Economic uncertainties begin to clear, offering potential for 2013 growth
- Growth in the U.S. was hampered in 2012 by concerns about the fiscal cliff.
- Issues remain in the eurozone, but we see that economy gradually improving.
- We expect China's growth for the year in the 7.5 to 8% range.
Global growth struggled in 2012, restricted by policy uncertainties throughout the year. A continuation of the eurozone crisis, disagreement in the U.S. about fiscal policy and declining global demand all contributed to economic weakness. While we expect these uncertainties will remain with us for some time, we believe aspects are beginning to fade.
Backing away from fiscal cliff
Growth in the U.S. was hampered in 2012 by concerns about the “fiscal cliff” of tax and spending issues. Growth in corporate capital spending on equipment and software slowed from an annual rate of 11% in 2011 to what looks to be 6% in 2012. In fact, capital spending in the third quarter (the most recent data available) actually declined.*
Furthermore, growth in personal consumption slowed from 2.7% in 2011 to a projected 2.0% in 2012.* We think the recent deal to avert the full impact of the fiscal cliff will result in a fiscal drag of roughly $200 billion in 2013, which will put pressure on growth in the first quarter of the year. Legislators will continue to negotiate during the next two months in the face of a needed increase in the debt ceiling. We think these negotiations will likely result in further fiscal tightening. However, we think increasing clarity from Washington about fiscal policy should allow corporations to increase spending once again. After a midyear lull in 2012, we also expect employment growth to accelerate throughout 2013. In addition, we think capital spending should gather speed as the year progresses.
In our view, these factors and an improving external environment – which we think will bring an improvement in exports – are likely to mean an improvement in U.S. gross domestic product (GDP). While we estimate the average pace of annual growth will look soft at 1.5 to 2.0% in 2013, compared with 2.3% in 2012, we think the weakness in the first quarter will pass quickly. We believe GDP growth could average about 3% in the second half of 2013.
Housing is another important piece of the equation for the coming year. We think housing will continue to recover and will be an increasing driver for economic growth. Since the housing crisis began, the U.S. has “under-built” relative to the number of household formations. Now that housing inventories have been reduced, construction will need to pick up to meet an expected coming demand for homes. Employment is likely to benefit as construction increases because housing has a relatively high multiplier effect on jobs throughout the economy. We also think a negative feedback loop in the economy from a decline in housing prices seems to have come to an end. This has positive implications for consumer spending via the “wealth effect.” For example, when housing prices decline, personal net worth declines. This results in debt deleveraging and a decline in consumer confidence, both of which put pressure on consumer spending and result in the negative feedback loop. With the trend in housing prices reversed, we expect that downside pressure has been abated.
As we have noted before, we expect manufacturing to be an important driver of U.S. growth going forward. Although this is a story that will take several years to play out, there are indications that a shift already is occurring. Cheap energy and more competitive labor costs relative to other countries should help this trend to continue. Lastly, we think the Federal Reserve (Fed) will likely continue to increase the size of its balance sheet throughout the year via quantitative easing, keeping interest rates low.
Expecting improved eurozone
Structural issues remain in the eurozone, but we see that economy gradually improving in 2013. While the eurozone as a whole is in recession at this time – with even countries like Germany seeing negative growth – we think the headwinds for the region are likely to lessen. We expect an improvement in global demand to benefit Germany and other exporting nations, which should ultimately filter into the domestic economy of the region. And while governments will continue to reduce their budget deficits, we think the magnitude of those cuts should be less than before.
In addition, we believe the pace of deleveraging in the banking system is nearing the bottom, which should have positive ramifications for domestic demand. The European Central Bank has taken many actions to stabilize the situation, including injecting liquidity into the banking system and setting up a backstop for sovereign debt under specific conditions. All told, while we think GDP for the year will likely be negative, the second half could show slightly positive growth. However, we believe the long-term issues of high government debt and large deficits, as well as the need for structural reform, remain for the eurozone. We therefore think a multi-year period of sub-par growth and periodic shocks is likely.
Economic turning point in Asia, emerging markets
The economy in Japan was hit hard by the global economic downturn in 2012, as well as by a territorial dispute with China. In fact, that dispute resulted in a massive decline in exports of Japanese cars to China. While there is no sign of a reversal to prior levels in these exports, the pace of decline has slowed. We think a recovery in global demand would filter through Japan’s economy, resulting in GDP growth in the spring.
But we believe the Bank of Japan (BOJ) will provide significant help for Japan’s economy. The strength in the Japanese currency has been a drag on growth over the past few years via its impact on exports and capital spending. Recent Japanese elections resulted in a change in power to a new ruling party, the LDP. The country’s new leader, Prime Minister Shinzo Abe, has been putting strong pressure on the BOJ to ease policy further. Moreover, he and the ruling party will have the opportunity by April to replace the governor and two deputy governors of the BOJ when their terms expire. We think this means there is a very high likelihood that the pace of monetary easing will increase, and we see a possibility that the BOJ will focus on weakening the yen in one form or another. Either way, we think the yen will weaken from here, which should help the economy. Despite the fact that the economy has likely bottomed, we think the Japanese economy still has serious long-term issues that need to be addressed.
We also think most emerging market economies have bottomed. The tide has shifted in China, where it seems that the domestic economy has turned higher. Government spending on infrastructure and some signs of life in the housing market seem to be driving this turn. We think a better domestic economy and an improvement in exports means GDP will likely accelerate from the low of 7.4% year-over-year in the third quarter. However, given the fact that the new leadership in China seems to be comfortable with growth in the 7 to 8% range, we don’t expect much in the way of further stimulus. We believe China is likely to have some quarters with GDP a bit above 8%, but in general expect growth for the year in the 7.5 to 8% range.
India continues to have a problem with investment spending, as issues with government policies have limited the pace of infrastructure spending and corporate capital spending. However, the government is starting to push through some reforms to boost the economy, perhaps recognizing prior mistakes. We believe the economy will grow in the 6 to 6.5% range in 2013 after growing roughly 5.5% in 2012.
The economy weakened dramatically in Brazil and looks to have grown roughly 1% in 2012. However, the government has focused recently on boosting domestic demand, which seems to be taking hold. When combined with a recovery in the Chinese economy, we think Brazil should have a better growth profile throughout the course of the year and look for growth of 2.5 to 3% in 2013.
Managing the risks in 2013
In summary, we are generally positive on the path of economic growth for 2013. But it’s clear that many issues remain. We expect inflation to be relatively contained in 2013, with an upward bias in some emerging market countries. However, a crisis in the Middle East that results in an oil price spike would be a definite headwind for global growth. We think continued indecision on the fiscal front in the U.S. also would hurt market sentiment. In other words, we believe a clear fiscal path – whatever that looks like – is needed for corporate America. In the eurozone, given the fact that the fundamental problems aren’t resolved, we think a policy mistake or other shock could result in renewed recession.
*Source: U.S. Bureau of Economic Analysis
Past performance is not a guarantee of future results. The opinions expressed in this article are those of Mr. Hamilton and are not meant to predict or project the future performance of any investment product. The opinions are current through Jan. 10, 2013. Mr. Hamilton’s views are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.
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