2014-02-26 01:44:01
The world economy will have a bumpy 2014. But the recovery is not, yet, at risk
FOR much of 2013 the world s big stockmarkets had a magical quality about them. They soared upwards America s S&P 500 index rose by 30% last year, and Japan s Nikkei by 57% buoyed by monetary stimulus and growing optimism about global growth. Over the past month, the magic has abruptly worn off. More than $3 trillion has been wiped off global share prices since the start of January. The S&P 500 is down by almost 5%, the Nikkei by 14% and the MSCI emerging-market index by almost 9%.
That investors should lock in some profits after such a remarkable surge is hardly surprising (see article). American share prices, in particular, were beginning to look too high: the S&P finished 2013 at a multiple of 25 times ten-year earnings, well above the historical average of 16. A few bits of poor economic news of late are scarcely grounds for panic. It is hard to see a compelling economic reason why one unexpectedly weak report on American manufacturing, for instance, should push Japan s Nikkei down by more than 4% in a day. Far easier to explain the market gyrations as a necessary correction.
From supercal to fragilistic
Prices always jump around, but in the end they are determined by the underlying economy. Here it would be a mistake to be too sanguine. Economists are notoriously bad at predicting sudden turning-points in global growth. Even if it goes no further, the dip in asset prices has hurt this year s growth prospects, particularly in emerging markets, where credit conditions are tighter and foreign capital less abundant. Tellingly, commodity prices are slipping too. The price of iron ore fell by more than 8% in January.
On balance, however, this newspaper s assessment of the evidence to date is that investors gloom is overdone. A handful of disappointing numbers does not mean that America s underlying recovery is stalling. China s economy is slowing, but the odds of a sudden slump remain low. Although other emerging markets will indeed grow more slowly in 2014, they are not heading for a broad collapse. And the odds are rising that monetary policy in both Europe and Japan is about to be eased further. Global growth will still probably exceed last year s pace of 3% (on a purchasing-power parity basis). For now, this looks more like a wobble than a tumble.
The outlook for America s economy is by far the most important reason for this view. Since the United States is driving the global recovery, sustained weakness there would mean that prospects for the world economy were grim. But that does not seem likely. January s spate of feeble statistics from weak manufacturing orders to low car sales can be explained, in part, by the weather. America has had an unusually bitter winter, with punishing snowfall and frigid temperatures. This has disrupted economic activity. It suggests that all the figures for January, including the all-important employment figures, which were due to be released on February 7th after The Economist went to press, should be taken with a truckload of salt.
All the more so because there is no reason to expect a sudden spending slump. The balance-sheets of American households are strong. The stockmarket slide has dented consumer confidence, but investors flight from risk has pushed down yields on Treasury bonds, which in turn should lower mortgage rates. Fiscal policy is far less of a drag than it was in 2013. All this still points to solid, above-trend growth of around 3% in 2014. One reason this may not excite investors is that it no longer implies an acceleration. America s economy was roaring along at a 3.2% pace at the end of 2013. The first few months of 2014 will be weaker than that, even though average growth for 2014 still looks likely to outpace last year s rate of 1.9%.
China s economy, for its part, is clearly slowing. The latest purchasing managers index suggests factory activity is at a six-month low. The question is how far and how fast that slowdown goes. Many investors fear a hard landing . Their logic is that China has reached the limits of a debt-fuelled and investment-led growth model; and that this kind of growth does not just slow but ends in a financial bust. Hence the jitters on news that a shadow-bank product had to be bailed out. Yet it remains more likely that China s growth is slowing rather than slumping. The government has the capacity to prevent a rout; and the recent bail-out suggests it is willing to use it.
If fears about a hard landing in China are exaggerated, then so are worries about a broad emerging-market collapse. That is because the pace of Chinese growth has a big direct impact on emerging economies as a whole. Expectations for Chinese growth will also be a big influence on the desire of foreigners to flee other emerging markets, and hence on how much financial conditions in these countries tighten. After more than doubling interest rates, Turkey s economy will be lucky to grow by 2% in 2014, compared with almost 4% in 2013. But in most places less draconian rate hikes will merely dampen a hoped-for acceleration in growth rather than prompt a rout.
The final, paradoxical, reason for guarded optimism is that the market jitters make bolder monetary action more likely in Europe and Japan (see article). With inflation in the euro area running at a worryingly low 0.8%, the European Central Bank (which met on February 6th after we went to press) needs to do more to loosen monetary conditions. Really bold action, such as buying bundles of bank loans, is more likely when financial markets are in a funk. That logic is even stronger in Japan, whose stockmarket has fallen furthest and where the economy will be hit by a sharp rise in the consumption tax on April 1st. So more easing is on the cards.
Still in need of a spoonful of sugar
If this analysis is correct, the current market pessimism could prove temporary. Investors should recover their nerve as they realise that the bottom is not falling out of the world economy. Our prognosis is a lot better than the outcome markets now fear. But it would not be much to get excited about. The global recovery will be far from healthy: too reliant on America, still at risk from China, and still dependent on the prop of easy monetary policy. In other words, still awfully wobbly.