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On the economic outlook, we continue to see growth returning in the largest economy in the world, the U.S. For the skeptics of government-released economic reports, we include below our key index from the private economic consulting firm, ISI Group. After bottoming at a record low below 30 in 2008, the Composite Company Survey (we also monitor the individual sector surveys as well) has shown a continued recovery. While it has receded slightly in 2011, the survey remains around the 50 level, which indicates continued expansion of the U.S. economy at an annual rate of around 2.5%. The survey is showing none of the breakdown activity we saw starting in late 2007, which made us much more wary about the stock market going into 2008.
The individual components of the survey are also fairly robust in key areas such as retail sales, consumer confidence, business spending, trucking and rail transport. But it’s Europe, not the US, that is the current worry for most investors. There is no doubt that the sovereign/banking debt crisis going on in Italy, Spain, Greece and Portugal is having a negative impact not only on European growth, but also global growth since the Euro-Zone still accounts for about 20% of the global economy. The chart below shows the PMI’s (Purchasing Manager Indices) for the entire Euro-zone (blue), Germany (green) and Italy (orange). This is a monthly survey of businesses about their assessment of current conditions and outlook in various industries. A value above 50 indicates expansion. While we can clearly see that economic activity has slowed down this year, we are nowhere near where we were back in 2008. Moreover, the data appears to have bottomed for now as the most recent data (December, not shown on chart) has turned back up for the region. Moreover, the data from Germany is acting better than the rest of Europe which is important since Germany is the largest single economy and the most important in terms of its influence on overall policy for the Euro-zone. Employment, consumer and business confidence and industrial production in Germany have all moved higher in December.
Also, as we have pointed out before, Europe has not been the engine of global growth for a long time, expanding at only a 1.5% annualized rate over the past ten years versus global annualized growth of over 4.0%. We expect negative growth in Europe in the 4th quarter of 2011 and perhaps into the first quarter of 2012, but then we expect those economies to stabilize, driven by the decline in the Euro currency, strength in the Northern European economies and better growth in the U.S., which will support European exports.
The next wild card in the global picture is China. There are strong fears that the inflation battle in China will take its toll on that economy as well, with interest rates being pushed higher and bank credit tightened in 2011 to slow down speculation in the property markets. This has lead to weakness in Chinese stocks in 2011, with the key Shanghai Index down almost 21% this year so far. Bearish investors looking for even more reasons to be negative have highlighted this weakness in Chinese stocks as a harbinger of an imminent economic slowdown or ‘hard landing.’ This would contrast with the moderation of growth or ‘soft landing’ that the Chinese authorities were trying to achieve. Rather than looking at stock markets though, which are highly influence by emotions, we look at global trade statistics to see if they validate the worries about global economic growth. The chart below shows the 6-month change in global exports, historically a very good lead indicator for global growth. Once again, the data shows a slowdown thus far in 2011 as the Euro-crisis and the ‘engineered slowdown’ in China have had a negative impact on global trade. But, once again, the data is nowhere near as dire as in 2008. The data series is also starting to moderate and, in some cases, increase again. China has once again turned into a net importer of basic commodities as they restock depleted supplies. Our vote goes to ‘slowdown’ not ‘breakdown.’
Chinese authorities have in fact recently shifted their focus away from controlling inflation—their top priority over the past year—and toward growth. China will focus on expanding domestic demand to counter a slowing global economy, the government said in a statement released after a meeting of the central economic work conference. The memo was definitely more pro-growth than the one issued a year ago, strongly suggesting that fiscal policy in 2012 will be more proactive than 2011 and monetary policy will be eased. We are looking for another cut in the reserve ratio for Chinese banks over the next few weeks.
As the biggest and one of the fastest-growing of the world’s developing economies, China has become a voracious consumer of industrial and agricultural commodities. Its shifting needs are now the most important driver in the prices of many of those goods. Producers often base massive capital investments largely on their expectations for Chinese demand for their products. Investors often make similar calculations before buying or selling commodities contracts or related securities. That’s why no single factor is likely to have a more far-reaching impact on commodities markets over the next few years than how Chinese demand changes as the country’s economy evolves. China is the key to the outlook for commodities markets, but it isn’t the only factor. Commodities prices could face upward pressure over the next 10 years if other countries start to consume anything like China did over the past decade. India consumes a small fraction of the world’s commodities—for instance, 3% of the copper, compared with China’s 37%, despite having nearly as many citizens. But that could change, because India is less developed than China, meaning it still has a vast amount of work to do on improving its infrastructure, particularly upgrading its power grid and it also wants to boost manufacturing. The list is long of other, smaller countries that consume fewer raw materials per capita than the developed world, leaving lots of room for global demand to grow. While some have been ratcheting up consumption, they haven’t been doing so as fast as China, suggesting their appetites could get even bigger. For instance, between 2000 and 2010, copper consumption in Brazil, Indonesia, Russia and Turkey increased almost 100%, according to data from the International Copper Study Group, an intergovernmental organization. Over the same period China’s consumption quadrupled!