"Kee" Points with Jim Kee, Ph.D.

“Growth scare.” That is how most economists are describing the market’s behavior over the past few weeks. Concerns are centered on Germany and Europe slipping into recession, China growth decelerating further, and a stalling Japanese rebound. Corroborating these fears has been a falling global oil price, with Brent crude currently trading at $88 per barrel. I think all of those concerns are legitimate, with European, Chinese, and Japanese growth increasingly dependent upon “policy responses” or actions in those countries. In fact, I would describe the outlook over the next few months as policy contingent.


The S&P 500 is off 6.7% from its recent all-time high in September (-5% if you include dividends), and that constitutes the second official pullback of 5% or more this year. Believe it or not, the market averages 3-5 pullbacks a year, depending upon how far back you go to calculate the average, with some years having a lot and some a few. We expected a few pullbacks at the beginning of the year, but we also expected stocks to ultimately end higher. That’s still the outlook.

 

The world at a glance…Eurozone weakness continues, and while summer is typically slow in Europe in general due to lengthy vacation schedules, recent German industrial production indicates weakness in German exports and capital spending. That makes perfect sense given the strength of the Euro during the first half of the year (hurting exports) and the impact of Russia/Ukraine concerns on business confidence (hurting capital spending). China is suffering from weak loan demand, and Japan appears to be bouncing back from the sharp second quarter contraction there, but much weaker than hoped. Among the BRIM countries, Brazil and Russia are struggling with recession, while India and Mexico are experiencing positive growth. Almost oddly, indicators in the US continue to look favorable, with most analysts (e.g. Wall Street Journal Forecasting Survey) expecting around 3% GDP growth over the next few quarters. And that brings up what is increasingly the question of the day, namely, can the US continue to grow when most of the rest of the world does not?


The IMF seems to think so.  While they have lowered their growth numbers for 2014 to 3.3% from 3.7% in April, their commentary is that the world is “no longer in crisis as it was three years ago,” but needs to do more to stimulate growth. Their elixir seems to be infrastructure spending, which they are urging particularly for emerging markets. The idea is that these public projects stimulate demand during their construction, which then facilitates supply as more trucks, trains, ships, and planes, move goods and people. But their report also describes global growth as fragile and uneven, which is exactly the way I would have described it three years ago!

 

Here’s what I think: As a strategist I used to be able to say that the rest of the world follows the US with a lag of about 6-9 months, but not vice versa! That is, the US could drag the rest of the world down, but not so the rest of the world dragging the US down. I think that’s still true to an extent, because not much has changed regarding Europe and Japan. But China is another matter. I am already hearing chatter (e.g. The Conference Board) about China’s “soft fall” or multi-year slowing to 3% versus a “hard landing” of the same magnitude but faster. I think a soft fall is the better bet, but I think the impact on confidence and investment spending here of big negative surprise growth numbers in China is not known but is probably the key to answering the question posed above. I’ll be looking more closely at and discussing the interdependencies of the big 4 – US, Europe, China, and Japan – going forward.

 

What do the markets think? Looking at market valuations around the world based upon very complex discounted cash flow models from Credit Suisse, you generally see the story outlined above. The areas of concern…China, Europe (particularly Germany), Japan, look cheaper than the areas of growth…US, India, Mexico. That tells me that all of the concerns I am looking at have been noted by the market. Upside would come from positive policy responses abroad and growth surprises here. I think the Conference Board’s Leading Economic Index for September 2014 data, to be released later this month (Thursday, October 23rd), is a particularly important data point for the US outlook. I will be analyzing it in some detail in Kee Points when it comes out.