During the worst of the financial crisis through the end of 2008 and even into the opening months of 2009, the market’s primary concern was risk appetite. Interest rate cuts were pervasive and expected return was the last thing on any traders mind. Sharp losses in nearly every investment class leveraged capital preservation into the upper echelons of importance. However, with interest rates bottoming out and safe havens no longer essential, we have seen speculative funds slowly finding their way out of risk-free zones and coming off of the sidelines to once again be put back to work. This leads us to a natural market truism: when fear isn’t the dominant influence, greed takes over.
Always trying to beat the market, traders are trying to find outsized returns and doing so by investing in the economy that is expected to recovery from its economic recession first and most aggressively. This evaluation of relatively growth potential comes with a hearty mix of objective data and highly-sensitive speculation; but with the markets, the latter is always more influential.
Since this market dynamic is developing greater clout among the speculative class, we should gauge which economies are considered leaders and laggards in the early global ‘recovery’ by market participants and which actually have the fundamental underpinnings for a timely return to expansion. As this is a highly speculative endeavor, we will have to leave out a number of factors to simplify a complex market appraisal; so we will need to narrow our focus for contributing factors. We will go over those dynamics that are essential for a genuine recovery; and you can decide whether the market’s outlook (and therefore the currency) has overshot or come up short of fundamentals.
[B]The Bigger Picture[/B]
It is easy to lose sight of the true development of long-term, economic factors when employing leverage and looking at daily, weekly or even monthly economic indicators. Most speculation as to a global recovery to this point is exactly that – speculation. Output for the world and the developing nations is still contracting. However, with traditional growth readings from individual economies coming out on a quarterly basis and official assessments of broader measures of activity coming out less frequently, traders are certainly going to be left unsatisfied. Now, there is a focus on the slower pace of contraction for individual countries’ growth readings, housing sector declines, employment depressions, and capital investment slumps among other factors. It needs to be stated though that a slower pace of decline is not expansion. What is perhaps less appreciated is that there is still the burden of establishing a real period of expansion rather than simply returning to positive growth.
When establishing an outlook for activity to this point, we are heading to that point where the recession will end. Yet, by the time that we reach that point, it is very likely that we will see the market is has moved on to projecting sustainable and meaningful economic growth. The essential elements to this appraisal will be employment, consumer spending and credit. For most economies, the consumer is the largest component of growth. When domestic consumption is not spending, businesses lose money, jobs are lost, money stops circulating and then the dependence on foreign sources of income is leveraged. Everything in this enclosed system moves in a circle. Therefore, when we see any one of these factors show genuine improvement, it is likely that the others will follow. If we had to boil it down to one indicator for assurance, employment would be the key. On the other hand, the labor cycle is typically lagging; so credit (and its impact on spending) will likely be the guiding light to true growth.
[B]Where Growth is Now: Majors That Have Already Reported 2Q GDP [/B]
[I][B]US[/B][/I]: The dollar is at a natural disadvantage when it comes to growth; because it pulls double duty. Not only does the market take the world’s largest economy’s numbers as a sign for its own pace of recovery; but it is also used as a proxy for the global economy. Therefore, when the US reported a smaller than expected 1.0 percent contraction in the year through June, its progress was naturally diminished as this was considered the benchmark. Looking beyond this quirk, the actual components of the release were far from inspirational. Personal consumption dropped twice as quickly as expected as stimulus checks wore off and credit further dried up. In fact, nearly every element of the economy was contracting except government spending. This is not a sign for long-term growth. However, the US government has moved in quickly to support the economy with stimulus and we have recently seen a downtick in unemployment, which is more a sign of a slowing trend than actual reversal.
[I][B]
[/B][/I]
[I]Chart pulled from Bloomberg Professional Services[/I]
[I][B]UK[/B][/I]: Months ago, the IMF forecasted the United Kingdom would be the worst performer among the largest industrialized economies going forward. Given the second quarter GDP report, that is an outlook that seems to be coming true. Contracting a record-breaking 5.6 percent through the year, there was little to support speculation of a timely recovery. Banking, business services and construction were the most painful factors to broader growth. In a statement following the release, Prime Minister Gordon Brown said that they had reached a point where they had reached financial stability; but the still did not “have a strategy for a return to growth.”
[I]Chart pulled from Bloomberg Professional Services[/I]
[I][B]China[/B][/I]: Though it is not a part of the OECD, China is the third largest economy in the world and many believe it could be the leader in the global recovery. Released back in the middle of July, second quarter GDP accelerated to a 7.9 percent annual clip from 6.1 percent in the first quarter. The headline reading is all speculators need; but a look into the statistics should give reason for pause. Much of the economy’s health can be attributed to construction and record lending. The Government is looking at placing curbs for new loans to avoid a dangerous asset bubble, foreign demand is absent as long as the rest of the world’s economy suffers and recently the government has suggested that domestic consumption cannot account for the slump in exports.
[I]Chart pulled from Bloomberg Professional Services[/I]
[B]Where Growth is Now: Majors That Have Yet to Report 2Q GDP [/B]
[I][B]Euro Zone[/B][/I]: The Euro Zone is on deck to release its GDP numbers; and speculation is running high. Traders have associated the ECB’s willingness to hold its benchmark rate well above many of its largest counterparts and policy officials’ calls to fast-track the removal of stimulus from the system as proof positive that conditions in this amalgamated economy are far sturdier than say in the US. In reality, the IMF has set the European recovery to be slower and more tenuous than either the US or Japan. The relatively limited amount of government aid afforded to the local markets and economy could prove a hindrance; and the early withdrawal of this safety net could lead to serious problems should there a double dip recession or extended period of stagnation.
[I]Chart pulled from Bloomberg Professional Services[/I]
[I][B]Japan[/B][/I]: Already coming off of what is called a ‘lost decade,’ Japan is mired in its worst recession on record. Through the first quarter, the economy contracted a staggering 14.2 percent on an annual basis. This reveals the dependency the world’s second largest economy developed for exports. Going forward, economists predict expansion through the second quarter; but long-term expectations are still cool. Domestic demand was already handicapped by wages and an aging populace before this storm hit. Even if firms are able to sell their goods abroad, they will still have to adjust to a period of stabilizing revenues which will keep unemployment elevated and a recovery lagging.
[I]Chart pulled from Bloomberg Professional Services[/I]
[I][B]Australia[/B][/I]: The Australian 2Q GDP numbers aren’t due until well-into September; but the bullish sentiment surrounding the economy is already firmly established. The land down under was able to avoid a technical recession through the first quarter by expanding a modest 0.4 percent. This nation’s strength owes heavily to its exports of raw materials to much of the Eastern hemisphere (including China); but in the meantime, domestic factors have been extraordinarily stable and even financial conditions have seen little more than a hiccup through the global crisis.
[I]Chart pulled from Bloomberg Professional Services[/I]