Of all the permutations of growth stories, scares and soft patches investors should remember that when all is said and done, the economy and market can only do three things; move down, up or sideways. Of the three, the last state is often the most interesting and challenging since while in such a state the debate will be centered on two main themes. Firstly, the reasons for said sideways movement that broke and otherwise upward or downward trend and secondly whether the market and economy will eventually will break this sideways movement by launching a new or resuming the old trend.
As far as goes the market's erratic movement in the first half of 2011 the immediate reason for the abrupt halt to the positive trend was the devastation of the earthquake in Japan and the subsequent (short term) slump of global equity markets. While the SP500 did have a sniff at new highs at the end of April and into May this level could not be held and we have since poodled back down below support levels.
One of the problems in the current environment is that while the immediate macroeconomic outlook is one of a slowdown, the question of whether it will turn into a more lasting double dip is more difficult to determine.
(click on charts for better viewing)
On the face of it, we should now be approaching the point at which the global economy reveals to us just what level of growth that we can expect to be "normal" and crucially; where this growth is supposed to come from.
What might be starting to creep up on investors' screen is that the answer to the question above might not be what they anticipated.
On the basis of the data I am looking at, the upward momentum of global leading indicators peaked a year ago (in Q4-09) and momentum has since steadily declined to reflect growth returning to "normal" after the sharp recovery following the global financial crisis. The most recent soft patch in the middle of 2010 gave way to a rebound, but the key is whether the recent relative decline in growth momentum is a messenger of a more sustained downturn or simply another so-called mid cycle soft patch. OECD's leading indicators point to a definite slowdown but also to a rebound towards the end of the year. The main point really is one of divergence between economies.
In Europe it has become almost unbearably painful to watch the charade which surrounds the slowmotion default in Greece and the frantic attempts by policy makers to suggest that all is well and the next loan tranche is coming. Everyone can understand why politicians, of all people, should not give way to short term panic and whims of the market but we are way past the point of no return and we need a credible long term solution to not only Greece but indeed the debt overhang in the entire so-called periphery.
Not surprisingly, the macroeconomic backdrop of the ongoing fiddling while Rome (or was that Athens or Madrid?) burns is deteriorating. Morgan Stanley recently noted then that;
We see increasing evidence that the euro area business cycle has reached a turning-point. This verdict comes very clearly from our Surprise Gap Index, which plunged deep into negative territory in May. Our Surprise Gap Index is our long-standing favourite proprietary indicator to pick out the turning points in the euro area business cycle.
My only quibble would be that some economies in the Eurozone never experienced an upturn in the first place. It must now be clear for everyone that choosing to put faith entirely in a process of internal devaluation with little or no additional help from the ECB (and even interest rate hikes to boot) has put us in a situation which is far more dangerous than the one we set off from.
A sovereign default was always going to be costly and the main channel of transmission to the real economy will the capital shortfall at banks and who essentially should pay to recapitalise them. Yet, the continuing steadfast position that any form of restructuring is out of the question pushed us further towards the point where events overtake policy makers to such an extent as to foster a collapse of sentiment and trust which will ricochet far beyond the growing queues in front of Athens' banks.
In emerging markets, growth will remain strong but policy makers in key countries such as India and China have grown weary over inflation and especially in the former seems to be content on accepting short and perhaps even medium term slowdowns in order to tackle inflation. There is no risk of a recession in emerging markets (and thus the global economy) at this point but any slowdown in emerging markets will be an important litmus test for the developed world and thus just how dependent we may now be on a continuing expansion in the so-called developing world.
Even in the face of mounting inflation problems as a result of importing low interest rates from the US I remain constructive on emerging markets and especially on China. Quite simply, I am working under the assumption that while authorities may move clamp down on inflation and excess growth in credit the main bias is thoroughly towards letting the boom continue. If I see signs that this assumption may be wrong I will duly change my views, but so far so good.