Issue 29: 2015

MACRO ANALYSIS

Global Rebalancing Shifts Gears

The United States and other equity markets moved to record highs in the fourth quarter.

Photograph by Andy Ryan

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In October 2014, the U.S. stock market dropped almost 10%. The ostensible reason was a global growth slowdown, with evidence for a faltering economy cited across the financial media. Yet a few months later the United States and other equity markets moved to record highs, and as fourth-quarter data showed, “the pace of growth abroad appears to have stepped up slightly in the second half of last year,” according to the Federal Reserve.

How could the pundits get it so wrong? One reason was confusion between inflation and real economic growth. Another was the rebalancing of global growth. While China is seeing slower growth, countries such as India are seeing rising growth. Also, the United States and Europe didn’t slow down in 2014. Europe, in particular, grew faster last year despite many worries that it was slowing. The European Central Bank’s (ECB) easing helped European economies to continue their expansion out of the double-dip recession that ended in mid-2013.

Two major shifts in mid-2014 helped to speed global growth. Oil prices dropped more than 50%, and the dollar’s foreign exchange value surged more than 10% on a trade-weighted basis. Initially, market focus was on the negative aspects of these shifts. Energy companies cut back on investment, and U.S. multinational companies reported lower-than-expected fourth-quarter earnings. Therefore, analysts slashed earnings estimates for 2015.

Europe grew faster last year despite all the worries that it was slowing.

Eventually, the markets reflected the positive aspects of lower energy prices and a stronger dollar. Estimates from macroeconomic models suggest lower oil prices will add up to a full percentage point to global growth, while subtracting about the same from inflation — resulting in more jobs and purchasing power for consumers worldwide.

The bottom line is that low oil prices are a shot in the arm for global growth.

In the United States, this is happening at a fortuitous time. Low unemployment, rising incomes, low interest rates and rising confidence are helped by lower energy prices. U.S. growth is shifting toward stronger consumer and housing sectors that will help stimulate global growth, which is evident in a rising U.S. trade deficit.

A strong dollar boosts global growth

Before the financial crisis, China led the way with its rising trade surplus that eventually topped 10% of gross domestic product (GDP). The flip side was growing trade deficits in countries, including the United States, where the excess of imports over exports reached more than 6% of GDP. China recycled its surplus into the deficit countries and allowed debt-fueled housing booms to get out of control, a dynamic that ended in the financial crisis. U.S. consumers then spent a few years deleveraging, and the trade deficit shrank to about 2% or 3% of GDP. Oil helped the rebalancing thanks to the boom in domestic production. A weak dollar also helped this rebalancing adjustment.

 

Many critics claimed the Fed was debasing the currency and trying to create a U.S. advantage. Finance ministers in stronger currency countries such as Brazil said the United States was provoking a currency war. However, the U.S. dollar is now in an uptrend and depreciating currency countries are accused of currency wars to gain a trade advantage. The United States has rebalanced its trade to where a weak dollar is no longer required to shrink the trade deficit. A U.S. trade deficit of less than 3% of GDP has typically been associated with a global dollar shortage, which is one reason why it’s appreciating. Other countries have trillions of dollars of debt they need to service.

A strong dollar is favorable for U.S. consumers. Imports are cheaper. This transmits U.S. strength to the rest of the world and indicates this expansion is a United States–led recovery. Rather than a currency war, we are seeing an appropriate rebalancing of exchange rates. The weak dollar back in 2002–2007 was a natural response to a growing U.S. trade deficit, but by 2008 the dollar was undervalued and is now readjusting itself.

A strong dollar adds to the favorable situation now developing for U.S. consumers.

In retrospect, we believe the critics were wrong. Inflation in the United States remains too low and has fallen short of the Fed’s target for several years. The European Central Bank let inflation fall while its balance sheet shrank. Instead of the Fed being too easy, other central banks were too tight, creating deflationary pressures,
exacerbating the global savings glut.

Commodity importers versus exporters

The rebalancing between growth in commodity importers versus exporters has gained momentum from the drop in oil and other commodity prices, with China playing an important role.

Traditional metrics weighted toward China’s old pattern of growth look weaker than new metrics of the growth mix. Those metrics are showing a cyclical pickup since late 2014. The structural trend is still moving down, but evidence of a cyclical pickup within the secular downtrend will temper China’s negative impact on global growth.

Like the United States, China benefits from a strong currency. An improving Chinese stock market is also a good sign of turnaround. With real estate under pressure and wealth management products more tightly scrutinized, equities are essential for Chinese investors.

As manufacturing and construction fall, the share of services is rising sharply. Likewise, the growth rate of nominal consumption is now well above the growth rate of nominal GDP. This was not the case between 2003 and 2008. In short, Chinese rebalancing reinforces the trends that have reduced commodity prices in recent years.

Lower energy prices and a strong dollar are forces for a stronger global economy. While some negative effects have dominated media coverage, the markets are looking at happier days ahead.

IMPORTANT INFORMATION

Investing involves risk. There is always the potential of losing money when you invest in securities.

Projections made may not come to pass due to market conditions and fluctuations.

Past performance is no guarantee of future results. Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets.

Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.

OTHER IMPORTANT INFORMATION

Equities Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.

International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards, and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.

Commodities Trading in commodities, such as gold, is speculative and can be extremely volatile. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest-rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Tangible assets can fluctuate with supply and demand, such as commodities, which are liquid investments, unlike most other tangible investments.

In October 2014, the U.S. stock market dropped almost 10%. The ostensible reason was a global growth slowdown, with evidence for a faltering economy cited across the financial media. Yet a few months later the United States and other equity markets moved to record highs, and as fourth-quarter data showed, “the pace of growth abroad appears to have stepped up slightly in the second half of last year,” according to the Federal Reserve.

How could the pundits get it so wrong? One reason was confusion between inflation and real economic growth. Another was the rebalancing of global growth. While China is seeing slower growth, countries such as India are seeing rising growth. Also, the United States and Europe didn’t slow down in 2014. Europe, in particular, grew faster last year despite many worries that it was slowing. The European Central Bank’s (ECB) easing helped European economies to continue their expansion out of the double-dip recession that ended in mid-2013.

Two major shifts in mid-2014 helped to speed global growth. Oil prices dropped more than 50%, and the dollar’s foreign exchange value surged more than 10% on a trade-weighted basis. Initially, market focus was on the negative aspects of these shifts. Energy companies cut back on investment, and U.S. multinational companies reported lower-than-expected fourth-quarter earnings. Therefore, analysts slashed earnings estimates for 2015.

Europe grew faster last year despite all the worries that it was slowing.

Eventually, the markets reflected the positive aspects of lower energy prices and a stronger dollar. Estimates from macroeconomic models suggest lower oil prices will add up to a full percentage point to global growth, while subtracting about the same from inflation — resulting in more jobs and purchasing power for consumers worldwide.

The bottom line is that low oil prices are a shot in the arm for global growth.

In the United States, this is happening at a fortuitous time. Low unemployment, rising incomes, low interest rates and rising confidence are helped by lower energy prices. U.S. growth is shifting toward stronger consumer and housing sectors that will help stimulate global growth, which is evident in a rising U.S. trade deficit.

A strong dollar boosts global growth

Before the financial crisis, China led the way with its rising trade surplus that eventually topped 10% of gross domestic product (GDP). The flip side was growing trade deficits in countries, including the United States, where the excess of imports over exports reached more than 6% of GDP. China recycled its surplus into the deficit countries and allowed debt-fueled housing booms to get out of control, a dynamic that ended in the financial crisis. U.S. consumers then spent a few years deleveraging, and the trade deficit shrank to about 2% or 3% of GDP. Oil helped the rebalancing thanks to the boom in domestic production. A weak dollar also helped this rebalancing adjustment.

 

Many critics claimed the Fed was debasing the currency and trying to create a U.S. advantage. Finance ministers in stronger currency countries such as Brazil said the United States was provoking a currency war. However, the U.S. dollar is now in an uptrend and depreciating currency countries are accused of currency wars to gain a trade advantage. The United States has rebalanced its trade to where a weak dollar is no longer required to shrink the trade deficit. A U.S. trade deficit of less than 3% of GDP has typically been associated with a global dollar shortage, which is one reason why it’s appreciating. Other countries have trillions of dollars of debt they need to service.

A strong dollar is favorable for U.S. consumers. Imports are cheaper. This transmits U.S. strength to the rest of the world and indicates this expansion is a United States–led recovery. Rather than a currency war, we are seeing an appropriate rebalancing of exchange rates. The weak dollar back in 2002–2007 was a natural response to a growing U.S. trade deficit, but by 2008 the dollar was undervalued and is now readjusting itself.

A strong dollar adds to the favorable situation now developing for U.S. consumers.

In retrospect, we believe the critics were wrong. Inflation in the United States remains too low and has fallen short of the Fed’s target for several years. The European Central Bank let inflation fall while its balance sheet shrank. Instead of the Fed being too easy, other central banks were too tight, creating deflationary pressures,
exacerbating the global savings glut.

Commodity importers versus exporters

The rebalancing between growth in commodity importers versus exporters has gained momentum from the drop in oil and other commodity prices, with China playing an important role.

Traditional metrics weighted toward China’s old pattern of growth look weaker than new metrics of the growth mix. Those metrics are showing a cyclical pickup since late 2014. The structural trend is still moving down, but evidence of a cyclical pickup within the secular downtrend will temper China’s negative impact on global growth.

Like the United States, China benefits from a strong currency. An improving Chinese stock market is also a good sign of turnaround. With real estate under pressure and wealth management products more tightly scrutinized, equities are essential for Chinese investors.

As manufacturing and construction fall, the share of services is rising sharply. Likewise, the growth rate of nominal consumption is now well above the growth rate of nominal GDP. This was not the case between 2003 and 2008. In short, Chinese rebalancing reinforces the trends that have reduced commodity prices in recent years.

Lower energy prices and a strong dollar are forces for a stronger global economy. While some negative effects have dominated media coverage, the markets are looking at happier days ahead.

IMPORTANT INFORMATION

Investing involves risk. There is always the potential of losing money when you invest in securities.

Projections made may not come to pass due to market conditions and fluctuations.

Past performance is no guarantee of future results. Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets.

Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.

OTHER IMPORTANT INFORMATION

Equities Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.

International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards, and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.

Commodities Trading in commodities, such as gold, is speculative and can be extremely volatile. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest-rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Tangible assets can fluctuate with supply and demand, such as commodities, which are liquid investments, unlike most other tangible investments.