Overview
Nearly all central banks, be they in developed or emerging nations, seem to have gotten the memo – ease, early and often. Although triggered by weaker growth (never a market pleaser), lower rates are one of the most reliable triggers of positive outcomes for stock markets. Of course, many other factors require analysis.
As much of the world appears to be slowing or stuck in a rut, the U.S. is displaying some signs of strength. Is it the result of a mild winter? Will commodity prices and other factors lead to a replay of the rising first-quarter enthusiasm followed by dashed hopes in the summer that we saw in the last two years? The data are likely to get weaker, but this could be driven by “optics” rather than a fundamental weakening.
North America
Tony M. Caxide, CFA®
Chairman - Senior Investment Council
In the U.S., most causal factors appear firmly rooted on the positive side of the equation. We would include in this group monetary policy and pent-up demand, and, increasingly, the balance sheets of consumers and the U.S. banking system. Also, although commodity prices rose to fairly elevated levels, the gains have largely reversed as we write this (oil and gasoline prices being the key exceptions). Further, our research suggests that it’s not the price level but the rate of change in prices that matters, and on that score we should be fine.
Nevertheless, we anticipate a near-term headwind. It appears that the 2007-2009 crisis impacted seasonal adjustment factors, and, ever since, the fourth and first quarters of the year appear stronger than normal and the second and third quarters weaker than usual. In 2012 we could see an exaggerated version of this phenomenon as the mild winter aggravates the pattern. The bottom line is that, after experiencing unusually strong data, we could be about to see releases that appear below average. This could be more optics than real, but may trigger market volatility.
Japan
Jeffrey G. Wilkins,
Deputy Chief Investment Officer
Despite a weaker Japanese yen as a result of both deliberate currency intervention and monetary easing by the government, Japan’s export-oriented economy remains fragile. After posting only its second annual trade deficit in the last two decades in 2011, Japan’s trade balance did break back into positive territory in February. However, the surplus was more than 30% below last February’s number. In an unusual show of solidarity, politicians appear to be reasonably united in their conviction to end both the yen’s appreciation as well as price deflation, which has improved but not abated. While the employment picture is improving slowly, the Japanese consumer appears to be holding back. Retail sales are once again falling.
Europe
Jeffrey G. Wilkins,
Deputy Chief Investment Officer
Liquidity injections late last year were successful in smoothing the Greek bailout and easing investors’ fears in the short-term. However, several European economies continue to face many issues. The rising cost of borrowing for Spanish and Italian debt, slowing growth rates, and high levels of unemployment are some of the economic challenges (all difficult to wrestle with biting austerity measures). Further, Europe is also vulnerable to external events such as economic growth rates elsewhere, specifically China and the United States.
Adding to the uncertainty, many countries are holding elections and/or referendums over the coming months, and not all the candidates are in agreement with the steps taken to date. Although equity-market valuations are appealing on a historical basis, geopolitical risks and the current European economic downturn are worrisome.
UK
Jeffrey G. Wilkins,
Deputy Chief Investment Officer
The UK economy is closely linked with its neighbors across the Channel and thus couldn’t escape the area’s weakness. Its GDP growth has just been revised to a -1.2% annualized rate of contraction, impacted by both global and domestic factors.
Since peaking in 2007, UK consumers’ consumption habits have been weaker than any of the other G7 countries, in part due to the UK’s higher inflation. But now that VAT increases are imbedded in the economy, the rate of change in inflation may continue to subside, which, with improvements in the labor market, may lead to improved spending.
Emerging Markets
Tony M. Caxide, CFA®
Chairman - Senior Investment Council
Many emerging nations have joined their developed brethren and started down the road of aggressive monetary stimulus. Although reflective of weaker growth (which the markets generally are not fond of), lower interest rates typically lead to rising prices for riskier assets like stocks (at the cost of bond prices, generally). Brazil is the most recent example. Burdened by a very strong currency and moderating global growth, its economy has slowed sharply. As a result, its administered rate has been cut repeatedly, and now lies at a two-year low. This brings its own risk, as inflation and credit growth remain elevated – a potentially explosive combination.