October 12, 2011
Weak stock markets, a Greek haircut and protectionist fervour
Chief Economist, CanaData
Through April of this year, the major North American stock market indices — Dow Jones Industrials, Standard & Poor’s 500, NASDAQ and the TSX — were breezing along, setting new post-recession highs with some regularity.
The fact the unemployment rate in the U.S. was stuck above 9.0% wasn’t that much of a problem for share prices.
Sure, domestic demand may not have been all it could be, but external markets — i.e., read emerging nations – were placing orders with American suppliers at a good clip.
The newly affluent in overseas markets were beginning to demand the finer things in life, from protein-rich diets to new means of transportation (e.g., cars) and labour-saving devices in the home (e.g., fridges and stoves).
Plus their governments had initiated massive public works projects to bring roads, highways, bridges, railroads and power plants up to standard.
These requirements have been placing demands on certain manufactured goods suppliers, plus engineering services firms, in the U.S. and on raw materials (iron ore, coal, potash, etc.) owners in Canada.
Inventory rebuilding at home also helped many American firms restore better activity levels.
All of this was achieved with little addition to the employed portion of the work force. There has been one notable exception: jobs in the high tech sector.
Automation, better data processing and improvements in logistics have facilitated greater output levels without the need to rehire staff.
In some other areas of the economy, information technology has led directly to stronger hardware orders (e.g., electronic gadgetry) or contributed to improved traditional sales through such means as expanded use of the Web.
The growth in retail sales made over the Internet is outpacing shopkeeper gains as a whole by a factor of about two-to-one.
The bottom line is that corporations have been realizing strong profit levels, while holding back spending on either labour or new physical plant. Investments in machinery and equipment have been somewhat more active.
Compared to their low points in the recession (February 2009), North America’s four major stock market indices rose between 80% and 100% up until April of this year.
Since April, however, they have all fallen dramatically. This September’s month-end closings were almost exactly the same as a year ago. The TSX performed worst at -6% year over year. There have been further losses early in October.
The Greek debt crisis, U.S. budget deficit and Chinese monetary tightening, in response to property price bubbles, are all weighing on the world economic outlook.
The Toronto stock exchange is being hammered by a commodity-price effect. Benchmark oil has fallen below $80 U.S. per barrel and copper, nickel and many other prices in the resource sector have lost ground, including gold.
Overriding everything else, at the moment, is an overdose of worry about the Greek situation. Default is now all but inevitable. That puts pressure on the banking system.
Athens has cut its spending to the point where operating revenues are close to matching operating expenses. But that still leaves ballooning interest payments. Further massive cuts to the civil service are planned.
The time has come to talk about a “haircut” on Greek debt. How much will investors get on the dollar? As low as 50 cents has been mentioned. The blow to some European banks will be significant. Some may go under or need government bailout money.
In turn, investors fear that banks will stop lending to each other and there will be another credit freeze similar to what occurred in early 2009.
It’s very important that Europe come up with a credible plan to contain the damage. And it needs to be bullet-proof in size and scope.
So far, the so-called troika comprised of the European Union, the European Central Bank and the International Monetary Fund (IMF) has disappointed in its rescue efforts. The emergency fund may need to be as large as $2 trillion.
In the meantime, the news is filled with too much negativity. Some good things are happening in the U.S. economy.
Contrary to most analysts’ expectations, the Purchasing Managers’ Index (PMI) of the Institute of Supply Management (ISM) increased in September to 51.6% from 50.6% the month before.
A reading above 50% means both the overall economy and the manufacturing sub-sector are expanding. According to the ISM, an annualized PMI of 51.6% corresponds with a “real” (after-inflation) gross domestic product (GDP) growth rate of 3.2%.
Unfortunately, protectionist sentiment seems to be gaining some headway. U.S. President Barack Obama’s American Jobs Act contains provisions to limit government procurement to domestic sources in such areas as infrastructure construction.
And there is a bill before the Senate spelling out what action should be taken against countries that are judged to be unfairly manipulating their currencies. This seems directly aimed at China.
It would impose punitive measures such as dumping duties if foreign governments remained unmoved.
Business groups, including the Chamber of Commerce, are not in favor of such an initiative. They realize the dangers of retaliation. Their own members may lose access to valuable export markets.
Inefficiencies in foreign trade reduce the capacity for specialization in areas of expertise, limiting access to products and services and raising costs for everyone.
For more articles by Alex Carrick on the Canadian and U.S. economies, please see his market insights. Mr. Carrick also has an economics blog. His lifestyle blog is at www.alexcarrick.com
