July 16, 2013

It’s a struggling world amid economic recovery

Posted in Economy, Inflation, Uncategorized tagged , at 5:33 PM by Robert Barone

Despite tax increases and sequestration, the U.S. economy managed to officially grow 1.8 percent in the first quarter and likely at a similar rate in the second.

Strangely, despite the lack of growth, the equity markets were up almost 16 percent in the U.S. in 2013’s first half. With the release of the June employment data, there is now no doubt that the job market is actually growing jobs, although questions remain as to the quality of those jobs (with part-time jobs growing and full-time jobs contracting).

While June’s official U3 unemployment rate held at 7.6 percent, the more comprehensive U6 measure (includes some discouraged workers and those holding part-time jobs but desiring full-time) rose from 13.8 percent to 14.3 percent, quite a large single-month jump.

Thus, four full years after the recession ended, the “recovery” in the U.S. remains fragile and uncertain. Nevertheless, it does not appear that a new recession is approaching.

Reality inflation

One reason for the fragility is the fact that household income has continued to lag real inflation.
According to Ed Butowsky, founder of Chapwood Investments, while household incomes have risen at a rate at or slightly above the “official” U.S. rate of inflation, the real cost of living rose at double-digit rates in nearly every one of America’s 50 largest cities.

Yet, despite the income challenges, somehow the American consumer has managed to find enough resources to step up purchases with both credit card debt and auto sales showing near-record increases in June.

Some say that consumer deleveraging has ended. In reality, it is the cost of servicing debt as a percentage of disposable income that is key, and this cost is at a modern-day low.

So, while the level of debt remains high, as long as rates are low the consumer can still comfortably service that debt. This is no different than the home purchase equation. A lower interest rate means that, for a given income level, the consumer can afford a more expensive home.

The world

When we look outside the U.S., we see two different camps with differing equity market results: those with activist central banks and those without.

It appears that, in 2013’s first half, the equity markets in the higher-growth areas of the world (China, Russia, Brazil) did poorly (China, -11 percent; Russia, -11 percent; Brazil, -18 percent) while the low-growth areas (Japan, Europe, U.S.) had positive performance (Japan, +32 percent; Switzerland, +15 percent; U.S., +14 percent).

This strange phenomenon can be explained by the money printing binge of the central banks in the U.S., Europe (including Switzerland) and Japan. The central banks in the rest of the developed world have not printed. Thus, the equity markets in areas with activist central banks are clearly responding to money printing while those in the rest of the world appear to be responding to fundamental economic growth.

Headwinds

Going forward, the headwinds for growth in the U.S. and the world are significant:

• Economic growth is consumer dependent (70 percent of GDP in the U.S.). Money printing cannot last forever and the Fed has already announced plans to “taper” its printing. As a result, we have seen interest rates spike up, and a growing economy means that interest rates will rise further.

This can’t be good for a consumer still struggling with job quality and income rising more slowly than the reality of inflation.

• Europe remains mired in recession with the debt and budget issues of the EU periphery (Portugal, Spain, Italy, Greece, Cyprus …) not yet resolved and in some cases, not yet addressed.

Central Banks in Europe and England recently reaffirmed easy money policies well into the future. But politically, no progress has been made on a banking union, a move that is quite critical to establishing financial stability for the euro.

• GDP growth rates in every part of the world have fallen since their initial bounce after the financial meltdown in 2010. This includes developed economies, developing economies and the BRICS (Brazil, Russia, India, China, South Africa) economies.

China’s officially projected 7.5 percent growth rate is now completely discredited. Marc Faber (The Gloom, Boom and Doom Report) recently opined on Bloomberg TV that China’s growth rate had fallen to 4 percent at a maximum. The prices of raw materials and shipping manifests back up the theory that a huge growth slowdown has occurred there.

• Besides the growth issue in China, a political crisis has erupted in Brazil, one of the BRICS’s stalwarts. The coup in Egypt, unrest in Turkey and the ongoing civil war in Syria all threaten tenuous Middle East stability, to say nothing of Iran’s ongoing nuclear program.

Conclusion

The headwinds worldwide are strong and significant. A growing U.S. domestic economy with the Fed stepping back from Quantitative Easing implies rising interest rates which, given the state of consumer finances, could prevent the economy from attaining “escape velocity” and keep it growing at subpar levels.

Furthermore, attaining that “escape velocity” has become more difficult with inflation reality much higher than official inflation figures and slower worldwide growth.

One obvious conclusion: The world’s political and economic systems appear as unstable as at anytime in the past 25 years. I don’t know what will cause the next crisis or when it might occur, but I do know that now is not the time to take a lot of risk.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs.

Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

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