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FINANCIAL MARKETS SEEM to be finding their feet after the collapse in confidence last month. The worries over the potentially awful consequences of a disorderly default by Greece or some other huge shock out of Europe are receding as eurozone leaders work feverishly to produce a credible package of measures to deflect those threats. Assuming the European leaders deliver the goods, the question for investors then is: Is a resolution of the European debt crisis sufficient to produce a durable recovery in financial markets?
Unfortunately, it looks as if the global economy may produce more bad news and keep markets on edge. The key is to look beyond the noise in financial markets and look particularly at the predictive, forwardlooking indicators and the underlying processes that are shaping economic events. Both parameters are hardly encouraging.
Forward-looking indicators turning down
The Organisation for Economic Cooperation and Development produces the most accurate economic lead indicators, which help forecast the turning points in the major developed and developing economies of the world for the next year or so. The latest OECD composite lead indicators (CLIs) are signalling deceleration in virtually all the major economies.
The aggregate indicator for the top seven developed economies is falling at a pace close to what was seen in 2008, with particularly sharp falls in the major European economies. For all major economies, except the US and Japan, the CLIs are now below 100, pointing strongly to a slowdown in economic activity below the long-term trend.
Developing economies are also showing clear signs of slowing. China’s lead indicator has fallen markedly of late while those for Brazil and India have plunged. CLIs for the largest emerging economies, except for Russia and South Africa, are below 100, alerting us to a high risk of below-trend growth.
The picture of deceleration provided by these lead indicators is supported by other forward-looking data. The JPMorgan global purchasing managers’ index also points in the same direction — the new orders component of this index is declining at the fastest pace in more than two years.
What is driving this deceleration?
If we put together recent data and developments in each of the major economies, the underlying challenges are clearer, telling us that the risks in the global economy are very real:
- The US could surprise very negatively. Some recent indicators of activity, such as the manufacturing and services purchasing managers’ indices, inched up in September. However, the most respected forecaster of the US economy, the Economic Cycles Research Institute has gone on record as saying that the US is either already in recession or about to enter one. Since ECRI has a 100% record of calling recessions in the US, this should worry us. The key to the US economy remains the American consumer and, here, the prospects are not good. The underlying trend in job creation in the US is simply not enough to absorb all the new entrants to the workforce. Consequently, the broadest measure of the unemployment rate, the socalled U6 number, surged in September to 16.5% from 16.2% in August. With job prospects poor, income growth weak and the housing sector continuing to act as a drag, it is not surprising consumers are cutting back on consumer credit and likely to reduce their spending;
- Europe is not going to help. Budget cuts are just beginning to bite while monetary conditions remain very tight considering the position of the eurozone’s economy. Unemployment is rising and business confidence has been battered by the sovereign debt crisis and weak policy responses. There are still signs of stress in the financial sector. The damage that has been done by the sovereign debt crisis has clearly been substantial;
- China is looking more risky. Chinese economic growth is certainly going to surprise on the downside. The economy faces a confluence of negatives. First, there is the lagged impact of the monetary tightening that has been intensifying since January 2010. Second, the most dynamic sector of the economy, the private small and medium enterprises (SMEs), is feeling the pain of a credit crunch. Third, there are increasing problems in the financial sector. The cash crunch faced by SMEs is leading to increasingly severe problems in the kerb market for loans that these companies depend on. Moreover, the sharp fall in the prices of commodities such as copper, which many Chinese have speculated on, is also creating financial problems. Fourth, as wages and other costs rise and as the currency appreciates, Chinese companies have to restructure. The risk of the Chinese economy slowing sharply to below 6% is rising; and
- Japan’s recovery is not helping as much as hoped. Reconstruction efforts will be stepped up in the coming months and that should provide some support for global demand. However, recent data for capital spending and surveys of business suggest that the recovery is not unfolding as strongly as hoped for. Clearly, the impact of slower global demand for its exports is offsetting part of the benefits of reconstruction spending.
In other words, these four large economies which account for about 60% of global output are decelerating. And the fundamental reasons are deep-rooted and unlikely to be reversed soon. In particular, the legacy of the 2008 debt crisis continues to drag down the US and Europe.
