EmailThere was nothing new in Fed Chairman Bernanke’s speech on Friday and nothing that confirmed that further easing is definite. The stock market action, however, indicates that investors remain convinced that the Fed will take actions that will support stock prices. Meanwhile, the global economic fundamentals have worsened.
Bernanke’s Speech
There has been plenty of ink spilled over every word of Fed Chairman Bernanke's speech on Friday. Most journalists and market participants came to the conclusion that the speech revealed hidden intentions to embark very soon on another round of quantitative easing.
This may be pure wishful thinking.
If the Fed has indeed already decided that another round of quantitative easing is coming, it might as well enact it right now.
The Fed can't be waiting for further economic data, because that would mean it hasn't already decided to ease.
The only plausible reasons for waiting, despite having made a firm decision to ease, are to coordinate action with the European Central Bank (ECB) or to create pressure for political developments in the US.
It is plausible that the Fed is waiting for coordinated action with the ECB, but there is no certainty the ECB will act. Furthermore, if the Fed definitely believes that the benefits of further quantitative easing exceed the costs, then waiting for the ECB makes little sense.
The idea that the Fed can increase the chance of Congress taking appropriate action is to count on more rationality out of politicians than is worth the effort.
The most logical conclusion is that the votes simply aren’t there yet for enacting another round of quantitative easing. That is why easing has not been enacted.
Whether there will be enough votes at the September 12-13 meeting remains to be seen. They could well ease then, but it is by no means certain.
Fundamentals Worsen
Stock market action suggests that investors are comfortable with the assumption that further quantitative easing is coming, and that it will provide support to stock prices.
That is the only explanation as to how the market can be so blithely ignoring worsening global economic trends.
On August 20, the Big Picture article titled "Global Economic Trends Aren’t Pretty Picture" showed clearly how the top global economies are all weakening.
Since then, the following data have been released:
- Japanese July retail sales (-0.8%) and industrial production (-1.2%) fell sharply.
- The government Chinese manufacturing survey fell below 50, to 49.2 in August.
- German retail sales unexpectedly fell 0.9% in July from June.
- Brazil posted lower than expected 1.6% annual growth in the second quarter.
- US economic data have been disappointing and have led us to a lower our third quarter GDP estimate.
The Japanese, Chinese, and German data were far worse than expected. And this is not a selective list. There are no offsetting bullish releases.
The implications for global economic growth are serious. Japan is now expected to post negative third quarter real GDP. It is likely Japan is entering recession.
China's economic growth is likely to slow significantly in the third quarter. The below-50 mark on the government manufacturing survey suggests that Chinese manufacturing is contracting. There are reports of excess factory inventories across China. If in fact the manufacturing sector is contracting, Chinese growth could be quickly sinking to a 5% annual rate. That sounds decent, but it would be down from the current 7.6% growth and from over 10% growth in early 2010.
German GDP growth, which was a meager 0.3% (1.2% annual rate) in the second quarter, could go negative in the third quarter. The recent retail sales decline accentuates weak export and manufacturing trends. If German GDP goes negative, that will pull the rug out from any support to the overall eurozone trend.
Compounding these global problems is that key US economic data have been disappointing. In particular, key components of the factory orders and personal spending data were below expectations.
Our forecast for third quarter real GDP has dropped to just 0.4%.
Where That Leaves the Top Global Economies
The global economic data have been unremittingly lousy.
A quick review of the top six global economies is as follows:
- Eurozone: a deepening recession with third quarter GDP outlook very poor as German growth disappears.
- US: economic stagnation worsens as confidence erodes investment. Recession risks for 2013 increase.
- China: slowdown accelerating with a potentially serious manufacturing problem developing.
- Japan: entering recession. Forecasts are for about -0.5% real GDP for the third quarter.
- Brazil: extremely sluggish sub-2% real growth for a supposedly emerging economy.
- UK: in deep recession in which real GDP has fallen for three straight quarters.
These top six economies account for 73% of the global economy, based on 2011 IMF data.
There is no global growth engine anywhere, and every economy is either stagnant, slowing down significantly, or sinking into recession.
No Worries
None of this seems to have bothered major portfolio managers. A recent round-table discussion of managers on TV exhibited one participant saying that European stocks were a "buy" because it was expected that the ECB would instigate purchases of government debt that would allow Spain and other countries to continue to finance their deficits.
It is not easy to understand why a government simply being able to accomplish the presumed normal task of funding its deficit makes stocks more valuable. Granted, the elimination of a negative can provide a boost, but that may already have been prices in the past few months.
Yet, European stocks were up on Monday and the reported reason was that eurozone economic data were bad, thereby increasing the likelihood of ECB action.
What It All Means
The fundamentals are clearly worsening. The global economic growth outlook is getting worse by the day. Profits for the S&P 500 in aggregate for the third quarter are expected to decline from the same quarter a year ago, and the poor economic outlook suggests that a rebound in fourth quarter profits, or even in early 2013, is unlikely.
Yet, global stock markets are doing well in large part because of expectations of further central bank quantitative easing.
The simple fact is that neither the first round nor the second round of quantitative easing from the Fed boosted real GDP growth above 2%. A third round won’t either.
A round of bond buying by the ECB isn’t going to end the eurozone recession.
The support for stocks from expected central bank action isn't based on the belief such action will generate economic growth.
It is based partly on the belief that the risk in stocks will be reduced because the likelihood of a credit market catastrophe will be lowered.
It is also based partly on the belief that increased liquidity will boost stock prices.
This last belief implies that it is worthwhile to buy stocks because the Fed is in effect creating a mini-bubble of support via increased liquidity, even though the fundamentals are deteriorating.
That may be a reason to buy stocks. However, it is imperative that anyone doing so understands exactly what is happening. The stock market is not reacting to the fundamentals, it is ignoring them. Investing on this basis is a very dangerous long-term strategy.
Founder and Chairman, Briefing.com
