THE MARKET'S TUG OF WAR, From Bob Doll, Bob Doll, vice chairman and chief equity strategist, BlackRock
Markets remain caught in a tug of war between reasonably strong economic fundamentals and escalating threats of external shocks. In the United States, the overall economic picture continues to be generally good.
Manufacturing and construction data have recently come in stronger than expected, corporate earnings remain a positive force, consumer and business confidence levels continue to be resilient and inflation pressures remain absent. There also continue to be disappointments, highlighted last week by the May employment report. Although the headline number of 431,000 new jobs was certainly a positive, the vast majority came about from temporary Census hiring, and private-sector jobs growth was quite weak. Nevertheless, average hourly earnings and hours worked both increased, and the national unemployment rate fell from 9.9% to 9.7%. On balance, we continue to expect improvements in private sector hiring and believe that overall economic growth should be decent in the second quarter.
Despite the generally positive backdrop, markets have been driven lower in recent weeks due to heightened uncertainty surrounding a number of issues.
Escalating geopolitical tensions in the Middle East have rattled some nerves, Chinese policy tightening has raised the possibility of an interruption in global growth, the credit crisis in Europe remains a problem, and the end game surrounding the oil spill in the Gulf of Mexico remains a wildcard. On that latter point, the oil spill could become a catalyst for far-reaching regulatory and/or legislative changes that could have a significant impact on the future of the energy industry, and the surrounding uncertainty has many investors concerned.
Despite the negative tenor of these events, we believe the financial stress in the system should be better controlled than it was in 2008, and we are not expecting a return to the conditions that plagued the global economy and financial markets two years ago. Central banks are still operating under many of the facilities put into place then, and the banking system as a whole has benefited from deleveraging, write-down and capital rebuilding. Additionally, the overall magnitude of sovereign debt exposures is significantly smaller than that of the mortgage-related holdings that ultimately provoked the 2008 credit crisis.
From our perspective, as long as the world economy does not sink back into recession (an event we consider unlikely), equity markets should be able to weather the current period of uncertainty. The economic recovery should continue, although we expect the pace to be relatively slow and interrupted along the way by periods of disappointing data. We believe investors will need to see a recovery in European debt markets and evidence that contagion can be contained before confidence can be restored.
EURO-PHOBIA, From Tom Lydon, CEO, ETF Trends
On Friday, the euro sank to a new low against the dollar, dragging down exchange traded funds (ETFs) with it. As concerns about Europe’s economy continue to mount, is the euro on a path toward parity with the U.S. dollar?
There’s a conundrum vexing the continent. Weaker states don’t like having their economic policies dictated by Germany. And stronger states don’t like spending billions to bail out their brethren from years of fiscal mismanagement. Back when the euro was first introduced, skeptics worried that the then-11-member states were too divergent to share a single currency and monetary policy. Those fears have been coming to pass lately.
ASIA’S MOMENT, From Charles Biderman, CEO, TrimTabs
It is now Asia’s time to shine.
In the two decades since the collapse of the Soviet empire, the U.S., Japan, and Euroland (the USJE) adopted two beliefs almost religiously:
1) All citizens should enjoy cradle-to-grave social benefits. In other words, education, employment, health care, housing, and retirement benefits should be provided, managed, or guaranteed by national governments.
2) Governments of developed countries can borrow basically as much as they want at low interest rates to fund these social benefits.
The entitlement explosion has burdened the USJE with so much debt relative to income that the process of restructuring debt and reducing social benefits has barely started. If history is any guide, this process will lead to social unrest and wars.
Debt restructuring is inherently deflationary. But the authorities in the USJE have demonstrated time and again that they will not stand idly by while the economy adjusts. As the latest stimulus wears off and economic growth slumps again, we predict that the authorities will go nuclear, printing money and pumping the economy with stimulus at rates that will make previous interventions look miniscule. At that point, high inflation and even hyperinflation could occur.
Turning back to Asia, broadband Internet adoption created an explosion of wealth in the past decade. This wealth creation was so rapid that Asia has not had time to adopt the ruinous entitlement policies of the USJE.
The huge cash flows generated in Asia stand in stark contrast to the huge amounts of bad debt in the USJE. As a result, we expect massive amounts of wealth to shift to Asia from the USJE in the next few decades. This shift is one reason we broadened our coverage to include Asia, starting with the Weekly International Liquidity Review and then with the Weekly Asia Flow Report.
VOLATILITY—THE HALLMARK OF A BEAR PHASE, From David Rosenberg, chief economist and strategist, Gluskin Sheff
In the past 30 trading days, the difference between the intraday low and high in the Dow has exceeded 200 points in 23 sessions—or over three-quarters of the time. That’s insane. If you look at the daily swings of 100 or more points (between the intraday high and low), then we are talking about 21 consecutive trading days or 106 days in the last 107! Now how’s that for a heart-stopper? But there is a way to minimize the wide fluctuations and allow the capital to grow prudently over time — even in a bear market too, so long as you are on the right side of the trade. It’s called true hedge funds or classic long-short strategies.
THE RECOVERY HAS SLOWED—BUT IT HASN’T STOPPED, From Alan Levenson, chief economist, T. Rowe Price
While the headwind from serial financial stresses is undeniable, the forces of cyclical recovery in the domestic economy are powerful.
Pent-up demand is being released. As credit conditions tightened and unemployment rose, consumers deferred spending where they could, particularly in longer-lived durable goods. Vehicle sales were a prominent example, plunging by 40% over the course of 2008 and early 2009. Since then, sales have risen by 20% (March-May average vs. year ago), including a 3.7% increase from April to May. Nonetheless, the annual rate of light vehicle sales is still roughly 25% below their long-term sustainable rate, determined by population growth and the scrappage rate.
Capital goods demand is also on the rise, particularly in information technology sectors, where a more rapid pace of product improvement and innovation shortens replacement cycles. Indeed, gross capital outlays in this sector appear to have fallen below depreciation last year, implying a decline in the net capital stock. Manufacturers’ shipments of IT goods rose 3.3% in April, and are on track for 15%-20% annualized growth in the current quarter.
Productivity gains have lifted competitiveness of U.S. exports. The ISM manufacturing survey index of export orders rose to a 21-year high 62% in May, reinforcing the staying power of the rebound in global trade that is bolstering U.S. factory output and employment. Moreover, strong productivity gains during the 2008-2009 recession have improved the cost competitiveness of U.S. products on world markets, raising the prospect that domestic producers can gain market share of the global economic recovery (Figure 2).
Production response passes from productivity to employment.
The scope for outsized productivity gains, however, appears to have run its course, as evidenced by the sharp slowing to roughly a 1.5% annual rate over the first half of this year from a 5.6% rate over the four quarters of 2009. In the context of buoyant output growth, hours worked must rise to make up for flagging productivity growth. An expansion of average weekly hours accounted for virtually all of the increase in aggregate hours worked in the first three months of recovery from the October, 2009 cycle trough. Over the last four months, rising employment has played an increasing role, accounting for over 40% of the increase in aggregate work effort (Figure 3).
Expanding hours worked boosted weekly paychecks even as wage growth slowed. The weekly wage bill – the product of weekly earnings and private industry employment – has expanded at a 5.1% annual rate since October, including a 6.9% rate over the last three months. Rising incomes and employment add to the capacity and willingness to spend, including big-ticket commitments to vehicles and household formation. The positive feedback loop to production and subsequent rounds of hiring increases the staying power of expansion in the face of persistent uncertainty from global aftershocks of the 2008-2009 U.S. financial crisis.
THE WEEK IN REPORTS
Monday, June 7:
April Consumer Credit
Tuesday, June 8:
Chain-store Sales (weekly)
Wednesday, June 9:
Federal Reserve Beige Book, Mortgage Applications (weekly), April Wholesale Trade
Thursday, June 10:
Jobless Claims (weekly), April International Trade,
Friday, June 11:
June U. Michigan Consumer Sentiment, May Retail Sales, April Business Inventories