Headlines suggest that the US’ Dow Jones Industrial Average has had the worst start to a year in 100 years. Just as well, considering that the first major news release of the year was the fourth quarter (2007) GDP growth estimate from Singapore. The estimate was a revelation. Singapore’s GDP contracted 3.2% on an annualized basis. The consensus estimate had been 3.1%. Although the contrast was attributed to the volatile pharma and drug sector, the miss was too big to be explained away by one factor.
Asia is beginning to feel the strain of the slowdown in US consumer spending. Of course, one would not realize this from the heady rises in Asian bourses on some days. In the US, although data have been mixed, the trend is towards greater weakness. Holiday season shopping has been clearly subdued. Philadelphia Federal Reserve’s regional manufacturing confidence has been declining. New orders for durable goods have also headed south. In the national purchasing managers’ surveys, new orders have slowed down relative to inventory. The latter is rising faster than the former, indicating a slowing of in manufacturing growth. This is also reflected in the steep drop in manufacturing employment in December along with the rise in the unemployment rate to 5%.
It is only a matter of time before a recession is officially declared in America. Similarly, it is a matter of time before realism sets in, in much of East Asia on their growth prospects this year and next. East Asian equities—regardless of whether they are in the north or in the south—are vulnerable to a US slowdown. Those that are relatively less stretched in terms of valuation such as Taiwan, South Korea and Thailand would turn in a relatively better performance. But absolute positive performance from equity markets in these countries would require a lot of imaginative policy, and luck as well.
In the case of India, its attractiveness as an island of domestic strength is becoming increasingly evident. But as an editorial in The Indian Express pointed out on Saturday, mounting subsidies in the pricing of hydrocarbon energy products are accumulating risks for the future. India’s energy pricing and transportation policies need to be drastically and urgently re-thought, as cities are choking with traffic, pollution and stress. Further, the finance minister’s call for lower deposit and lending rates, when inflation expectations and actual inflation experience among households are high, is confusing. Anecdotal evidence suggests that banks have not really given up on aggressive lending practices. Therefore, the central bank should remain on guard against risks to financial system stability. Investors in the Indian equities market should be minding that risk. In general, a substantial relative outperformance in 2008 by Indian equities versus regional and global peers looks almost assured.
Regardless of subsidies in India and in many other countries, the price of crude oil would remain a thorn in the flesh of many governments this year, too. In spite of signs of a global economic slowdown, the price has stayed well above $90 per barrel. The market for crude oil is not just pricing in a cold winter in the Western hemisphere, but also increased geopolitical risk. In the final days of 2007, the assassination of Benazir Bhutto must have brought home some stark truths to those who have deluded themselves into thinking that stability in Pakistan was a matter of supporting some army general or the other. Bare Talk continues to believe that in the days ahead, Pakistan would be an increasing global headache or worse, even if many spin doctors in India and elsewhere would have us believe otherwise. That means that the geopolitical risk premium embedded in the price of crude oil would only rise and not decline. Thus, the outlook for the price of crude oil requires only an acceptance of hard reality rather than the creative imagination of “new paradigm”ers.
The move in the price of gold last week, too, has been significant for it came in spite of the big rally in the yen against the US dollar. Usually, periods of yen strength are associated with reduction of risk appetite. Many argued that gold was as much a beneficiary of global liquidity as “carry-trade” currencies and other momentum assets were and hence, it would drop when global risk aversion rose. Last week’s price action in gold has clearly disproved it. Gold is now rising because of increased sensitivity to geopolitical and inflation risks. That is likely to continue in 2008.
In short, it is a likely uphill struggle in 2008 for market participants and investors alike. However, as Willem Buiter observed in the Financial Times, if this leaves the financial sector a little less important to the world and less attractive to many young people, that would be one useful contribution that the sector would have made finally, to the world at large.
(V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore.These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org)