Marietta attends University of Chicago Booth’s Economic Outlook 2015

On January 15, 2015, Mary Allmon and Jim Rauh accompanied their colleague and current Booth MBA student, Jonathan Smucker, to Chicago and attended the University of Chicago Booth’s Economic Outlook 2015. The presenters were dynamic speakers with impressive resumes:

• Austan Goolsbee, University of Chicago economics professor and economic advisor to the Federal Reserve Bank of New York, and former cabinet member

• Randall Kroszner, University of Chicago economics professor and former Federal Reserve Governor

  

• Carl Tannenbaum, Senior Vice President and Chief Economist at the Northern Trust

The presenters collectively agreed that 2015 would be a year of slightly faster U.S. GDP growth, that European policy makers must act in order to fight deflation, and that India is on the right track. These statements are all consistent with Marietta’s 2015 Outlook. The presenters also agreed that the recent plunge in the price of oil was unexpected, but was a net positive to the economies of oil importers, the US included. They did not necessarily agree on the causes of the drastic price move: Goolsbee cited slowing demand in China while Tannenbaum mentioned geopolitical games being played within OPEC. Tannenbaum echoed a statement similar to Marietta’s Dec. 4 Oil Blog “OilSpills: Winners and Losers” that while US oil production growth will slow in the short term, it is unlikely to be permanently damaged. The speakers also agreed that the Fed was likely to raise interest rates in the second half of the year, with fall being the median prediction.

Global Economy Slowing Again, but Accelerating Growth Coming

In each of the last 3 years, the global economy started the year with a burst of momentum, lifting global stock markets.  In each of these years the U.S. and international economies subsequently hit a spring and summer “soft patch” resulting in double digit declines for global market benchmarks.  Building evidence that the leading economies of the world are once again experiencing a “soft patch” has understandably created concerns that another sharp correction in equity markets may be imminent.  A correction is always possible, especially following the hefty gains registered since last September.  Nevertheless, we confirm the view in our April 3 Outlook that this economic “soft patch” will likely be short and shallow, and that markets will enjoy strong rallies as the year progresses (as in each of the past 3 years).  We are reducing modestly Marietta’s 2013 global GDP forecast from 4.0% to 3.7% to adjust for the current slowdown, but maintaining our outlook of 4.5% in 2014.  We also anticipate a further advance in global stock markets next year as economic growth accelerates.     

Evidence of a developing global economic slowdown is widespread, although the deterioration seems less troublesome than in past years.  In the U.S., employment data shows that in March employers added the fewest workers in 9 months.  March retail sales suffered their biggest drop since June 2012.  Regional manufacturing reports also reveal disturbing trends.  First quarter GDP growth of 2.5% came in below consensus expectations of 3.0%.  The situation in Europe is more worrisome:  auto sales are disappointing, manufacturing is weakening, construction is slumping, and unemployment has risen to a new high.  Some of the stronger economies, such as France, are teetering on the brink of recession, and the slump in the peripheral countries of Greece, Portugal, Italy, and Spain is deepening.  Even the fast-growing, leading emerging economies are exhibiting problems.  Disappointing GDP and manufacturing data in China have again kindled fears of a hard landing (see our 12/24/12 blog Chinese Economy and Stock Market Rebounding).  In Brazil, sliding consumer confidence and rising inflation and interest rates have prompted economists to scale back their growth estimates for the year.  Commodities are a good measure of the pulse of the global economy, and they have been sliding since February.    

The causes of the current “soft patch” vary from country to country.  In Europe, the Cyprus debt crisis and continuing political and economic uncertainty in Italy, Spain, and Greece are causal factors, but the primary culprits are the government austerity programs.  We attribute the slowdown in China to the bumpy progress of the government in shifting the focus of economic growth from exports and infrastructure to consumer spending.  The U.S. slump is attributed to a variety of causes, although it must be noted that there are economists who claim that the statistics are based on faulty seasonal adjustments and there is, in reality, no “soft patch.”   We think the slowdown is real, and we blame it primarily on the expiration of the payroll tax cut and the higher income taxes on affluent Americans.  In combination, they will cost taxpayers some $150 billion this year.  The government’s sequester, which kicked in on March 1 and will cut spending by about $85 billion this year, is also a brake on growth.  Any discussion of the ebbing strength the U.S. economy must include the lack of business confidence.  Businesses are sitting on record piles of cash ($1.8 trillion in U.S. corporations listed on the major stock exchanges) and are evidently too uncertain about the future economy to invest in new plants and/or employees.  In our view, political gridlock in Washington, federal fiscal irresponsibility, and excessive regulation all contribute to this reluctance to invest in the future.      

Our positive forecast, then, is based on a future improvement in the confidence and optimism of business in the leading economies.  This is the role of the policymakers, and we think they will respond appropriately.  The major supports for future global growth are the world’s central banks, which are moving decisively forward with accommodative policies.  International Strategy and Investment (ISI) has counted 379 stimulative policy initiatives around the world over the past 20 months.  More is coming.  A decline in global inflation, in part a beneficial byproduct of the decline in commodity prices, is providing central banks, particularly in the U.S., Europe, and China, with a green light to proceed.  The Federal Reserve has stated repeatedly its determination to keep rates low until unemployment, now slightly below 8%, drops to at least 6.5%, and on May 1 indicated its willingness to increase its pro-growth activities if the economy falters.  The most recent convert to a pro-growth policy is the European Central Bank (ECB), who cut interest rates on May 2 in response to a drop in inflation below 2.0% and a rise in unemployment above 12%.  The next central bank to join the parade may be India.  The Economist (April 6, p. 14) summarized the synchronized recovery program:  “The message from the rich world’s central banks is clear:  the era of ultra-loose monetary policy is here to stay.”  The full impact of these unprecedented stimulus measures, which typically takes 6 months or more to have full effect, is unclear but, in our opinion, is decisive.  

Recent developments in Japan are instructive.  Prime Minister Shinzo Abe has urged the Bank of Japan (BOJ) to combat decades of deflation by engaging in monetary easing designed to raise inflation to at least 2%.  The BOJ has responded, and the key consequence has been a dramatic decline of the yen, which in turn has increased significantly the competitiveness of Japanese exports.  In a different economic environment, Japan would be condemned as a currency manipulator.  In today’s growth threatened world, however, the International Monetary Fund, the World Bank, and the G20 leading economic countries have expressed support for the BOJ.  At home, the Japanese stock market has surged, consumer confidence is at a 6 year high, retail sales are rising, exports are rebounding, and Abe’s approval rating has soared to a record 76%.  Politicians and central banks around the world are taking notes.

Politicians in the U.S., Europe, and other countries are jumping off their austerity platforms and onto the growth bandwagon.  Partisan bickering over taxes and budget deficits among U.S. politicians has cooled and compromise to limit the negative consequences of sequester is increasingly in vogue.  In Europe, the severe and immediate austerity policy championed by Germany has come under attack.  The views expressed by The Economist are gaining adherents:  “In Europe the combination of a timid ECB, harsh austerity and minimal structural reforms is not giving growth much of a chance” (April 6, p. 16). 

We are not depending on the policy makers alone to lift the U.S. economy.  In addition to the quantitative easing activities of the Fed, the strengthening housing market and the rising stock market are bolstering growth.  The rise in residential real estate prices, which in February increased year-over-year by the most since May 2006, is especially encouraging.  Housing lifts employment, consumer net worth, and consumer and business confidence.  The same is true of rising stock prices.  In combination this “wealth effect” helps account for last month’s jump in consumer confidence.  Most investors believe the stock market is itself a forward indicator of the economy’s future, and today the S&P 500 Index closed at an all-time high with a gain of 12% since the beginning of the year.  Clearly, investors are not overly worried.

Assessing recent trends and developments, the IMF in April released its updated Overviewof the World Economic Outlook, which we consider positive and supportive.  Although the IMF reduced its global 2013 GDP projection from 3.5% to 3.3%, they left in place their 4.0% estimate for 2014.  All of the key economies, including the U.S., Euro-Area, Japan, China, India, and Brazil, are expected to achieve higher growth next year than this year.   In particular, U.S. growth is forecast to rise to 3.0% and China to 8.2%.  Even Italy and Spain are expected to emerge from recession.  We detect a note of relief at the IMF.  Looking back on 2012, they began their report: “Activity has stabilized in advanced economies and has picked up in emerging market and developing economies, supported by policies and renewed confidence.” 

In each of the past 4 years we have posted a blog regarding the then current “soft patch,” and in each case we predicted (correctly) an economic and market recovery.  We again counsel investors to exercise patience and remain cautiously optimistic.

China, India, and Brazil: When Too Much Growth is Bad

On December 25 the People’s Bank of China (PBOC) hiked both the key 12-month lending rate (from 5.56% to 5.81%) and the 12-month deposit rate (from 2.50% to 2.75%). This marked the latest effort in the Chinese government’s year-long campaign to ward off inflation by cooling its overheated economy. Although these steps were widely anticipated, the Shanghai stock market immediately retreated and triggered selling in many other emerging-country stock markets.

The related issues of strong economic growth, rising inflation, restrictive initiatives implemented by policy makers, and a disappointing stock market have been building for a year and are not limited to China. A similar set of conditions has plagued the leading emerging countries of India and Brazil. At the beginning of the year, consensus 2010 GDP growth projections were 8.6% in China, 6.3% in India, and 3.8% in Brazil; economists currently estimate 2010 growth of 10.2% in China, 8.8% in India, and 5.5% in Brazil (The Economist, 1/2/10 and 12/18/10). Along the way, inflation and fears of asset bubbles have spread: inflation in China is currently running at an annual rate of 5.1%, in India at 9.8%, and in Brazil at 5.6%. In all three countries the governments and central banks have reversed the economic stimulus initiatives of 2008-09 and are now applying the brakes.

In a May 12 blog on International Stock Markets: Searching for Goldilocks, we highlighted the negative impact that these restrictive policies in China, India, and Brazil were having on their previously sizzling stock markets. Since May, the inflation threat has grown and clouds have continued to hang over these markets: The Shanghai Composite (CSEX) is down -15.1% for the year to date, the Brazilian Bovespa (BSPI) is off -0.1%, although the India BSE 100 Index has mustered a respectable 12.9% gain. For the same period, the S&P 500 Index has rallied 12.7% despite unimpressive GDP growth of about 2.8%.

At this point the consensus view, which we share, is that in early 2011 the policy makers in each of these 3 countries will escalate their war on inflation with additional measures, and the consequence could well be stalled or disappointing markets. There will be many investors who fear that the steps taken by the policy makers will be too little and too late, and the result will be destabilizing inflation and asset bubbles. Many other investors will be convinced that the policy makers will go too far and cripple economic growth. To the contrary, our view is that the policy makers will be able to pilot a soft landing, i.e. to cool their economies to healthy and sustainable growth with reduced inflation. We note that most economists predict modest slowdowns in 2011 sufficient to arrest inflation fears: the latest poll taken by The Economist forecasts slowing 2011 GDP growth to 8.9% in China, 8.6% in India, and 5.1% in Brazil. If our view is correct, then we expect a buying opportunity lies ahead for the stock markets of these leading emerging countries and the multinational companies that supply the rising demand of their mushrooming middle classes.

Global Growth Opportunities: India

We are impressed with the strength and future prospects of India’s economy, and we think its equity market is increasingly attractive. During the 2003-2007 global expansion, India’s robust GDP growth (which hit 9.1% in 2007) was driven by consumer demand arising from a mushrooming middle class. With only about 20% of the GDP dependent on exports, the economy was relatively isolated from the recent recession in the developed countries and enjoyed growth of 5.1% in 2008 and 7.7% in 2009. Now the economy is accelerating again: the World Bank estimates GDP growth will top 8% in 2010, with further gains of 8.7% in 2011 and 8.2% in 2012.

India’s astonishing growth, second only to China’s among the leading emerging economies, will continue to rest on the size, youth, and growing prosperity of its working class. The U.N. forecasts that the working-age population in India is expected to expand to 275 million, a rise of 46%, by the year 2025. An article in The Economist indicates that by 2020 three out of every ten new entrants to the global workforce will be Indian. Conversely, the working-age populations in the U.S and China are expected to grow by a mere 12% and 10%, and the working-age populations in Japan and Europe are expected to decline by -17% and -13%, respectively.

In addition to a burgeoning workforce, household incomes are also rising. In 2009, the IMF estimated India’s per person annual income at $1,031. At less than half the annual per person income in China and the other leading emerging economies, there is plenty of room for income growth without damaging productivity or international competitiveness. Multinational corporations, including those in China, are expected to increase outsourcing to India.

Challenges that may restrict long term growth include high inflation, inadequate physical and social infrastructure, and an ineffective and protectionist government. The Economist lists India’s inflation at 11.3% and their latest poll of economists predicts full-year 2010 inflation to be 11.4%. Recent trends such as moderating food and commodity prices, however, should reduce 2011 inflation to a manageable 5-6%.

A retardant to India’s current growth but a boost to future growth is a dilapidated infrastructure, which the government intends to upgrade with a $1 trillion investment between 2012 and 2016. To successfully implement these upgrades, India needs government reform. Historically, India’s democratic government has favored protectionism, complex labor laws, regulations that differ from industry to industry and has tolerated a lack of coordination among local government agencies. The 2009 election of Mr. Singh and Mrs. Gandhi is promising.

The investment implications of India’s rapid and assured future growth, coming at a time when the economies of the U.S., Europe and Japan are struggling, are manifest. The benchmark Sensex Index of India stocks rocketed 501% during the 2003-2007 expansion, and it soared 130% from the beginning of the global stock market rally on March 9, 2009 through September 12, 2010. In contrast the S&P 500 advanced a modest 67% and 63% during these two periods. We recommend investors focus on the stocks of Indian and other multinational companies which provide goods and/or services to the surging working class or which support infrastructure improvements.