Caution is king as the dash for safety is merited
SERIOUS MONEY:THE GLOBAL economy began to stabilise during the summer of 2009 following the most severe downturn since the 1930s. The recovery that subsequently materialised outpaced the previous post-1945 recessions of 1975, 1982, and 1991, as relatively lacklustre growth in real income-per-capita in developed economies was more than offset by a robust rebound in economic activity across the emerging world.
Three years on, the world’s largest advanced economies continue to struggle, and require ultra-accommodative monetary policies to prevent the already sizable output gap from widening further. Despite the ongoing life support, recent data indicate that activity across virtually the entire developed world has down-shifted close to “stall speed”.
Equally troubling, is the observation that unlike previous “growth scares”, the emerging world’s primary growth engines have struck a speed bump, with a pronounced slowdown evident in Brazil, China, and India. Roughly two-thirds of the global economy is slowing, stagnating, or contracting.
Against this background, the voracious appetite for risk assets apparent earlier in the year has all but disappeared. Investors’ increasing emphasis on wealth preservation over capital gains has seen global equity indices slip into negative territory year-on-year, and lose virtually the entire advance in prices recorded during the first quarter of 2012. Few risk assets have escaped investors’ desire for safety and the unsettling global outlook has precipitated a pronounced decline in commodity prices. The Thomson Reuters/Jefferies CRB Commodity Index has plunged more than 15 per cent since late February, and is more than 20 per cent below the highs registered last summer.
More trouble could well be in store for risk assets, as investors’ dash from trash has pushed yields on both short- and long-term debt securities across safe haven sovereign bond markets to levels that are not consistent with economic expansion. The message emanating from government debt markets that include Canada, Germany, Japan, the Netherlands, the UK and the US is one of mounting stress and economic turbulence.
Investor concern has pushed rates on short-term sovereign notes deemed default-free to near-zero, while the scramble for “safe” assets has seen the yields on long-term government bonds plunge to historic lows of well below 2 per cent. The yield on 10-year US Treasury bonds, for example, dropped to below 1.5 per cent in early June, while 10-year German Bund yields fell below 1.2 per cent. The yield on British gilts declined to levels never seen before in a dataset that extends back to the first issue of British government debt in 1694.
What has sparked the recent panic and the purchase of safe haven sovereign debt at prices that suggest zero real returns at best on both short and long maturities? The dash for safety can be partially explained by the fact that the slowdown is detectable almost everywhere and virtually assures a growth recession or below-trend growth – if not worse – during the second half of 2012 and beyond. The US is experiencing the weakest economic recovery in the post-1945 era, with growth averaging just 2.4 per cent over the last 11 quarters, as compared with 4.8 and 5.5 per cent respectively over a comparable length of time following the deep recessions of 1975 and 1982. Growth is running at less than half the pace that is typical for this stage in the cycle, and slowed to below 2 per cent in the first three months of the year.
The slump in payroll additions to a miserable 73,000 per month average in April and May, alongside weaker capital expenditures and government outlays, suggests that further deceleration took place in the second quarter. More troubling is the fact that tax cuts and spending increases amounting to roughly 4 per cent of GDP are set to expire at the end of 2012, and the uncertainty surrounding the fiscal cliff is hurting growth.
Much has already been written on the euro zone, where the economic performance since the great recession struck trails the Japanese experience following the deflation of its twin property and stock market bubbles more than two decades ago. The periphery is mired in recession, and recent data confirm that the loss of confidence and resulting impact on economic activity has spread to the core, including Germany. It is safe to conclude that the euro zone will not provide a boost to global economic growth anytime soon.
The malaise apparent in advanced economies has been accompanied by a growth slowdown in Brazil, China, and India. The Brazilian economy slowed to a standstill in the first quarter, and expansion in China dipped to the slowest rate in almost three years over the same period, while India’s quarterly growth performance deteriorated to its worst level in seven years. A return to above-trend growth may not arrive as soon as optimists believe, given overinvestment in China, a tapped-out consumer in Brazil, and a disturbing fiscal deficit in India.
Investors have dashed to safety, as data confirmed weakness in economic activity virtually everywhere. Investors must appreciate that fiscal and monetary policymakers are short of tools with which to combat the latest weakness. Caution is warranted.