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World economy and markets - Through a glass, weakly

2014-10-11 14:50:05

Oct 10th 2014, 9:41 by Buttonwood

FINALLY the penny (or should it be the pfennig) is dropping. The global economy isn't really doing that well. Your blogger has been banging on about this for months now; while the US economy may have recovered from the surprise drop in Q1 GDP, data from the rest of the world has been much less impressive. The action on Wall Street over the last cpuple of days has been instructive; first, shares rallied on dovish Federal Reserve minutes, then that gain was wiped out yesterday as more weak numbers from Germany came through.

A report out yesterday from four institutes predicts that the German economy was flat in the third quarter, after shrinking 0.2% in the second. August looks to have been particularly terrible, with big drops in exports, industrial production and factory orders. Most investors have given up on Italy, and know that France is struggling, but for Germany, the engine of the euro zone, to be heading for recession is another matter.

The clue has been in the big market surprise of the year; bonds have performed much better than people expected. Every time US Treasury bond yields perk up, some commentators say this marks the end of the 30-year bull market. But 10-year yields are back down at 2.32% again; German 10-year yields seem to be moored below 1%. Albert Edwards of SocGen is often derided as a perma-bear but he has been consistent in arguing that bond yields would head lower and that, eventually, equities would de-rate to reflect lower growth prospects as they have in Japan. As the third quarter results season approaches, once again, analysts are playing the game of reducing forecasts so companies can "beat" expectations and bullish headlines can be generated. As Mr Edwards writes

According to Factset, analysts Q3 forecasts have been sliced from 9% yoy growth at the start of July to 4.6%. Thomson Reuters numbers are a bit higher, with Q3 2014 eps growth expectations having been lopped from 11% on July 1 to 6.4%. But will this be enough in the light of recent substantial dollar strength?

In relation to his last comment, the strength of the dollar (see this week's issue for details) will knock a few per cent off overseas earnings; remember that the most-cited explanation for the very high profits share of US GDP is the strength of multinationals.

The final indicator of economic weakness is the fall in commodity prices. While this is good news to some extent (lower petrol prices, in particular, act as a tax cut for consumers) but it's not just oil. Food prices have dropped for six months in a row and the Economist's metals index has dropped 5.5% over the last month.

All this weakness is occurring at a time when many developed markets have barely regained the output lost in the 2008-09 recession. There are a couple of reasons why economic cycles might be shorter and weaker than they were in the 1980s and 1990s. The first is high debt levels; debt has been reshuffled, not reduced, so any rise in rates can cause problems for debtors. The second is ageing economies; workforces are set to shrink in the developed world and it is very hard to grow an economy with fewer workers.