Global investors this month pulled the most money from stock funds in any April in at least 17 years amid escalating concerns that Europe’s economy is faltering. Equity funds had net redemptions of $18.6 billion through 25 April, according to data from EPFR Global, a research firm based in Cambridge, Massachusetts. The April withdrawals were the largest since at least 1996, the first year for which comparable data is available.” (source: http://www.bloomberg.com/news/2012-04-27/equity-fund-redemptions-in-april-are-largest-in-17-years.html).
The chart, based on data taken from the Investment Company Institute (ICI), shows that public participation in American equities underwent a massive structural change after the technology bubble. It shows no signs of reversing yet. Months of inflows into US equity funds are sparse after 2000. It remains the case even now. This is not the sign of a healthy market.
Browsing through the release of data in Europe over the last few days, one finds a bunch of disappointing economic data from Finland to Belgium to France to Italy to Spain. The unemployment rate in Finland jumped to 8.5% from 7.7%. Hourly wages recorded zero growth in February and Mach in Italy. Business confidence slumped, too, in April while the indicator for March was revised lower. Belgian business confidence, considered a bellwether indicator for the overall business confidence in the region, deteriorated to -10.7 in April, its worst reading since October 2009, save for November 2011 when fears over the collapse of some European financial institutions were pervasive. Number of job-seekers went up by 16,600 in France in March. Consensus forecast was for a rise of 2,800. The unemployment rate in Spain went up to 24.4% in the first quarter from 22.85% in the fourth quarter of last year. The euro zone consumer, economic and industrial confidence indicators declined in April.
In the first round of presidential elections in France, Socialist candidate Francois Hollande emerged the winner and a right candidate garnered 20% of the votes polled. The Merkozy train is likely to derail. The Dutch government resigned because it could not get its allies to agree on a budget that would freeze the deficit at or less than 3% of GDP in 2013. However, it passed the budget later with the support of allies. The Dutch economy is officially in recession. For all practical purposes, Spain has entered into its second recession since the global crisis. Standard and Poor’s, while downgrading the credit rating of Spain from A to BBB+ on 26 April, commented that fiscal austerity alone is not helping. Europe desperately needs growth. (“One euro is not enough”, 14 November, Mint).
The bewildering thing is not that the euro has not weakened despite all the unsettling developments on the political front and disappointing economic news. It actually closed the week higher because US economic data, including the much-anticipated strong economic growth in the first quarter, has been disappointing. Growth was 2.2% in the first quarter. The US annualizes the quarter-on-quarter growth numbers. The optics is better. Consensus forecast was for a growth rate of 2.7%. Not only that, the quality of growth was poor. More than a quarter of that growth came from accretion to stocks. Inventories have now contributed significantly to growth in the last two quarters. In contrast, investment in equipment and software—indicator of investment spending by businesses—has been a drag on growth in the last two quarters.
This is not only poor quality but also unsustainable. Strong consumer spending keeps up imports and net trade has also been a drag on growth for America. Therefore, it is no surprise that America is keen to thwart European desire to see the euro weaker. American politics does not favour another round of money printing and, hence, the Federal Reserve is working overtime to come up with other ideas to keep the dollar weak such as the pledge to keep the federal funds rate on hold until 2014.
These are driving inflation expectations higher in the US. The forward inflation rate, five years from now, is at 2.7%. It is higher than the rate of 2.5% that prevailed in 2007. Then, the interest rate was at 5.25%. Now, it is at zero per cent. With growth weak, all the dollars that the Fed printed are raising cost of living all around. Just ask Singapore.
The stock market in the US is ignoring these developments as it has in the past. This is both complacent and myopic. Strong corporate earnings were offered as a defence in 2007. That could not prevent a stock market rout in 2008. There is no reason to expect anything different this time. Markets seem to be able to look only at the numerator (and that too, earnings and not dividends) whereas rising risks must be factored into the denominator (the discount rate). Investors refuse to do so because central banks have permanently shut down the signalling function of interest rates.
Escalating social and political risks, slowing growth and rising inflation mean that we are already in a macro environment that would hurt both stock and bond returns. Stocks first and bonds next. Dance near the door, if you still want to party.
V. Anantha Nageswaran is a senior economist with Asianomics. These are his personal views. Comments are welcome at email@example.com
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