%) is modestly lower on the back of some weaker company earnings. South Korea’s GDP added 0.9% in Q1 which was in line with market estimates. In credit the Asian IG index is 1bp tighter with new issues being the main focus. Also in credit, bids for two commercial real estate CDOs (worth $7.5bn) from the Fed’s Maiden Lane III portfolio are due today and three banking consortiums are reported to be interested in the assets.
For the rest of the day, the Eurozone consumer/economic/industrial/services confidence surveys should be interesting. Germany’s CPI is also due today and markets are expecting prices to edge lower in April. German inflation might be the key to this crisis one way or the other. Elsewhere in Europe we have consumer confidence from Portugal, business confidence from Italy and Irish house prices to digest. ECB’s Draghi and EU’s Barnier will attend an ECB conference on Financial Market Integration. Over in the US, focus will probably be on the initial jobless claims and pending home sales. On the auction front, Italy plans to raise up to EU8.5bn in short-dated debt and we also have $29bn of 7yr UST supply today. Macro events aside we have a busy day of earnings on both sides of the Atlantic (63 S&P 500 and 40 Stoxx600 firms lined up).
Finally before we remind readers of the replays numbers to the conference call, as an Englishman we could have warned (from bitter experience) our Spanish friends yesterday that the one thing you don’t do is let a German side go to penalties!! It rarely ends well. Commiserations and congratulations to our readers in Madrid and Munich.
Colin Tan, CFA
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