New Year, Same Market

The New Year began with a rally in Europe. Considering the damage Europe did to world markets last year, a rally there is certainly welcome. Unfortunately, turning the calendar page has little to do with turning the page on past conditions. Europe remains today the same as it was yesterday: a project under construction. We remain hopeful that Europe will get on with the project, but hope only takes us so far.

As we said in the last issue, Europe will be a chronic pain for the markets over the course of this year, but short of a breakup of the eurozone (not to be ruled out but highly unlikely), Europe will not determine market performance. What will determine performance in our view is the fortune of the U.S. economy.

In that regard, the year end has brought good news in the form of the extension of the payroll tax cut and extended unemployment benefits. Upon passage of the extension Wall Street raised its outlook for this year’s growth by about one percentage point. Speaking very broadly, the top Wall Street forecasters are now looking for 2.5% growth over the year. But this is not unanimous. IHS Global Insight, which has a top forecasting record, is looking for slower growth of about 1.5%.

The extension of the tax cut was only for two months. Wall Street is assuming that the extension will run for the full year, on the basis that Congress will be reluctant to refuse a tax cut it just supported. It’s a pretty safe assumption.

Our own view is on the side of the higher outlook. We are impressed by the American consumer’s behavior over the last quarter. We know that consumer incomes are not rising fast enough to allow the recent increases in spending to continue at the same rate. However, real consumer spending power is being bolstered by a source not contained in the official statistics-the decline in inflation.

We overlooked the effect of this decline in our year-end global outlook. This was brought home to us when Wall Street included the benign inflation forecast as one reason for a sunnier view of the consumer this year.

The economy went out with a bang last year. Estimates of last quarter’s growth run as high as 3.5%. As the views for this year show, no one expects to see a repeat this quarter. Neither do we. But if there are surprises, the early economy may be stronger than expected. We are singularly impressed with the turn in the housing data. In particular there was an unexpectedly large increase in pending home sales in November. As Moody’s Analytic’s Dismal Scientist commented, “…the index is at its highest since the expiration of the second homebuyer tax credit in April 2010.”

The earliest reports on December activity are also providing pleasant reading. The key manufacturing report (ISM) rose to its highest point since June. The index had been flat over the summer and fall and kicked into gear over the last two months. More significant for us, the new orders index, which had also disappointed over the summer and fall, climbed again and is now at a healthy level.

Do not expect the surprises to continue to occur at this rate or with this importance. But we do expect the positive tone to continue.


You may have noticed that in our general discussions of the outlook we always manage to bring China into the discussion. This is deliberate. China is a key player in the global outlook. Jim O’Neill, Goldman Sachs’ Chief Global Economist, headlined an article in The Financial Times two weeks ago, “Global growth in 2012 will hinge on China’s soft landing.”

This might strike you as something of an overstatement. Is China that important? According to O’Neill it is. As he writes, “The rest of the world is increasingly relying on China importing from it, and so helping those economies still suffering hangovers from 2008 to overcome them.”

Talking of China as an importer rather than exporter must make you wonder whether O’Neill has everything topsy-turvy. What he is talking about we assume is China as an importer from the developing world. China is a huge importer from countries such as Brazil (food) and Australia (iron ore) as well as from Africa. A Chinese soft landing means the developing world will continue to have a market for its exports. Otherwise, as O’Neill says, China “will add to the world’s woes.”

The news from China has been mixed. The latest has been encouraging. The Chinese equivalent to our manufacturing index rose in December, as did their nonmanufacturing index.

A successful soft landing for China will be a great boost for investing in emerging markets once again. We will be talking about solid 8% growth for China then and much better performance from the Asian markets.

While the opening days’ performance tells us nothing about the year, we are heartened to see something of a January Effect occurring. We’ll take it.

Walter S. Frank has been the Chief Economist and Chief Investment Officer for Moneyletter for the past 25 years. He has had a long and distinguished career as an economist, financial advisor, and money manager. Mr. Frank is a regular contributor to Barron’s and The Economist magazine.

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