Play the mini-cycles, not the euro crisis

April 20, 2012

For all the headline attention on euro zone political heat over the next six weeks or so  (Spain is already in the spotlight, Sunday is the first round of the French presidential elections, Greece goes to the polls on May 6, Ireland votes on the EU fiscal pact on May 31 etc etc),  global investors may be better rewarded if they follow the more mundane runes of the world’s manufacturing cycle for tips on market direction.

As showcased by the IMF this week, the big picture global growth story remains one of a relatively modest slowdown this year to 3.5% before a substantial rebound in 2013 to well above trend at 4.1%. Of course, there are some who think that’s hopelessly optimistic and others who may quibble about the absolute numbers but agree with the basic ebb and flow.

Yet within even these headline numbers, many mini-cycles are  playing out — especially within manfacturing, which accounts for about 20% of global GDP.  But problems in deciphering these twists and turns have been compounded over the past year or so by the impact from natural disasters and supply chain disruptions such as Japan’s devastating earthquake and Thailand’s floods.

Crunching the numbers  for Q1, however, JPMorgan’s global economists reckon global maufacturing output hit an annualised quarterly clip of some 5.6%. Even though that’s still off the pace of one year ago, it’s back near levels seen in Q3 of last year before the late-year slump. Breaking that down, the United States accounted for more than a half the Q1 rebound while emerging Asian economies, benefitting most from the bounceback after Thailand’s floods, zoomed at a 20% annualised rate.

However, this impressive manufacturing bounce is already ebbing again in the second quarter. The Thai bounceback looks spent and an acceleration in US inventory accumulation is now slowing output there.

Although only one part of a more complex GDP picture (we will see Q1 GDP readouts from the United States and Britain next week as well as flash April business sentiment gauges for Europe and China),  world equity markets appear to be taking a lead from the manufacturing pulse — surging in Q1 and now cooling into April. If so, what can be said about the rest of the year?   JPMorgan at least reckons we’re in for another reacceleration around mid-year, for a variety of the seasonal, inventory and disaster-related reasons already affecting the mini-cycle and with a rebound in utilities output as weather normalises stateside and in Europe.

So while Europe’s ongoing sovereign debt and banking crisis continues to pose risks to the global economy, its impact ont he wider world may be getting weaker. And it’s curious that a possible re-acceleration of manufacturing this Summer could come in tandem with important junctures in the euro saga itself — namely the European Banking Authority’s June recapitalisation deadline for euro area banks and also the introduction of the permanent European Stability Mechanism to shore up the rest.  Deadline-driven deleveraging and global asset sales by euro zone banks,  mercifully  slowed by the ECB’s cheap 3-year LTRO in December and February,  was easily been the biggest external transmission mechanism of the euro crisis last year. Once that has passed, it’s possible there may even be some financial sector relief to add a fillip to any manufacturing resurgence.

Either way, many investors are starting to say that the ‘surprise factor’ and global impact of the euro crisis is fading even if wrangling about the euro’s suture form and structure will continue for years.  Rupert Watson, head of Asset Allocation at Skandia Investment Group, said on Friday that the Spanish wobble was not the start of a new phase of the euro crisis and unless you were directly invested in euro periphery markets the fallout from the problems there would be minimal elsewhere.

The economic, political and social challenges facing some eurozone countries are likely to continue for years. They will remain a focal point for economists, politicians and historians. However, we think that unless you are directly investing in these countries, the significance of these problems is much more muted. With corporate profits continuing to rise, valuations favourable, interest rates low and investors generally underweight equities, we think the outlook for equities remains favourable.


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