It is August, rather beautiful weather on the US East Coast instead of the normal stifling humidity, and perhaps that is lifting spirits. Certainly the stock market is levitating.
It is hard to find any real fundamentals that could justify the impressive rise of stocks this year. Europe has entered a double-dip recession, with the major motor of the continent — Germany — struggling to maintain 0.3% growth, and many indicators suggesting that by year end Germany will be joining its Euro brethren in recession too. How the Greek, Spanish, Cypriot, Portuguese, Irish, Italian, even Slovenian (the list keeps growing) fiscal crises will be resolved with no major economy driving growth in Europe is a mystery to me. But traders seem to want to believe Draghi and Merkel when they say the Euro will be saved, somehow (ECB bond buying? greater monetary union?)
It all seems quite fanciful to me. Things in Greece are increasingly dire, with money poised to flee the country, unemployment at depression levels (25% or more), and the government slashing pensions, employment, and salaries even further on pain of excommunication from the Euro. The country has gone from last to first in Europe in suicides. There is simply no way the country can pay its debts, so either a Europe that is slowing down elsewhere has to assume those debts, or Greece must default (either by leaving the Euro to revalue its debts in much cheaper drachmans or staying in and simply defaulting on its obligations). But with so many other countries in ‘near Greece’ conditions, when Greece either has its debts assumed or defaulted, investors will expect other countries to follow, and even with careful orchestration some kind of surprising ‘reset’ of finances will be inevitable in all southern European countries and perhaps Ireland as well. While a mix of some default and some assumption of debt is the best possible outcome, the problem remains that with all of Europe slowing and even Germany facing very weak growth, the accumulated debts of Spain, Italy, Portugal, and Ireland would overwhelm the entire Eurozone’s ability to pay. At that point, it becomes essential to cut loose the weak countries to save the strong.
Elsewhere in the world, more of the same. According to the New York Times today, “Chinese manufacturing PMI data … hit their lowest levels since November as new export orders slumped and the stock of unsold goods rose.” Along with slumps in coal and iron prices, a variety of indicators suggest that China’s growth has not merely slowed from 10% to 7%, but may have crashed down to 3% or less in the first half of this year. After all, China’s growth after 2009 was sustained mainly by state-led investment (50% of GDP!) which could hardly be sustained. With China’s main export markets at a standstill, and domestic consumption too weak to drive the economy, what else could we expect?
Brazil and other commodities exporters have been hurt by China’s slowdown. Growth in Brazil fell to under 3% this year, although a newly-announced stimulus program based on hoped-for foreign direct investment is aiming to boost the economy going forward.
And in the US? As with Europe, investors seem to be hoping for magic from the Fed, awaiting some new stimulus. But with interest rates near zero and the Fed having already done several rounds of “easing” and “twisting,” how much firepower do they have left in the face of the coming ‘fiscal cliff?’ Even if the fiscal cliff problem is solved at the last minute, no one is going to invest in new capacity as long as the threat of massive tax hikes and government spending cuts looms, so the US will likely stumble along at best, or stall and fall back into recession, by the end of the year. The problem in the US, as a new PEW research report makes clear, is that the middle-class has lost so much wealth, and is under such pressure from stagnant incomes, that it is not spending. And since consumer spending in the US is 70% or more of GDP, there is no way for the US economy to return to growth unless private investment or government spending are massively increased to compensate for the decline in consumption. But private investment is handcuffed by uncertainty about the fiscal cliff and the dim prospects for domestic and overseas consumption growth, and government spending is essentially blocked by conservative Republicans in Congress who see every dollar spent by the government as a plague on mankind.
OK, let’s recap. The world’s largest economy (Europe) is in recession again, and will have the Greek crises to resolve one way or another later this year. The world’s second largest economy (the US) is stalling out and facing a fiscal cliff. The world’s third largest economy (China) has seen its growth fall by half to two-thirds from its pre-2008 levels. In the world’s fourth largest economy (Japan), after a promising Q1 2012 following recession in 2011, growth has fallen back to 0.3% in Q2 and falling imports and exports indicate growth will be flat or negative in Q3. The world’s seventh largest economy (skipping Germany and France at fifth and sixth), Brazil, has slowed to half its pre-recession growth rate and is counting on new private investment to recover. Those economies constitute seventy percent of world GDP, and they are all going nowhere fast.
Against this background, the S&P 500 is up 12% on the year and 7% in the last month, and perhaps even more astonishingly is at 4 year highs, back to 2008 levels. From one perspective, that is reasonable, given that real US GDP has now exceeded its 2008 pre-recessio peak level by about 2%, and corporate profits have taken the lions share of growth and so are at all time highs.
But one has to ask how long that can continue against the background of a deep stalling of global growth that set in this Spring. Either the EU and the Fed will pull twin rabbits out of their hats, and get the European and US economies moving forward again and the markets will continue their surge upwards, OR … Well either way, we could be in for a jolting fall surprise.