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正文
Downunder Daily : Meanwhile, Back In The Real Economy...
While tremulous markets are TARP-fixated, news in the real economy worsens. Developed-world business confidence is now stumbling, which points to investment cutbacks that will compound the likely retrenchment in consumer spending. Our US team today cut its Q3 GDP forecast to 0.5% from 1.0% after weak durable goods data. It also expects a 1.8% fall in US final domestic sales in Q3. The issue for investors, of course, is how much of this is already in the price of risk assets, particularly equities.
I track a GDP-weighted average of headline confidence in the G7, which leads an OECD index of developed-economy business confidence. Confidence is falling sharply at the margin (Exhibit 1). The big change has been a slump in European confidence. Bad vibes in the US have jumped the Atlantic (Exhibit 2).
Falling corporate confidence signals the spread of weakness from the consumer to the corporate sector. This happens in all cycles, so was to be expected. There had been hopes that investment would be unusually resilient this cycle due to infrastructure demand, or the pull of emerging economies. That now seems unlikely.
To be fair, business confidence has in the past dipped without causing a commensurate slowdown in business spending (Exhibit 3). I think this time it will give a good lead. Investment spending relies on two things: animal spirits and finance. Both have now turned.
This sharply increases the likelihood of a (technical) OECD recession. This has a few implications.
First, with developed economies in recession, developing economies slowing, and global inflation falling, I don't think that there will be many central banks that will have the excuse not to ease policy in the next couple of quarters.
Joachim Fels, co-head of our global economics team, is now flagging the prospect of coordinated rate cuts (The Global Monetary Analyst: Pulling All Strings?, 24 September). So far, there have been Anglo rate cuts (US, UK, Canada, Australia, NZ). Now easing is spreading to Asia. China has eased, and yesterday saw an unexpected move from Taiwan (see Sharon Lam, Taiwan Economics: A Pleasant Surprise, 25 September).
The second impact of global growth weakness is the prospect of large downgrades to consensus earning forecasts. This is hardly news, at least to anyone other than the sell-side analysts who contribute to these consensus surveys. Equity markets have been falling for some time. Exhibit 4 shows the 12 month change in the ex-US MSCI index, with the change attributed to either earning forecasts changes or the movement in the market's PE ratio. As is typical before a downturn - look at 1990 and 2000-01 - the market de-rates ahead of the looming downgrade to consensus numbers.
Last cycle, however, when the downgrades finally came through the market kept on falling. The big difference between then and now is valuation: the last bear market started with market-wide PE ratios of around 25, now the ex-US market is on a single-digit PE (Exhibit 5).
At that price, equities are bracing for big earning declines. Exhibit 6 shows the ex-US MSCI index, and the consensus earnings series. The chart is drawn so that when the lines overlap the market is on a prospective PE of 14. If 14 is fair value (not saying it is, but it was the typical valuation through the bull market) then the index is pricing a 30% earnings fall.
Our equity strategists are now tactically bullish equities: equities appear cheap, tactical indicators are oversold, and TARP is likely to be passed. Medium-term, however, it's not clear if equities have passed the cycle low point. That will in part depend on the severity of the cycle and how far earnings can fall. My view is that we are now seeing an earnings bubble deflate, so the risk is that earnings fall further than is now being priced into equities.
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While tremulous markets are TARP-fixated, news in the real economy worsens. Developed-world business confidence is now stumbling, which points to investment cutbacks that will compound the likely retrenchment in consumer spending. Our US team today cut its Q3 GDP forecast to 0.5% from 1.0% after weak durable goods data. It also expects a 1.8% fall in US final domestic sales in Q3. The issue for investors, of course, is how much of this is already in the price of risk assets, particularly equities.
I track a GDP-weighted average of headline confidence in the G7, which leads an OECD index of developed-economy business confidence. Confidence is falling sharply at the margin (Exhibit 1). The big change has been a slump in European confidence. Bad vibes in the US have jumped the Atlantic (Exhibit 2).
Falling corporate confidence signals the spread of weakness from the consumer to the corporate sector. This happens in all cycles, so was to be expected. There had been hopes that investment would be unusually resilient this cycle due to infrastructure demand, or the pull of emerging economies. That now seems unlikely.
To be fair, business confidence has in the past dipped without causing a commensurate slowdown in business spending (Exhibit 3). I think this time it will give a good lead. Investment spending relies on two things: animal spirits and finance. Both have now turned.
This sharply increases the likelihood of a (technical) OECD recession. This has a few implications.
First, with developed economies in recession, developing economies slowing, and global inflation falling, I don't think that there will be many central banks that will have the excuse not to ease policy in the next couple of quarters.
Joachim Fels, co-head of our global economics team, is now flagging the prospect of coordinated rate cuts (The Global Monetary Analyst: Pulling All Strings?, 24 September). So far, there have been Anglo rate cuts (US, UK, Canada, Australia, NZ). Now easing is spreading to Asia. China has eased, and yesterday saw an unexpected move from Taiwan (see Sharon Lam, Taiwan Economics: A Pleasant Surprise, 25 September).
The second impact of global growth weakness is the prospect of large downgrades to consensus earning forecasts. This is hardly news, at least to anyone other than the sell-side analysts who contribute to these consensus surveys. Equity markets have been falling for some time. Exhibit 4 shows the 12 month change in the ex-US MSCI index, with the change attributed to either earning forecasts changes or the movement in the market's PE ratio. As is typical before a downturn - look at 1990 and 2000-01 - the market de-rates ahead of the looming downgrade to consensus numbers.
Last cycle, however, when the downgrades finally came through the market kept on falling. The big difference between then and now is valuation: the last bear market started with market-wide PE ratios of around 25, now the ex-US market is on a single-digit PE (Exhibit 5).
At that price, equities are bracing for big earning declines. Exhibit 6 shows the ex-US MSCI index, and the consensus earnings series. The chart is drawn so that when the lines overlap the market is on a prospective PE of 14. If 14 is fair value (not saying it is, but it was the typical valuation through the bull market) then the index is pricing a 30% earnings fall.
Our equity strategists are now tactically bullish equities: equities appear cheap, tactical indicators are oversold, and TARP is likely to be passed. Medium-term, however, it's not clear if equities have passed the cycle low point. That will in part depend on the severity of the cycle and how far earnings can fall. My view is that we are now seeing an earnings bubble deflate, so the risk is that earnings fall further than is now being priced into equities.
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