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Derek Hamilton
Vice President,
Global Economist
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Waddell & Reed Market Perspective - January 2012
Markets leave behind a year of volatility and uncertainty in 2011 but face some of the same issues in looking ahead to 2012. Tighter monetary and fiscal policies across emerging markets coupled with the European sovereign debt crisis have resulted in slower global economic growth the last few quarters, and we think that slowdown is likely to continue in the first half of 2012. As growth slows, we expect governments globally then will begin turning to easier policies. We think the combined impact of these policy changes and recent declines in commodity prices should help stabilize the slowdown by midyear, allowing economic growth to improve in the second half of 2012.
U.S. shows momentum entering 2012
Developed markets continue to focus on debt loads and the ensuing economic headwinds they create. But unlike most world economies, U.S. gross domestic product (GDP) growth has some momentum going into 2012. While there are some signs of improvement in the U.S. economy, growth still is likely to slow somewhat as we go through the year. In general, U.S. GDP remains dominated by consumer spending, which still is under pressure. Income growth has been muted, although we recently have seen encouraging signs of better employment growth. Overall, the U.S. needs to see employment continue to increase and at a faster rate.
However, lower commodity prices are a positive sign for U.S. consumers. In the first half of 2011, commodity prices were pushing higher and squeezing the ability of consumers to maintain their spending levels. Now that prices have come down from the highs of 2011, consumers have a bit more to spend on other goods. For example, Brent crude oil prices have fallen steadily from around $125 per barrel in April 2011 to about $110 at year end. If the global economy bottoms as we expect, oil prices may move higher in the second half of 2012, which would be a headwind for U.S. growth.
There are factors in addition to consumer spending that we think will affect the prospects of the U.S. economy in 2012. Uncertainty about U.S. fiscal policy is likely to increase during the year, especially as the U.S. elections draw near. Capital spending by businesses is likely to continue to increase, although we think it will be more slowly than the last few years. Export growth, which recently has been a driver of GDP growth, is likely to slow as global economic growth slows. Finally, we think slower government spending at the federal, state and local levels will continue to be a drag on U.S. growth. Overall, we expect U.S. GDP will grow around 2.5 percent in 2012.
Eurozone debt still a concern
The story in Europe still is one of austerity in the face of weak economies. We continue to believe that the eurozone countries will be in recession, and expect the southern countries to face a deeper contraction than the northern countries. It will be difficult for the northern, export-oriented countries to continue to grow, given their exposure to southern Europe’s economies and the slowing emerging markets.
We also expect the euro currency to continue to depreciate against the U.S. dollar. This would cushion some of the headwinds for the northern eurozone countries, since it would reduce the relative cost of their exports. However, given that southern eurozone countries have much less exposure to exports outside of the region, they will not benefit as much from a weaker currency. For the eurozone overall, the fiscal drag from tax increases and spending cuts will continue to be quite large, and the impact may increase as the year progresses.
The banking system in Europe also is under tremendous pressure to shrink, and we believe this undoubtedly will lead to less lending in the region. Given the dependency on bank lending for corporations in the eurozone, this deleveraging is another headwind for growth. We thus expect GDP for the eurozone countries to decline by about 1.5 to 2 percent. Given the focus on lower fiscal deficits, the European Central Bank (ECB) will be the only institution able to help buffer the downturn. While there is some question as to whether the ECB will enter into a quantitative easing-style program by purchasing government bonds, similar to past actions by the U.S. Federal Reserve, we have little doubt that the ECB’s balance sheet will continue to increase rapidly. So the end result is essentially the same. The ECB also has some room to cut interest rates a bit more, but that room is limited with its base rate at 1 percent as 2012 gets under way.
Outside of the eurozone, growth in the U.K. has been helped by exports, the majority of which go back into those countries. This situation coupled with its own fiscal austerity means we think the U.K. also will have a recession, although more mild than in the eurozone. We estimate U.K. GDP will decline about 0.5 percent in 2012. The Bank of England is currently engaged in its own quantitative easing program by purchasing government bonds, and this is scheduled to conclude at the end of February. We believe the central bank is likely to push forward with another round at that time, given the expected weakness in economic growth.
Growth in Asia and emerging markets
The economy in Japan continues to recover from the widespread effects of the earthquake, tsunami and resulting nuclear disaster that damaged the country in early 2011. Rebuilding continues in the areas affected by these disasters, which will support domestic demand to a point. However, given that the economy is extremely sensitive to global trade, we expect exports to slow going forward. This ultimately will feed into the domestic economy, hurting capital spending and employment. We estimate GDP in Japan will grow by about 0.5 percent in 2012, driven by these rebuilding efforts.
We expect economic growth in the emerging markets to continue to outperform the developed world. Growth had slowed in the second half of 2011 because of tighter monetary and fiscal policies and slower global growth. But we think this slowdown is likely to bottom out in the first half of 2012 because policymakers have started to ease.
We think GDP growth in China is likely to be 8 percent in 2012, with exports continuing to slow. The housing market there has started to correct, and we anticipate weak activity in that sector this year. This weakness will be partially offset by the government’s social housing program, which is designed to provide more affordable housing. Consumer spending held up well in 2011 and shows little sign of slowing at this point. As the economy slows further, in part because of weaker exports, we think China will continue to pursue an easier policy, both on the monetary side (via more liquidity in the banking system) and via increased government spending.
The growth picture looks more complex in India. Economic activity has been slowing following stubbornly high inflation and aggressive central bank tightening. Credit growth has slowed and shows little sign of turning, and capital spending has been extremely weak because of high interest rates and a government that has slowed project approvals. It is becoming increasingly clear to us that India’s government is not conducting policy for the benefit of economic growth. We are becoming concerned that further delays in economic reforms could damage long-term economic growth potential. For 2012, we expect India’s GDP to grow 6.5 percent, which would be the lowest annual growth rate in 10 years.
Finally, we expect a slight slowing in Brazil’s economic growth. The country’s economy grew at a rapid clip in 2010. But we estimate Brazil’s 2012 GDP growth will be slightly less than the 2011 pace of 3 percent.
Elections add to uncertain outlook
As we look ahead to the global economy in 2012, we know there are risks to the story, both to the upside and downside. It is possible that eurozone leaders finally will take action to restore confidence in the region’s currency and economies. In addition, the momentum in the U.S. economy in the second half of 2011 could continue throughout 2012, resulting in stronger growth than anticipated. The expected easing in emerging markets could be more substantial or have a larger effect than expected, resulting in stronger growth. But that could be considered both a blessing and a curse: While hard landing fears could erode, commodity prices could reaccelerate and cause inflationary pressures to return in these economies. And higher commodity prices would hurt demand in the developed world. Finally, recent saber-rattling in Iran again highlights the risk of supply disruptions in oil-producing regions.
We expect two issues that we have discussed in the past – economic volatility and a lack of political leadership – also are likely to be present in 2012. Economic volatility in part is a derivative of the lack of political leadership, which leads to a lack of confidence from consumers and businesses alike.
Elections will be at the forefront in 2012, including the critical U.S. presidential election. There are a number of issues the U.S. needs to deal with in the near future. First and foremost, there is a significant issue for the U.S. economy coming on Jan. 1, 2013, the date on which multiple tax cuts and programs are scheduled to expire. At some point, politicians also will have to deal with the U.S. budget deficit, whether by choice or through the force of the markets. This will require major decisions on overall tax policy and entitlement spending.
There also are presidential elections scheduled in countries including France, Finland, Mexico, South Korea and Taiwan. Given the crisis in Europe and issues related to aging populations and slowing economic growth, these elections will be watched closely by markets around the world.
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. 6, 2012. Mr. Hamilton’s views expressed in this article are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.
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