(From a piece published in Minyanville)
By Jay Pelosky
A recent investment outlook roundtable was the catalyst for some big picture thoughts about the global economy. We found that five themes define the current economic outlook. "Steady as she goes" is the meme because, for all the angst about the state of financial markets, changes to the key underpinnings of what is occurring (or not) in the world economy have been limited.
To start, we remain in a global deleveraging process, with individuals, corporates, and governments attempting to reduce their debt loads. This is most acute in the developed economies but may spread to the emerging economies due to Europe’s debt crisis.
Coupled with the deleveraging process is a shortfall in global aggregate demand. Western consumers seek to pay down debts built up in the early years of the 21st century while individuals in emerging economies have increased purchasing power due to rising rates of economic growth. The demand rebalancing from the US to the rest remains incomplete.
Political dithering in Europe has allowed a liquidity problem in most cases to morph into a solvency one for many banks and some governments. If anyone needs a bullish start to 2012, it is European banks as they seek to raise capital. But returns for Italian bank Unicredit do not bode well, with negative implications for the magnitude of its region-wide credit crunch.
Central banks in the United States, Europe and Asia have employed varying degrees of monetary policy to offset these interrelated problems. However, what monetary policy there is has been nullified to a large extent by a wrong-headed political embrace of austerity, especially in Europe, but also to a lesser degree in the U.S. Expect a deep recession in Europe where even Germany feels the pain. The U.S. Federal Reserve's efforts at quantitative easing show what happens: banks hoard capital, liquidity stagnates, economies weaken, central bankers become politicized, and earnings fall. The European Central Bank is now learning this lesson.
The global framework remains much as it has been for several years: developed economies face sub par growth/recession and deflation risks while emerging economies enjoy higher growth with rising inflation, now morphing into stagflation (defined as inflation rates higher than growth rates). Growth drivers in the developed or emerging economies for 2012-2013 are very hard to identify given the deep recession one can expect in Europe, the fiscal drag baked into the US cake, and China’s politico-economic transition. Bottom line – downside risks seem to far outweigh upside opportunities.
Five themes emerge from this worldview: bifurcation, corporates lead, US is the place to be, the search for higher yields, and the global tide turns. Let's explore each in turn:
Bifurcation: spreads around the globe, across assets and among peoples. 2011 was the year of Occupy Wall Street, but it was the 1% who made the money, a clear example of bifurcation that will influence the globe’s socio-political landscape for years to come. Bifurcation between labor and capital stimulates social tension, between political parties it ensures gridlock and dependence upon unelected central bankers, and between financial assets it creates volatility and shrinks liquidity.
Corporates lead: Among the three main actors (individuals, governments and corporates) corporates are in the best shape, certainly among the developed economies and only marginally less so in emerging economies, where governments, by contrast, are in good fiscal shape. The consumer is strapped in the West and worried about inflation in the East. Governments have taken on the debt of the banks and in many cases are much worse off than 2008, right after the financial meltdown. U.S. corporates will have close to $2 trillion in cash over 2012…stock buybacks are likely to be the C suite strategy of the year!
US (financial assets) outperform the rest: is a longstanding theme. U.S. corporates are best placed to find growth opportunities. The U.S. economy is in better shape than the rest of the developed world. Supported by a manufacturing renaissance and energy boom, the Fed is keeping the same interest rates thru 2013. All of this has put the dollar on recovery mode.
The search for higher yields: will define the investment landscape for some time to come. The number of pension, endowment and other funds that have 7 to 8 percent return targets is very large—the opportunity set to generate such returns with low risk is very small—ergo; find-those-spots-and-get-there-first is likely to be an effective investment strategy.
The global tide turns: We are witnessing the reversal of the global financial tide as well as the end of the global supply chain. European banks' woes ensure the tide is turning and will continue to turn as capital is brought home. Rising wages in emerging countries, high fuel costs, extreme weather in more parts of the world, and the desire to be closer to one’s customers suggests that the next stage for the global supply chain will be a roll back to regionalization.
(To read the rest of Pelosky's analysis, click here)
Jay Pelosky is the founder of J2Z Advisory LLC, an investment strategy consultancy, and a board member of the World Policy Institute.
[Photo courtesy of Ken Teegardin]