As I searched last week's data for trends, two things struck me. First of all, various business investment surveys signal that capital expenditure is about to accelerate significantly – if it hasn’t already started to. This is important and exceptionally welcome news. Indeed, this is just what we need to make recovery broader based and more self-sustaining. Investments lead to new jobs and to income growth, which in its turn boosts consumer spending. Another trend I would like to mention here is that while industrial activity has strengthened, particularly in the developed economies, at the same time inventory levels in the US have risen. This is probably the result of a conscious choice by US companies and could imply that US industrial output growth will be levelling off somewhat in the short term, allowing demand to catch up. If this happens, there are bound to be doom-mongers claiming victory in the debate whether or not the recovery we are currently seeing is just a blip on the radar. But they're wrong.
Most market watchers feel corporate investments have lagged recovery in recent months.
Han de Jong Chief Economist
In closing, I will report briefly on my trip to Asia last week, where I held presentations for private banking clients in Singapore, Taipei and Hong Kong.
Capex accelerating in developed economies
Most market watchers feel corporate investments have lagged recovery in recent months. In many European countries, economic activity is still depressed due to the decline in investments. In de US, capex growth has by no means been weak in the past quarters, but neither has it been really strong. More encouraging were the eurozone industrial output figures, published last week. Total output rose by 1.8% m-o-m in November, and the provisional October figure was revised upwards from -1.1% to -0.8%. Year on year, industrial output increased by 3.0%. More importantly, however, the production of capital goods climbed by 3.0% m-o-m and by 4.4% y-o-y. And while the m-o-m numbers are volatile, the y-o-y ones are relatively stable. We hope this trend materialises in the form of actual capital expenditure in the eurozone.
In this connection, I would like to highlight some positive developments in Spain. This country is starting to reap the benefits of its improved competitiveness and possibly also of reforms in recent years. In the first ten months of 2013 Spain reported a current account surplus of EUR 7.9 billion. Not only is this over 2% of GDP, it is also the biggest surplus since data compiling started in 1969! Spain’s strong data has rekindled international investor interest. Besides, the combination of a current account surplus and capital inflows is of great importance to Spanish banks. These fund flows add up to higher cash levels for them, reducing their dependence on liquidity provided by the central bank. The labour market, too, appears to be bottoming out. The various indicators do not yet form a consistent pattern, but the Spanish Ministry of Economic Affairs has reported that unemployment numbers fell by 61,000 in December. While Spain’s labour market already showed its first signs of recovery this summer, they were attributed at the time to the successful tourist season. Recent data confirms, however, that this was more than a seasonal effect. And in the meantime, industrial output is also continuing to rise steadily.
Hopefully, the improvements in Spain will ratchet up the pressure on Italy and France to implement reforms and improve their competitiveness. In his speech last week, French President François Hollande did announce substantial tax cuts, but he failed to provide details on their timing and how they are to be financed. Positive as these developments may be, the euro crisis leaves no room for complacency. Last week, news broke that Greece’s industrial output has fallen further. Which is worrying indeed.
In the past few years, US companies have been investing much more heavily than European ones. But US surveys now show that entrepreneurs have become more cautious in recent months due to uncertainty about the government’s budget policy. With this uncertainty now all but gone, we have been looking hard for signs that capital expenditure is picking up again. A few weeks ago, an upbeat report appeared about durable goods orders in November, and last week the NFIB (National Federation of Independent Business) published the positive results of its latest small business confidence survey. While the response rate was modest - 635 usable responses from a sample of 3,938 SMEs - it does provide an up-to-date gauge of sentiment in an important area of the economy. The NFIB reports continued growth of overall confidence, plus a number of interesting highlights. For example, the component “reported capital outlays” jumped from 55 in November to 64 in December, its highest level since 2005. Part of this advance may evaporate in the early months of 2014, but if you are looking in the data for signs of higher capital spending, because that is what you are expecting, it certainly counts as a highlight.
What also lifted my spirits, even if it has no direct bearing on capital expenditure, was the USD 55 billion surplus in the US federal government books reported in December. While this was partly due to dividend paid to the government by the likes of Freddie Mac and Fannie Mae, it does reflect a very positive budget deficit trend. Over the full calendar year 2013, the federal government deficit amounted to USD 560 billion, which is about 3.3% of GDP. Assuming that state governments and local authorities had a more or less balanced budget, we can conclude that the total deficit was below nominal GDP growth - and consequently that the US debt ratio is now falling. Another striking news item was that federal spending had fallen by 5.2% in 2013. And that is in nominal terms, meaning that the real decline is even bigger. As a European taxpayer looking at figures like these, I can only gnash my teeth in envy and frustration.
Not so uplifting was last week’s US housing market data, which showed that the housing market is facing headwinds from higher lending costs. On the other hand, this may not be such a bad thing. Housing prices rose significantly last year, fuelling fears of a new housing bubble. December retail sales were also far from impressing, and to make matters worse, the figures for the preceding two months were revised downwards. That said, retail sales minus food and energy showed better growth than total retail sales.
To return briefly to capital expenditure in developed economies,. Japan machine orders were 5.8% down in November, following an increase of 16.4% in the two preceding months. The trend certainly indicates recovery of investments. So all in all we can conclude that in the three most important regions of the developed world, there are signs that businesses are increasingly comfortable about making investments.
Pause in output growth ahead?
Industrial output growth has accelerated in the wealthiest economies over the past few months. That is good news. A normal cycle, however, does feature short-term fluctuations in output growth. For a proper assessment of such fluctuations, we need to look at inventory data. Unfortunately for most economies inventory data is patchy and of mediocre quality. An exception, though, is the US. The US National Accounts statistics show that inventory building contributed significantly to total GDP growth in 2013. In the first three quarters of the year, GDP expanded by an average of 2.6%. A quick calculation tells us about 1.0 percentage point of that was attributable to inventory building. This means that real growth has been overstated, given that inventory increases usually consist of imported goods. This just goes to show how important the inventory cycle is. Q4 figures suggest that inventory building continued in that period, but that does not necessarily imply there was a further positive contribution to GDP growth. Historical data shows that periods when inventory building provides a significant boost to GDP growth are followed by periods in which this mechanism unwinds and actually curbs GDP growth. This results in a pause in output growth until total demand catches up with supply. In my view, however, this is a perfectly natural stage of the cycle. I believe inventory building in the past few quarters to have been largely a conscious choice on the part of businesses. Companies were justified in anticipating higher demand. It’s not that the increase in demand was below expectations; it’s just that production was slightly over-enthousiastic. With excess supply now being absorbed, US business confidence indices may drift slightly lower, but that is nothing to worry about. Before long, accelerating demand will push production figures up again. We should beware of generalising these conclusions to include Europe, but the mechanism is harder to trace on this side of the Atlantic.
Last week I toured Asia and spoke to many of our private banking clients in Singapore, Taipei and Hong Kong. What surprised me was how negative they were about economic developments in Asia. Sentiment hadn’t been this poor in years. Their pessimism (in relative terms at least) seemed mainly based on fears over China, where policy makers are trying to get or maintain a grip on the country’s lending mechanism. We are confident that the authorities will succeed in this and that Asia will benefit, more than our clients seem to expect, from accelerating industrial activity in the developed economies and expanding world trade. Perhaps their (relative) pessimism also has to do with the lacklustre performance of Asian stock markets in the past few years and particularly in 2013. In the wake of the sell-off, Asian equity is now downright cheap, so it may be the wrong time to be bearish. On the other hand, the US Federal Reserve is ever so slowly turning off the money tap. So it is hard at this moment to call the direction of capital flows in the coming year. Asian investors may even start looking to Europe again. The past ten years were marked by a sharp decline in Asia’s interest in, and indeed respect for, Europe. Last week I tried to pitch European assets to them as a way of improving the diversification of their portfolios. Not that I am likely to have made much of an impression. I felt more like a voice in the wilderness. For Asian markets, it could be good news that no major capital flows from Asia to Europe are to be expected any time soon.