Cyclical concerns likely to keep policymakers on alert
The global growth outlook continues to be cloudy. Aggregate demand remains tepid in developed markets and the developed market fiscal outlook is the main source of uncertainty. Moreover, emerging markets are experiencing their own cyclical downturn; mainly due to a growth slowdown in China and broad softness in exports. As opposed to 2011, policymakers across the globe now face easing inflation pressures and we expect global monetary accommodation to accelerate. At this stage of the business cycle we maintain our cautious investment stance, with a preference for sectors and financial instruments that offer income generation and cash flow visibility.
As we discussed in recent articles, our main medium-term concern for the U.S. economy is a fiscal policy vacuum due to the election period. Recent business and consumer confidence data appear to be confirming our concerns. The pace of employment growth remains lackluster despite a positive trend in job openings. In addition, despite an elevated unemployment rate (8.2%), the recent increase in wages may be indicating structural issues in the labor market i.e. a lack of or a deterioration of labor skills due to lengthy unemployment periods.
On the manufacturing front, we note that recent data has been dissapointing with a small contraction in the ISM Manufacturing PMI Index (less than 50 as seen below). In addition, the spread of manufacturing new orders vs. inventories is indicating a soft industrial production outlook. The main silver lining in our indicators is the fact that economic and earnings expectations have been declining in anticipation of this fundamental weakness. We caution however that in absolute terms the growth outlook is still fragile. Businesses and consumers need visibility over the 2013 fiscal outlook and the outcome of the U.S. election is likely to have a meaningful impact to business and consumer confidence. It is plausible that economic weakness may tilt the odds for a Republican controlled administration, which could be perceived as a positive catalyst for risk assets such as U.S. equities. Fewer regulatory pressures and a lack of political gridlock would bode well for business sentiment.
On the monetary side, with inflation in check amidst a sluggish economic environment, we expect the Federal Reserve to continue its accommodative stance. This is especially important for the U.S. housing market recovery which appears to be on a U-shaped recovery path as the foreclosure pipeline is gradually cleared.
In Europe, the Eurozone leaders’ piecemeal crisis approach continues. The focus seems to be on crisis containment rather than a more sustainable framework that would see e.g. Spanish bad debt restructuring and recapitalization of the European banking system as bad debt is written off. In the meantime, the path of least resistance is for euro devaluation by the ECB in an attempt to improve the broader competitiveness in the Eurozone.
In conclusion, we continue to assess the risk-reward in the marketplace. At this stage of the global business cycle we maintain our cautionary stance. We focus on income generation (MBS, preferred shares) and financial instruments such as large cap defensive equities that offer cash flow visibility and dividend growth.
Christos Charalambous CFA
Senior Strategist
christos.charalambous@edgewealth.com
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