Stephen Roach:
>>While markets can often turn on a dime, a $32-trillion world economy doesn’t. That’s especially true of the US, where the backward-looking data flow, if anything, has been biased to the downside over the past week. Retail sales sagged appreciably in September, consumer confidence was down sharply in early October, new claims for unemployment insurance benefits went back up after a statistically distorted plunge, and industrial production recorded its second monthly decline in a row in September. Housing starts did surge, but that did not outweigh the persistently tough news elsewhere in the economy. On the basis of the latest statistics, we see little reason to change our assessment of an anemic 0.9% annualized growth rate in current-quarter real GDP.<<
Last week I could do no wrong. This week I’m a bum. A huge reversal in stock and bond markets has rekindled the hopes and dreams of economic revival. Those great forward-looking discounting mechanisms that drive financial markets must know something, claim the optimists on the economy. What have I missed this time?
While markets can often turn on a dime, a $32-trillion world economy doesn’t. That’s especially true of the US, where the backward-looking data flow, if anything, has been biased to the downside over the past week. Retail sales sagged appreciably in September, consumer confidence was down sharply in early October, new claims for unemployment insurance benefits went back up after a statistically distorted plunge, and industrial production recorded its second monthly decline in a row in September. Housing starts did surge, but that did not outweigh the persistently tough news elsewhere in the economy. On the basis of the latest statistics, we see little reason to change our assessment of an anemic 0.9% annualized growth rate in current-quarter real GDP.
Nor does the broader world economy suddenly look to be in any better shape. Signs out of Euroland are continuing to worsen. The latest production data remain skewed toward weakness. Germany looks especially vulnerable, with an early read on business expectations taking a sharp tumble in October. And there’s no help on the way from an intransigent ECB. At the same time, the Japan story is far from uplifting, with the latest data revealing further weakness in machine tool orders, another decline in Tokyo department store sales, and persistent softness on the production side of the equation. Only in China did the data flow over the past week signal any vigor, with accelerating trends in industrial output, retail sales, exports, and GDP. Notwithstanding the "China factor," it’s hard to point to any signs of incipient revival in the non-US portion of the world economy that might provide fundamental justification for the recent surge in global stock markets.
But the screens don’t lie, and world equity markets have certainly exploded to the upside in recent days. America, of course, has led the way, with the S&P 500 Composite Index now up an astonishing 13% from its October 9 lows. Even so, this index remains some 18% below its year-earlier level, fully 42% below its March 2000 high, and still back at levels prevailing in mid-1997. For index-based investors -- we should all be so lucky -- five years of stagnant current-dollar returns translate into a cumulative loss of about 12% in real terms. Relative to historical returns of 7% per annum, the opportunity cost of this wealth destruction is all the more severe. In other words, notwithstanding the powerful moves in five of the past six trading days, wealth-dependent American consumers still remain very much in the hole.
The recent rout in the Treasury market needs to be viewed in a comparable light. With the yield on the 10-year surging by some 70 bp since October 9, the bond market has gone through one of its worst firestorms on record. Yet in the general scheme of things, today’s "elevated" interest rates hardly pose a threat to the real economy. The best way to see that is in a "real" interest rate framework -- the inflation-adjusted rates that drive real economic activity. On this basis, real yields on the 10-year Treasury as measured in the TIPS market have increased by some 40 bp from last week’s lows "all the way" back to 2.6%. But even so, these yields remain below the 3.0% level of a year ago and well off the 4.25% highs of early 2000. In short, as wrenching as the recent backup in yields feels, it has yet to result in restrictive enough interest rates that would impede economic activity.
The impact of these gyrations cannot be minimized on one count, however. It heightens an already elevated uncertainty factor -- hardly a plus for the real economy. Dick Berner has said it for a long time: Uncertainty is the enemy of growth, and I couldn’t agree more. Most equity strategists, including ours, believe that the October 9 lows were the real thing -- that this wrenching bear market in stocks has finally run its course. That’s certainly possible, but I well remember similar claims being made about the lows of September 21, 2001 and again regarding the lows of July 23, 2002. Why should last week’s low be any different -- especially if the economic recovery remains anemic at best? To the extent this debate is alive and well, there’s nothing all that comforting about the violence of the recent reversal in the markets. It speaks more to the fragility of any market adjustments than it does to sustainability. In this era of financial-market-driven economies, such disbelief and uncertainty can hardly be viewed as a plus.
Nor is market volatility the only source of uncertainty overhanging the economic outlook. Geopolitical concerns have also intensified, with the apparent terrorist attack in Bali only heightening the angst over a likely war in Iraq. As I speak with investors about these issues, an interesting and important dichotomy has emerged -- especially with respect to Iraq. Americans are focusing mainly on the likely success of the looming battle, whereas non-Americans are focusing more on the perils of a post-Saddam Iraq. The American point of view concludes that sharply lower oil prices must be in the offing as soon as the battle begins, an outcome that would be the functional equivalent of a big tax cut for the world economy. The non-American point of view believes that a lasting US or Anglo-Saxon presence in administering a post-Saddam Iraq would serve a lightning rod for an Islamic backlash and intensified terrorist activities. Such instability could easily spill over into the Israel-Palestine dispute. The oil price would undoubtedly remain sharply elevated in that scenario, a surefire recipe for renewed global recession. To the extent that it’s virtually impossible to know with certainty which of these bipolar outcomes will come to pass, the geopolitical uncertainty factor will undoubtedly remain high in the months ahead. That’s hardly a plus for global growth.
The confluence of financial market gyrations and heightened geopolitical angst does little to neutralize the uncertainty factor that remains an impediment to global recovery. Add in a lack of pricing leverage and still very depressed earnings, and it is difficult to envision businesses stepping up with capital spending and hiring that might otherwise fuel a more sustainable and vigorous cyclical recovery. The same would be true of consumers -- the anxiety factor is antithetical to job and income security and hardly conducive to debt-intensive discretionary buying. Yes, a lot has changed in the markets in the past week. But nothing has really changed on the economic front. The French put it best: "Plus ca change, plus c'est la meme chose."
morganstanley.com |
