Double dip?

Fears of a double dip have risen with many now expecting the global economy to slip back into recession by the end of the year. The clearest indicator of this possibility is the ECRI index for the US, which has fallen sharply in the last few weeks. In Europe, the German ZEW index has also dropped significantly since late last year. Other leading indicators are less clear cut. The JP Morgan all-industry PMI index, which summaries all the monthly national indices, peaked in April and fell slightly in May and June. The OECD lead indicator is still rising but its rate of change has decelerated sharply. It could also be argued that global stockmarkets which fell by 7.6% in the first half of 2010 are suggesting a deteriorating outlook.
It is perhaps not surprising that the decline in equity markets coincided with the onset of worries over Greece defaulting and the possible break-up of the euro-zone. The response of governments within the euro-zone has been to impose fiscal deflation on many of its member states. Germany has refused to reflate to compensate. Given the fragility of the global recovery, this is lunacy. The timing of the UK government’s desire to get its fiscal books in order, while generally desirable, leaves a lot to be desired. This moment in time is not the best for fiscal cut-backs. The other factor that is not helping is China’s need to tightening policy. China is running the risk of a property ‘bust’ and needs to bring bank lending under control. In the short run, this is negative but from a long term perspective, it is should ensure that China’ dramatic growth story should continue.
Generally, leading indices normally slow about 12 months into a recovery. This is often due to fluctuations in the inventory cycle, and the recovery reasserts itself a few months later. This may well happen this time but the concern is that the fiscal stimulus put in place by many governments in late 2008 is now coming to an end with nothing to replace it. If this is correct, it is beholden on governments to come up with a new fiscal stimulus and to bin any thought of cut-backs. St Augustine remains relevant – please make us virtuous but not yet.

Hedge funds

Hedge-fund managers, those ‘masters of the universe’, are struggling. They have not made any money so far in 2010 after the worst second-quarter performance in a decade. With all the macro-economic volatility and issues within the euro-zone, one would have thought hedge funds would be in their element. Instead, they have scaled back trading after bad losses amid sometimes vicious crosscurrents in stock, commodities and other markets. . For example, one of the Paulson funds lost 12% in June alone. Man Group has seen an outflow of c$1bn from their hedge funds. Outflows from the sector will continue as trustees cannot justify paying 2% management fees for zero returns and 50% correlation with equity markets.

The outlook for the 3rd quarter

I was optimistic about the durability and strength of the global economic recovery at the beginning of the year and I retained that optimism at the beginning of the 2nd quarter. Now I am much less optimistic for which I blame Europe. Too many European banks are effectively bust and the authorities are lothe to do anything about it. The upcoming publication of the stress tests for the banks should make interesting reading. Greece should not be part of the eurozone, as it refuses to abide by the rules. Germany macro policy and her political will is deflationary. Europeans are determined to shoot themselves in the feet. As for the rest of the world, the extent of tightening in China is an issue and bad news for commodity producers. But I think the Chinese authorities are handling the situation well (in contrast to the Europeans). Generally, there are concerns about the durability of the economic recovery, as companies sit on cash and employment markets remain in a dreadful state throughout the developed world. But the recovery is not being driven by the developed world but by the developing world, and the emphasis of that growth is shifting from exports to consumption.
Equity markets have weakened by about 15% in the second quarter, after rising by 70% from the nadir of the bear market in March 2009. The current sell-off is providing buying opportunities for the themes that have dominated the recovery – namely, emerging market growth and exporting to these markets. Infrastructure and health are other themes. I would be wary of sectors dependent on growth in the developed market, e.g. consumption or anything to do with employment or government spending.

China's renmimbi revaluation

On the 21st June, the Chinese announced that they would loosen the RMB tie with the dollar. This first happened in July 05, when the fixed peg of 8.28 against the dollar was abandoned. By the end of 2008, the RMB had appreciated to 6.83, when the turmoil of the financial crisis persuaded the authorities to hold the RMB at that level for the time being in the interests of stability. The recovery in the global economy in 2009 and the implementation of a domestic stimulus package resulted in an economic boom in China with GDP reaching 11% in the year to March 2010. Despite this, the Chinese still managed to run a large, albeit declining, trade surplus with the rest of the world. With the US still running a large trade deficit, the Americans put China under pressure to allow further RMB appreciation. The whole issue became political and the essential point got lost in diplomatic dialogue between the two countries. This is that it is in China’s domestic interests to allow the RMB to appreciate. China is the mirror image of the problems of the Euro-zone. The peg with the dollar implies that China and the US are running similar monetary policies, but the domestic demands of each economy are very different (as is the case with Greece and Germany). China is booming and the US is struggling, meaning that they need very different monetary and exchange rate policies. It is the need for an independent monetary policy that is domestically determined that should drive China’s exchange rate policy and is very much in her long term interests. The fact that she has relented is good news from everyone’s point of view. It is a pity that the Europeans cannot resolve their own economic contradictions so easily.