Clueless. No, I am not referring to any particular policymaker. I am referring to Bare Talk’s mind on Sunday while contemplating another column. What topic to focus on? Of course, in theory, there is no dearth of choice. After all, the European Union has announced the results of the stress tests it had conducted on the euro zone banks. The chairman of the Federal Reserve had given his traditional semi-annual testimony to the US Congress. In India, the Reserve Bank meets this week for its monetary policy decision. The US will be reporting its second quarter economic growth figures this week. So one could focus on any of them. Instead, this column will analyse the recent divergence between the health of the market and the macroeconomy in different regions.
Clearly, in the last three weeks, financial markets have gone from teetering on the edge of the precipice to breathing a lot more easily. Measures of market volatility have declined. Commodities have rallied and commodity currencies have strengthened. The UK reported a much stronger-than-expected gross domestic product growth, and the pound sterling has been buoyed by that report. Euro zone economic statistics, for all the handwringing, have failed to vindicate the pessimists so far. Euro zone economic momentum remains surprisingly robust. Of course, in Asia, economic numbers have remained impressive and generally more positive than expected.
The world economy, led by Asia and with Europe pulling through, might keep growing at a sluggish pace. But the US economy appears to be the laggard. Having travelled in India in the second part of last week, Bare Talk just had the opportunity to catch up with chairman Bernanke’s testimony to Congress. The testimony attempted to strike a tone of confidence, by visualizing a scenario in which the Federal Reserve could shrink its balance sheet by selling off the assets it had acquired during the crisis and in which interest rates could go up, etc. It was an exercise in behavioural therapy. But one sentence at the beginning of the testimony gave away the lack of underlying conviction: “Although fiscal policy and inventory restocking will likely be providing less impetus to the recovery than they have in recent quarters, rising demand from households and businesses should help sustain growth.”
The Financial Times (FT) got it right when it wrote that notwithstanding the strong data in the UK, the chances of another round of quantitative easing on either side of the Atlantic have increased. That is a fair assessment.
Large parts of the US economy remain under stress. Chief among them are small businesses and households. The July report of the National Federation of Independent Businesses grimly stated that for the Index of Confidence of small businesses to languish around 90 points for this length of time was unprecedented in its history. No surprise that Bernanke’s testimony had a long appendix on the various measures taken to address the needs of small businesses.
The leading index gauge of the Economic Cycle Research Institute continues to contract. The last time we checked, it was at -10.5. That is, its annual contraction rate is -10.5%. Historically, such a rate of contraction in their leading index has resulted in a significant reduction in economic growth in the following 12 months, if not an outright recession. In fact, such a rapid rate of contraction should heighten and not lessen recession anxieties in the US for 2011.
Indeed, it is disingenuous of the US to blame the crisis in the euro zone for the tightening of financial conditions on its shores and for the resultant loss of economic momentum when economic activity in the euro zone is catching observers off-guard with its strength. The drag on the global economy is the US.
The question is whether its economic drag would begin to affect US stocks and hence global stocks. US stocks have rebounded?from?2 July onwards. Surprisingly, Asia has lagged behind the US, and European stocks have only marginally outperformed US stocks in this period (performance year-to-date is nothing to shout about either). That appears wholly inconsistent with fundamentals.
John Authers notes in his recent column in FT that analysis of corporate fundamentals and individual stock-picking have mattered little in the face of massive sectoral, geographical and global correlations. Investors’ herd behaviour drives stocks up or down in herd. This is not sustainable even if the wait is frustratingly long for such mindless correlations to give way to differentiated market performance.
If a putative Chinese recovery and tentative signs of easier liquidity conditions in that country are the reasons for the recent strong showing by stocks globally, then it is a puzzle as to why Asian stocks are not in the vanguard of this rally. Either this trend will reverse or Asian policymakers have to ponder over this decoupling between their macroeconomic fundamentals and stock market performance.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org
To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk