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Global Markets Weekly - 20 April 2009

• Reaction to the current earnings season has been broadly positive…
  The outturn of the current US earnings season has the potential to reinforce or disrupt the rally that continues in most equity markets. Results published so far have been broadly in line with analysts’ expectations, while the reaction to some banks’ results, private capital raising activities and desire to repay government funding has been positive for the sector overall .
• …while banks have also benefitted from verbal support from the US administration
  Banks have been the best performing S&P 500 sector over the last week, also being assisted by stories in the US press that Obama administration officials believe all nineteen of the banks currently undertaking the Federal Reserve Bank of New York administered ‘stress tests’ will pass. This would serve to reduce the prospect of further dilutative capital injections – whether from private or public sources. Emphasising the recent pro-cyclical nature of the equity rally, traditionally defensive sectors, such as utilities and gold companies, have been some of the worst performing over the week.
• US inflation is now negative for the first time in over fifty years, emphasising increasing spare capacity…
  Nevertheless, US economic data emphasised the macroeconomic reality of an economy experiencing shrinking levels of final demand and consequent deflationary pressure. Retail sales in March were lower than expected, now declining at over 10% on the year and, at 69.3%, industrial capacity utilisation is the lowest since records began in 1967, and most likely since the late-1940s. The accumulation of high levels of spare capacity is a critical driver behind the rapid decline in US inflation. Data for March showed the first negative annual inflation number since 1955 . Post-war episodes of deflation was very brief, lasting around 12 months. Current Fed policy is directed to avoiding the kind of self-reinforcing debt deflation seen during 1930-33, when the price level declined by a cumulative 25%.
• …the associated high unemployment is hitting consumer confidence
  Falling prices mean that households enjoyed a corresponding ‘real’ wage increase in March. Faced with increasing unemployment and falling house values, however, consumer confidence remains at levels consistent with declining household spending. This is also true in Europe, where Eurozone consumer confidence is at its lowest level since it began being measured in 1985 - and continues to decline.
• Weak Western consumer demand has sharply impacted very open economies…
  Falling levels of consumer demand in Western economies have already impacted growth in Asia. Chinese export volumes have gone from expanding at 20% in the third quarter of 2008 to declining by 20% so far this year. Despite the frequent focus on China, however, it is one of the least directly export-dependent countries in the region, with only 8% of the workforce employed in export industries . The first round effect of the sharp decline in global trade has been larger in more open economies in the region, such as Singapore.
• …although "spillover effects" mean that we may not yet have seen the full impact of declining trade volumes
  A recent study by the Hong Kong Monetary Authority (HKMA) suggests that a more dynamic analysis is required when assessing the total impact of an export demand shock on a fast growing economy such as China. In particular, there are important “spillover effects” from export demand growth to investment, job creation and ultimately consumption. These effects will take longer to materialise than the direct impact of falling exports, although they are potentially more significant. The HKMA concludes that each 10% drop in exports will eventually hit total GDP by 2.5%. The Chinese fiscal stimulus package, amounting to 3% of GDP, is a welcome counterbalance to this contractionary pressure. However, investors who believe that recent data improvements show that the Chinese authorities can already declare victory over the forces of global slowdown are probably taking a dangerously one-dimensional view of Chinese growth .

Indices, Interest rates and Inflation

View the full Global Markets Weekly report (pdf).

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