TROUBLE IN THE US ECONOMY
WHAT IT MEANS FOR YOU
in December last year, after its first interest rate hike in a decade, the Federal Open Market Committee indicated there likely will be four interest rate hikes in 2016. Such was the optimism over the US recovery. Then came the January crash in equities as investors digested the extent of China’s flagging growth. Talk of further rate hikes under these circumstances seemed suicidal. Now it looks as if any increase in rates will have to wait till later in the year, or even 2017. Dovish comments by US Federal Reserve
chair Janet Yellen and some of her colleagues on the outlook for US interest rates have contributed to a flow of funds to emergingmarket currencies and assets in recent weeks, boosting currencies like the rand and the FTSE/ JSE All Share Index.
Yellen has expressed concern over weakerthan-expected global growth and uncertainty over the outlook for US inflation, China and global oil markets, indicating that US interest rates will stay lower for longer. Earlier this month, the International Monetary Fund (IMF) downgraded the growth outlook for all major advanced economies, including the US, Canada, Japan and the eurozone. The US is now expected to grow by 2.4% this year, lower than the 2.6% forecast by the IMF in January. The US grew 2.1% in 2015 and 2.4% in 2014.
The outlook for global growth was cut to 3.2%, from a January forecast of 3.4%. On the plus side, the outlook for China, the world’s second-largest economy, was increased by 0.2 percentage points to 6.5%.
Despite the IMF’s cut in the US growth outlook, judging on the economic statistics from a range of government bureaus, the US economy looks perky. The unemployment rate now stands at about 5%, the standard benchmark
for full employment. The US Bureau of Labor Statistics reported that there were 215 000 new jobs in March, continuing a trend that began in 2010. Including part-time and discouraged job seekers the US unemployment rate rises to 9.7%.
The recent surge in US stock prices – despite expectations of lower first-quarter profit figures – has been a tonic for world markets. On 18 April, the S&P 500 closed at its highest level since the start of December, and only 2% below its record high of May 2015, according to ft.com data.
In January the Dow Jones Industrial Average plunged more than 10% in 10 days, and then promptly recovered all these losses. The FTSE 100 fell 10% in January but has since recovered 14%, breaking new highs for the year. Japanese stocks lost more than 20% of their value in January, recovering 13% since then. The Shanghai Composite Index was butchered 27% over the same period, rebounding 16% by 15 April.
These were frightening days for investors. Oil bottomed at about $26/barrel in January before surging to $44 on 12 April. The rebound in asset and commodity prices in the first three months of the year has been fed by a steady diet of positive economic news. The supposed meltdown in China has not materialised, as demonstrated by news that the economy grew 6.7% in the first quarter of 2016.
The Long-Term US Treasury Bond exchangetraded fund (ETF) is up 9% since the start of the year, while ETFs comprising corporate bonds have gained roughly 7%, not counting the yield of 4.4%, courtesy of signals from the Fed that the days of easy money and low interest rates will continue. Returns from corporate bonds are primed to beat equities in 2016, as they have done in 14 of the last 19 years, according to Eddy Elfenbein, editor of the blog Crossing Wall Street.
In January Morgan Stanley put out a report that the US economy could continue growing until 2020, which would make this the longest US expansion since World War II. It based this analysis on job growth of about 200 000 a month in 2015, a trend that has continued into 2016, which in turn has fattened the wallets of consumers.
The University of Michigan’s Consumer Sentiment Index averaged 92.9 last year, the highest since 2004. Though the index has dipped in each of the last four months, the University of Michigan expects inflationadjusted personal consumption expenditures will grow by 2.5% in 2016.
Lower debt levels
Another cause for cheer is the fact that Americans are less indebted than they were in 2008. Morgan Stanley reported earlier this year that personal debt to disposable income is down to 106% from 135% in 2008. Delinquent debts – those more than 90 days overdue – have fallen to 4% from 9% in 2008. Corporate America is sitting on a cash mountain of close to $2tr, swamping the $400m in corporate loans that fall due in the next two years. The problem is that little of this cash is being invested in new productive capacity. Excluding energy and utilities, Morgan Stanley expects the ratio of capital expenditure-to-sales to drop to 4.6% later this year, roughly half that prior to the last recession.
Most of this $2tr cash mountain is held by
The HSBC analysts are concerned that medium-term earnings in the US will disappoint due to higher wage demands and rising finance costs which leaves less room for share buybacks.
the 50 largest corporations and, according to Moody’s, about two-thirds of it is held abroad – beyond the reach of the US Internal Revenue Service. US presidential candidate Donald Trump says if he gets the nod from voters later this year, he wants much of this money repatriated at beneficial tax rates and invested in the local economy.
“We’ll likely complete the labour market recovery, get back to full employment and get the normalization process for monetary policy
underway,” Jan Hatzius, chief economist and head of Global Economics and Markets
Research at Goldman Sachs, says in a report published by the bank. He expects the economy to perform slightly slower in 2016 than the previous year, with lower oil prices helping to boost consumer spending, resulting in GDP growth of 2.25% this year.
Goldman Sachs says the US economy is benefitting from lower commodity prices such as that of oil, and a glut of corporate savings that will eventually force a rise in interest rates. This in turn means US dollar strength is here to stay, as money moves away from “emergingmarket fragility to developed market stability”. In this environment, currency wars are a real possibility: emerging-market economies are likely to steal competitive advantage by allowing their currencies to weaken against the dollar and euro.
“We’re at an important inflection point in history as far as the growth dynamics of the emerging markets versus developed markets,” says Charlie Himmelberg, co-head of Global Markets Research at Goldman Sachs, in an April report to clients.
“The world is at an inflection point – we have had 15 years of strong emerging-market growth and this boosted commodity prices. Now supply has caught up to demand and prices have adjusted accordingly.”
Before the stock market crash at the start of 2016, Citigroup warned there was a 65% chance of a US recession in 2016. And just last week the US National Federation of Independent Business reported that smallbusiness sentiment had dipped to a two-year low. HSBC’s global equity team shaved its S&P 500 target for 2016 to 2 050 from 2 100. “The market remains bound by an uncomfortable mix of factors, including peak earnings and margins, above-average valuations and an appreciated US dollar. In addition, it’s the best-owned market globally,” says HSBC’s Ben Laidler and Daniel Grosvenor in a note to clients.
The HSBC analysts are concerned that mediumterm earnings in the US will disappoint due to higher wage demands and rising finance costs, which leaves less room for share buybacks. The banking sector has been particularly hard hit in recent months. The top five US banks lost 20% of their market capitalisations, or $120bn, between November last year and February this year. Roughly 70% percent of US banks with a significant global presence were trading below their tangible book values, or what they would be worth if liquidated. Many banks are engaged in a brutal cost-cutting campaign, including staff lay-offs, to unlock value. Muted demand for credit, low interest rates and higher compliance costs are blamed for the slump in banking equities, which are trading at roughly half their values prior to the 2008 financial market crash.
Perhaps the one signal that all is not well in the global economy is gold’s run from $1 053 to a high of $1 284.64 an ounce on 11 March, the highest in more than a year, according to Bloomberg data. Bullion has had the best quarter in nearly 30 years in the three months to end March. Though most major investment banks remain bearish on gold, at some point the bears are going to have to exit their losing trades.
The outlook for SA
The growing US economy, coupled with positive signals from China, should help support the South African economy, which is expected to grow by only 0.6% this year and 1.2% in 2017. Both countries are major trading partners, and a recovery in China in particular should boost local commodity exporters.
The IMF blamed SA’s low growth on weaker export growth, higher interest rates and policy uncertainty. Other economists are less bullish, with Capital Economics warning that the country will struggle to post any growth at all this year. The dovish views from the US Fed on interest rates have contributed to the rand strengthening 17% against the US dollar from its January low of R16.80. It was trading at R14.30 against the dollar at the time of writing. This should help to contain inflation, which breached the Reserve Bank’s upper target of 6% again in March.
Econometrix economist Azar Jammine says he is less pessimistic about the SA economy than he was a year ago. “I see the country pulling together in various ways. One event that may turn out to be a landmark for the country is the Constitutional Court decision compelling President Zuma to repay part of the money spent on his Nkandla residence. And just as we underestimated the extent of the drought a few months ago, I think we are also underestimating the recovery from the drought. Another factor that gives me cause for optimism is the fact that there are quite a few indicators coming out suggesting things are not as bad as we supposed – for example, business and consumer confidence.”
The South African Chamber of Commerce and Industry’s Business Confidence Index rose to 81.2 in March from 80.1 in February, but is still nearly eight points below where it was a year ago. Private sector borrowing also shows signs of growth in the first quarter. Two areas of concern are inflation and borrowing costs, which account for the expectations of little to no growth over the course of the year. South Africans will have to wait until 2017 before any real growth.
One event that may turn out to be a landmark for the country is the Constitutional Court decision compelling President Zuma to repay part of the money spent on his Nkandla residence.
Jan Hatzius Chief economist and head of Global Economics and Markets Research at Goldman Sachs
Janet Yellen Chair of the US Federal Reserve
Donald Trump US presidential candidate
Charlie Himmelberg Co-head of Global Markets Research at Goldman Sachs
Azar Jammine Economist at Econometrix