This week we introduce the Monthly Macro, a recurring installment that will appear on the first Tuesday of every month and will recap the high level macro developments of the previous month. We will highlight the global themes that we believe are the most important and discuss why they matter for investors. This month’s piece will focus on green shoots in the US, the changing attitude towards austerity in Europe, the pending questions surrounding China’s economy and the latest round of monetary madness courtesy of the Bank of Japan.
The past five years have been marked by the “two-speed” recovery in which emerging regions of the world are growing rapidly while developed regions languish. Recently, however, the IMF began referring to the “three-speed” recovery, carving out a third category for the stable and growing United States. Indeed, the US continues to muddle along in the right direction. The first estimate of Q1 GDP revealed 2.5% annualized real growth, solidly positive and well above the fourth quarter’s 0.4% pace. Housing has been a key tailwind and continues to accelerate. Recent data from Case-Shiller showed the average home in the 20-city composite increasing by 9.3% over the past year through February. That is the largest annual increase since May 2006, and it’s one of the primary reasons why the household sector’s balance sheet is looking so healthy again.
WHY IT MATTERS: Despite all the concern over the elections, fiscal cliff and sequester, the pullback in government spending appears to be getting trumped by individuals and corporations loosening their pocket books. The US remains the “cleanest dirty shirt” among developed nations and should remain in that position for the foreseeable future. This means US assets should be the beneficiaries of global capital flows while at the same time the markets will keep a watchful eye on how the Fed responds to the improving data.
Austerity On The Outs
In contrast to the US, Europe remains stuck in a quagmire of economic contraction. Eurozone unemployment just hit another record high and has climbed for twenty three consecutive months. But the regional number doesn’t tell the whole story. While the southern countries are seeing jobless rates approaching 30% in some cases, Germany is sitting contently with one of the lowest unemployment rates in the world. This gap in economic reality is exacerbating the tensions between member states. Austerity, the practice of slashing government spending and increasing taxes, is becoming less and less popular across the southern periphery. Spanish Prime Minister Mariano Rajoy, a leading proponent of austerity in his first year in office, recently spoke out against “spending cuts for the sake of spending cuts”, and newly elected Italian Prime Minister Enrico Letta said in his inaugural address that “Italy is dying from austerity alone.” Meanwhile, the stalwart that is Germany’s Angela Merkel countered with a public statement suggesting that what others vilify as austerity she sees as simply “balancing the budget”.
WHY IT MATTERS: We don’t see Europe’s economic malaise reversing course anytime soon, thus this battle over fiscal policy might just be getting started. After a year of austerity many are seeing it as a failure and are ready to move on. Additional flare ups in the region are likely and will lead to bouts of volatility in global risk assets. In the words of Bundesbank president Jens Weidmann, without additional reforms being implemented across Europe, "the calm that we are currently seeing might be treacherous.”
Big Questions In China
The emerging markets story remains all about China. First quarter GDP growth came in at 7.7%, down from 7.9% in Q4 and below consensus estimates for 8.0%. The market reacted negatively to the disappointment, but is slightly slower growth necessarily a bad thing? The latest survey of property developers showed the fourth straight month of national home price appreciation despite the government’s efforts to cool the property market and control the bubble. Meanwhile, concerns are growing rampant about China’s “shadow banking” industry which Fitch estimates is now as large as 60% of the country’s GPD. Even President Xi Jinping recognized the need for a prudence when he said, "It does not mean we cannot maintain economic growth at a very fast pace, we just don't want to anymore."
WHY IT MATTERS: China’s near-term economic future is highly uncertain at this point. The prospect of a credit bubble is concerning as any negative surprises would have a far reaching impact on emerging market equities, commodities and gold (all of which we own). On the flip side, if China avoids a financial crisis and continues to chug along it will be a boon to those same asset classes. In some respects, getting the China call right might just be the most important determinant of performance in the coming months.
According to ISI Group there have been 383 “stimulative policy initiatives” announced over the past 20 months. One of the largest ones came on the back of a recent change in Japanese leadership that ushered in a dramatic transformation of fiscal and monetary policy for the country. Last month the new Bank of Japan governor Haruhiko Kuroda committed to a quantitative easing program that makes Bernanke’s look like child’s play. The new effort will nearly double Japan’s monetary base by the end of 2014 through open-ended purchases of long-dated Japanese bonds as well as stocks and REITs. Imagine if Bernanke announced that he was going to triple the size of his QE program and begin including S&P 500 stocks in the purchases! These announcements by the BOJ have caused the Yen to decrease in value and money to flood out of Japan into European and US sovereign bonds, pushing yields even lower than they already were. As a result, one irony of the monetary madness in Japan is that it has reduced the need for additional monetary intervention in other regions of the world.
WHY IT MATTERS: In the same way that Europe has been blazing the way in the “austerity” experiment, Japan is now pioneering “extreme QE”. If the policy is able to produce an improvement in economic growth and/or higher inflation it could become seen as a viable option for other countries in the future. However, if it fails to produce real results while only adding to the nation’s astronomical debt levels it will further invalidate quantitative easing as a means to support the real economy, thereby casting further doubt on the current policies of numerous other central banks, our Federal Reserve included.
The global investment landscape remains heavily geared towards public policy rather than fundamentals. Thus, the most important aspect of our macro analysis is understanding and anticipating the policy programs of global central banks and fiscal authorities. At the same time, it’s important to not become myopically focused on specific areas of policy without recognizing how it fits into the overall economic landscape. A perfect example is here in the US where one might be concerned about the dysfunctional happenings in Congress without recognizing the green shoots appearing in housing and the corporate sector.
It’s also important to remember that regardless of the big picture there are always good investment opportunities to be identified and researched in isolation. This is why we take a “mosaic” approach, combining both top-down macro analysis with bottom-up research on individual investments. It’s our hope to convey a variety of thoughts from a variety of angles to our clients through these Weekly Insights, and we hope the addition of this monthly macro piece serves that goal.
Author David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.
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