A Mixed Global Outlook
The past quarter had three distinct driving forces that directed capital markets flow globally. The most influential continued to be the weakness in Europe and the issues related to sovereign debt and liquidity. The US markets seemed to gain traction during the fourth quarter, as both manufacturing, employment, retail sales and housing all showed better than expected results. The last major market issue was the slowing of growth in China, and the somewhat reversal of monetary policy enacted by the PBoC.
The inability of European officials to put closure on the debt crisis, is progressing into its third year and should remain the key determinant for the general investment climate and global capital markets. The regime of cost cutting and austerity that has been accepted throughout the region risks producing a deep and/or protracted economic downturn. It is very difficult to promote growth while fiscal cost cutting is being undertaken. While European economies need governments to invest into municipal projects such as roads and bridges, they are being forced into cutting social programs and other employment benefits.
The economic and financial linkages cannot be underestimated even though the European Union trades mostly with itself. Already there has been a significant drop in Asian exports to Europe, for example. U.S. businesses and many Japanese businesses meet European demand more through local production than exports. This, coupled with an environment of unfavorable currency translation, will still impact corporate balance sheets.
The scope for financial contagion may be even greater than the economic implications. European banks are under pressure from investors and regulators to strengthen their balance sheets. The ability to raise new capital, without an EU-wide guarantee, may be prohibitive.
It is unlikely that the ECB will backstop sovereigns nor is it likely that a European bond will be created. One of the results or not creating a bazooka and just muddling through will be a weaker euro, but barring an outright collapse, depreciation is likely to be broadly welcomed by European officials and businesses. A weaker euro is also consistent with the easing of monetary policy.
Another key driver of during the 4th quarter of 2011 was the slowing of growth in China. Many believe that China will engineer a soft landing for the world’s second largest economy. Part of the policy response may be a more stable Yuan. The Yuan was the strongest currency in Asia in 2011, appreciating about 3.8%.
China’s PMI declined below the 50 level during the beginning of the 4th quarter leading many to believe there would be a potential hard landing. In late December, the HSBC flash PMI improved to 49.0 from 47.7 in November. While this is not the official PMI, the two series often move together . Official PMI for December rose to 50.3 compared to the November reading at 49.0.
During the middle of the quarter, the PBoC reduced reserve interest rate requirements by 50 basis points which was the first decline in rates since the financial crisis during 2008. It is clear now that the Chinese central bank is now more concerned about future growth rates than inflation pressures. Chinese CPI fell below 5% for the first time in more than a year, giving the central bank room to maneuver.
China money and loan data for November were also helpful, and give cover for the PBOC to continue easing. Overall loan growth eased to 15.6% year over year from 15.8% year over year in October, the slowest since October 2008 as new loans fell -4.2% month over month. M1 and M2 growth slowed also to multi-year lows.
Into a world upon its own, the US economic data has been robust and continuing to point to an economy that is on the mend. Despite weaker than expected GDP for the third quarter, there is likely to be an overall change in the 4th quarter. Some of the changes came in the form of housing, employment, manufacturing and consumer spending in the form of retail purchases.
On the employment front, jobs data continues to gain traction. Both the US ADP and BLS data continue to show signs of improvement. During November, not only did the employment change continue to show solid results, but the employment rate moved close to the 8% level. This region was not expected to be reached until late 2012, according to the Federal Reserve. Additionally, jobless claims have continue to show market improvement. Jobless claims are down to 380K, but have been below 400K for 3 consecutive weeks, reflecting solid traction in the employment arena. Claims levels below 400K usually coincide with increases in payrolls of more than 200K per month. Solid growth in the jobs market will eventually spill over into consumer spending and housing.
In December, employment picked up. Nonfarm payrolls climbed by 200,000 in December, according to the U.S. Labor Department. Private companies added 212,000 jobs, while federal, state and local governments contracted by 12,000. The report comes on the heels of a much better than expected ADP employment report, released on Thursday, which showed that private sector jobs increased by 325,000.
The unemployment rate, obtained which is a household survey instead of a corporate survey, declined to 8.5% in December, its lowest level since February 2009. November’s rate was revised up to 8.7%. Analysts surveyed had expected a gain of 150,000 in payrolls and a jobless rate of 8.7%. November’s nonfarm payrolls was revised down to show a rise of 100,000 from a previously reported 120,000, and October was revised to a 112,000 gain from 100,000.
On the housing front, the US received solid reports toward the ladder half of the 4th quarter. Housing Starts in November increased 9.3% to an annual rate of 685,000. The results were better than forecast. Economists had expected housing starts would rise by 0.3% to an annual rate of 630,000. The increase in November was driven by a 25.3% increase in multi-family homes which are a target of rental investors. Construction of single-family homes, which made up about 65% percent of the market, rose only 2.3%.
On a year over year basis overall new-home starts in November were up 24.3%. The Commerce data showed that building permits, which is a reflection of future starts, rose 5.7% from a month earlier to an annual rate of 681,000, the highest since March 2010. Permits in November had been projected to fall 1.7% to an annual rate of 633,000. Additionally, pending home sales rose by 7.2%, which reflects an increase in contracts that were signed. The future of the housing market continues to show progress which could spill over into durable goods and eventually manufacturing.
The trends in the market will likely interesting to watch. Can the US disconnect from Europe and Asia? Can the dollar continue to rise, but not affect the rise in US equities. Most of these issues will unfold during the first quarter, and will likely guide the markets trajectory for the balance of 2012.
