The markets for risky assets are feeling the heat and their behaviour is best described as 'sell first, think second'. So is today's sell-off a run-of-the-mill market correction or are markets at breaking point? We think this is still an ordinary correction, but see conditions as more dangerous than on previous corrections.
The markets for risky assets are feeling the heat and their behaviour is best described as 'sell first, think second'.
Han de Jong Chief Economist
Economic indicators are not the issue
Last week’s indices confirm our view that economic growth is gaining traction in the developed countries, noticeably so in Europe. The European Commission’s European Sentiment Indicator again inched ahead, from 100.5 points in December to 100.9 in January. Its ninth successive increase took it to its highest level since 2011 and close to its long-term average. Barring the occasional setback, Germany’s Ifo business confidence indicator has been on the up since the end of 2012, and the trend continued into February. German consumers are also displaying greater confidence: we have to go all the way back to 2007 to find better numbers. Unfortunately, German retail sales came down in December, by 2.5% month-on-month and by 2.4% year-on-year, but these figures tend to be pretty volatile and I’m inclined not to set too great store by them.
Headline inflation in the eurozone fell in January to 0.7%, while core inflation edged up from 0.7% to 0.8%. What it boils down to is that inflation is too low for the ECB’s liking and that the central bank is likely to take additional measures to reduce deflation risk. In December, the eurozone’s M3 money supply growth (broad measure) fell to 1.0% year-on-year. Although the underlying numbers were a little better, money supply is continuing to grow too slowly. Lastly, the ECB’s Euro Area Bank Lending Survey shows a continuation of recent trends: although most banks are still tightening up their lending criteria, this majority is shrinking fast and has almost become a minority. Corporate demand for loans continues to shrink, but that’s also true for the number of banks reporting the trend.
The data from the United States was also generally positive in the past week. Fourth-quarter GDP increased by an annualised 3.2% compared to the third quarter and private consumption was up, as was investment in operating assets. As the sceptics would have it, GDP moved up at such a rapid clip because net exports were unsustainably high – but this conveniently ignores the fact that smartly lower government spending is putting a similar – and a similarly unsustainable – squeeze on GDP. US consumer confidence also rose, while the housing market figures show a mixed picture, as mortgage costs have been rising since May of last year. Figures for durable goods orders and unemployment claims weren’t exactly brilliant, but let’s blame it on the weather… Durable goods shipments were less bad than actual orders – an important distinction, as it’s the shipments that go into GDP calculations. GDP figures for the fourth quarter reveal that companies are investing more in plant and equipment, confirming what we’ve been saying for a while now: business investment is picking up. Personal income was unchanged in December, but Americans did spend 0.4% more and the spending figure for November was revised upwards – meaning that the savings ratio went down and reflecting overall improved asset positions.
In Japan, industrial production recorded significant year-on-year growth in December: 7.3% compared with 3.8% in November. Korea also saw industrial production advance smartly and Taiwan reported accelerated economic growth in the fourth quarter: 2.2% year-on-year, compared with 1.5% in the previous quarter.
If growth in the developed economies isn’t the problem, then what is?
The turmoil that has gripped financial markets is down to developments in a select number of emerging economies, and the growth prospects of the developed economies are clearly not at issue. But then what is, and where do we go from here?
A number of countries, including Ukraine, Turkey, Thailand and Argentina, are currently facing financial or political chaos, whose causes are wholly domestic matters for the most part. More serious concerns are the general growth prospects, lagging reforms, unsustainable growth models and questionable financial stability in China. In addition, lending had taken off big time in many emerging countries in the past few years, but that looks likely to end in the wake of US tapering – loan growth on that big a scale was always going to be unsustainable anyway. All things considered, it’s hard to predict what will happen. The markets are jittery, but let’s not forget that 2013 was an amazing year for risky assets and that the large majority of analysts were predicting that the good times would keep rolling – a sure-fire sign of an impending correction.
We’re also taking note of a bunch of other factors. For one thing, economic governance in the emerging countries has greatly improved in past years and many of them have robust buffers in the shape of sizeable currency reserves. They’ve also become more flexible, as they´re no longer tied to any fixed exchange rates, and some of them even boast trade surpluses. The fact that the wealthier economies are on the mend won´t hurt either. As for China, we feel that policymakers are more likely to get on top of the credit issue than not – they may not be following a neatly charted path: they’re developing and adjusting policy as they go. We believe they have the will and the means, financially and policy-wise, to address any problems that might emerge.
Granted, loan growth in a large number of emerging markets is a concern, but we reckon many of these countries are in better fundamental shape than they were a year ago, and they should receive a big boost from reviving economic growth in the US, Europe and Japan. So once we’re past the ‘sell first’ and arrive at the ‘think second’ part, recovery would seem the most likely scenario.