Commodities | Oct 17 2006
By Greg Peel
“Flip-flopping”, says Morgan Stanley’s Stephen Roach.
That’s how he describes the latest mood shift in global investor sentiment. One day we’re having a commodity price correction based on real evidence of economic slowdown, and the next we’re back into commodity boom mode.
“Stubborn as always, I’m wary of such a quick about-face”.
Stubborn indeed. World-renowned economist Roach is what they call in the market a “perma-bear”. He may have actually been bullish once but no one can seem to remember when. Maybe it was at the beginning of the tulip bubble.
Roach spent most of last year railing against the dangerously wide US current account deficit, and touting the inevitable conclusion of a collapsing US dollar. He then went quiet for a while. But as the reality of a sliding US housing market has become the most prominent headline of late, Roach is back to point out where his earlier predictions are coming to pass.
But housing market concerns are now so…yesterday. “It’s as if a $46 trillion global economy turned on a dime”. Roach is prepared to be proven wrong, but he suspects the latest flip-flop will be short-lived. His latest report passes judgement on the three factors he sees driving this turnaround in sentiment – a falling oil price, “Fedspeak”, and the China factor.
If a lower oil price is going to provide a boost to the American consumer, then how come the oil price doubled from 2003 to 2005, yet real US consumption growth increased from 2.7% to 3.7% in the same period? And at the same time global economic growth averaged 4.9% – the strongest burst of growth since the 70s.
Roach suggests it is because the 70s oil shocks were about supply, while this time it’s been about demand – ergo, not damaging. Now a boost in economic growth is expected because a lot of the oil price fall is to do with an increase in supply.
Is it? Or has there been a fall-off in demand as well? Roach believes the rational American consumer [they have those?] will “see through” the oil (and gasoline and heating oil) price falls, and treat them not as a windfall, like some energy-related tax cut, but as a chance to rein the household budget back in. As the US housing bubble rapidly deflates, Roach sees rational consumers switching from asset-based savings to income-based savings.
77 million American baby-boomers face retirement in the next few years, and income-based savings have fallen to negative for the first time since 1933, and what a depressing year that was. This compares to a savings rate of 8% during the 70s oil shocks, which provided a cushion to ride out the pain. Roach believes the housing slide will “take a meaningful toll on the seemingly unflappable American consumer”.
Roach believes recent statements from the Fed have had but one purpose – to rein in the excesses of the bond market, which had already come to be pricing in up to three rate cuts in 2007 on the back of a slowing economy. The Fed has reiterated its intention to be firm rather than accommodative in monetary policy, and the “beige book” (that which tables anecdotal reports of economic conditions around the country) showed a return to consumer confidence, which would have dashed the hopes of those looking for economic deterioration.
Nevertheless, Roach believes predictions of aggressive Fed easing ahead hardly seem unreasonable.
There is no great evidence yet of a slowdown in the Chinese economy. Roach believes, however, that 11.3% GDP growth in the second quarter, 19.5% industrial output growth June to June will represent the “high-water mark” for this cycle. He is anticipating (as many economists do) a fall to 8% GDP growth a year from now, and 12-13% for industrial output.
This only means China’s economy will cool from “white hot” to “red hot”, but it will be meaningful enough a deceleration to impact commodity markets and China’s suppliers in Asia. And “whispers in Beijing” suggest this is the preferred outcome of government officials as well. There is otherwise too much risk of excess capacity, deflation, and a protectionist backlash.
Roach does not believe China will suffer a hard landing, but he has long held the view a slowdown is crucial to the sustainable growth objectives of the Chinese leadership.
Hence Roach cannot see how the combination of a downshift in the American consumer on the one side, and Chinese supplier on the other, will not precipitate a global slowdown. Sure, Germany and Japan are talking economic revival, and that could serve to offset somewhat, but they are unlikely to fill the void.
This is not good news for the export-led economies of Asia (including Japan) which are leveraged to both US consumption and Chinese production, nor to Canada and Mexico – suppliers to the US – nor to Russia, Australia or New Zealand – commodity suppliers to China.
“Until the broader world economy establishes a solid base of internal demand – especially private consumption – it will have a hard time withstanding the impacts of slowing in the US and China”, says Roach.
Don’t say you weren’t warned.