Global markets entered 2012 troubled by Europe’s sovereign debt debacle, China’s economic slowdown and heightened Middle East tensions, all dominant issues in 2011.

In the event, even with Europe probably in recession and China continuing to slow, the global outlook currently seems to be on a more reasonable footing. Confidence has been boosted by numerous policy-related factors, not least the ECB’s recent massive liquidity injection. Elsewhere, post-tsunami disaster recovery in Japan is a positive catalyst whilst the developing economies are stabilising and rebalancing towards greater domestic activity, a positive for future global industrial production.

Against this background the contribution of the US will be crucial. Despite the rise of the emerging markets, the US economy and financial markets are still highly significant for investors with a global perspective. Traditionally seen as the engine of growth and a safe haven during periods of global turmoil, the US has itself experienced turbulence in recent years: a hard recession followed by an uneven recovery, due largely to the depressed housing market which continues to act as a brake, and disappointing employment growth, certainly in comparison to previous cycles.

The suddenness of the 2008-09 economic meltdown obliged US corporations to cut costs, largely labour, quickly and rigorously. Given the resultant large entrenched body of long-term unemployed, the US labour market did not reach a turning point until March 2010, since which time the employment data has been consistently robust and is now a key factor driving all markets.  

The US is one of only three developed economies to have recouped the output lost during the last recession – the other two being Canada and Germany. The myriad of structural, economic and financial factors restraining the global economy – not least deleveraging and increasing financial markets regulations – suggest that the moderate growth trajectory will continue for some time, as will the broadly accommodative monetary policy of recent years in support of continuing growth. Hence, it will be the increased traction of the US economy that will largely drive global growth rates for the foreseeable future. At this juncture the US economy might average 2.3%-2.5% during 2012 – hardly buoyant. That said, since 1928, US economic growth has been the strongest during Presidential election years, so upside surprises cannot be ruled out.

Interestingly, periods of poor economic growth do not imply disappointing equity market returns. Admittedly, the Federal Reserve’s quantitative easing policy – a means of boosting the economy by printing more money – has helped, but nonetheless, up to the end of the March 2012, the S&P 500 Index has appreciated 108% from its low in March 2009.  The S&P 500 typically performs strongly during Presidential election years and appreciated 12% in the first quarter of 2012. Given the outlook for Europe and China, the US’s relative strength could persist for some time, with the dollar remaining on a solid footing too.

In modern times, the flexibility of Corporate America in reacting to extremes in the business climate has been consistently underestimated. This time around, US corporations have not only pulled through the worst downturn since the Great Depression, but in far better shape than could have been imagined in 2008. An “earnings driven recovery” since autumn 2008 has seen corporate cash and profits used to boost investment and consumption. With competitiveness bolstered by the lowest G7 unit labour costs, continuing profit increases are enabling US businesses to expand production and investments to meet improving global demand. Furthermore, both business confidence and spending, and consumer confidence and spending, accelerated, following the resolution of last summer’s debt ceiling crisis. A noticeable rebound in economic activity followed, with still considerable pent-up demand for goods and services.

Finally, as the November 2012 Presidential election draws closer, so too will important deadlines on tax and spending policy. Significantly, President Bush’s tax cuts will end, whilst a previously agreed deficit reduction plan will be actioned, raising the possibility of economic slowdown. That said, the Fed has warned politicians that aggressive federal spending cuts might derail the economic recovery. Hopefully, the potential fiscal drag due in 2013 might be less draconian than current bearish expectations.

Nick Roe-Ely
Investment director

Source:

• Standard & Poors. www.standardandpoors.com.
  S&P 500 Index 1408.47 (30/3/2012). S&P 500 Index 676.53 (9/3/2009).
• “August Armageddon? US gloom and doom overdone”, Nick Roe-Ely, XCAP Asset Management Monthly X-cerpt, September 2010.
• “The US expansion gains both momentum and breadth”, Nick Roe-Ely, XCAP Asset Management Monthly X-cerpt, April 2011.