FYI | May 15 2007
By Chris Shaw
After a string of gains share prices experienced a few wobbles late last week on poor US economic data that included a weak trade report for March and poor April employment numbers, causing increased concern for investors with respect to the growth and earnings outlook in the world’s largest economy.
It appears these concerns were quickly shaken off as the US market on Friday regained most of what it lost the previous day, a continuation of a trend in place over the past several months whereby the market has been able to correct and then recover strongly.
SVB Senior Analyst Dave Baghat suggests such performance is not altogether surprising, as since the major correction in markets in May last year global economic conditions have actually improved in a number of ways.
These include signs the industrial cycle is picking up, particularly in Europe and Asia, which is crucial as it coincides with evidence US consumption is showing signs of weakening. At the same time oil prices are down from last year’s highs, reducing inflationary pressures, while an easing in employment growth in the US has been matched by an easing in wage pressures.
Concerns remain over the state of the US housing market, which is obviously in a bad way, but as Baghat points out the fact the correction in the sector has dragged out over many months makes an implosion far less likely than could have been the case. At the same time central banks appear unlikely to do anything to upset the apple cart as the Fed appears on hold, the European Central Bank has flagged a rate increase next month and the Bank of Japan is likely to move slowly on lifting rates.
To Morgan Stanley’s Stephen Jen it all points to evidence the global economy is successfully de-coupling from the US economy while the US itself is in the midst of a mid-cycle slowdown. This is a good thing, he notes, as IMF data shows the previous occasions there have been soft landings in the US these are usually accompanied by healthy growth in the rest of the world while hard landings have a negative impact on global growth.
The broker itself sees little chance of a hard landing, its indicator prescribing only a 12% chance to such an outcome. Assuming a soft landing Jen argues there is no need for equities to be weak in sympathy, as the slowdown in the US would actually reduce overall risk and make global growth more sustainable. The risk in his view is world growth is actually too strong and rekindles inflationary pressures, which could see central banks move to correct positions seen as being behind the interest rate curve.
With no signs such moves are likely Jen views the current environment as positive for riskier assets, a view shared by Baghat who points out equities are still reasonable value against bonds and when compared to the overall cost of financing positions.
To those who argue the current situation is one where global economies are out of synch rather than evidence of a de-coupling Jen suggests looking at China and Canada, as both economies are continuing to grow strongly despite weakness in their major trading partner.
The environment is not as positive for the US dollar, Jen arguing the greenback should remain weak until there are signs the US economy is reasserting itself. Baghat agrees, though he notes while the greenback has been weak the weakness has not been uniform and Asian emerging market economies have not experienced as much currency appreciation as would have been expected given the conditions.
Looking forward he expects this to continue, as while the current environment is supportive for currencies such as the yen they have remained weak as a function of interest rate differentials.
Jen sees this as continuing in the shorter-term, but suggests investors look to go long the US dollar against overvalued currencies such as the euro on any signs the US economy is reasserting itself.