2011: Glimmers of Hope

The counterpoint to Fingers of Instability is Glimmers of Hope (see here for an explanation of the thinking behinds Fingers of Instability and Glimmers of Hope), which looks at some of the things that could go right in the economy and drive markets higher.

- Private Sector to drive GDP growth 
While Our Man believes that the underlying problem in the US (and other places) is primarily a solvency issue, the Government and the Fed believes that through increased fiscal spending and liquidity (i.e. QE1, QE-lite and QE2) they can help provide an escape valve.  In essence, QE and fiscal stimulus have supplied liquidity to the market to help boost GDP and asset prices.  This has provided support for the private sector, allowing it time to repair its balance sheet and rebuild confidence in the economy.  The underlying hope is that with confidence rebounding and balance sheets in better shape, the private sector will be able to take over the leadership in driving GDP growth and balance sheets can be further repaired as a function of this growth.  The Q4 survey data showed the first hints of truly positive data points, and this was supplemented by the Q4-10 GDP data which saw Real Final Sales leaping to 7%+ annualized from the 1-2% run-rate since the recession ended.  (Tim Duy has other morcels of good news from the recent Q4-10 GDP data)

- QE2 & the Wealth Effect
The other aim of Quantitative Easing has been to help US households rebuild their balance sheets & net worth, primarily through rising equity prices and the attempt to curtail the fall in house prices.  The additional hope is that a rising market will further help build confidence in the economy by boosting investors’ “animal spirits”.  Should this prove successful, there’s the possibility of the strong market performance (since QE2 rumours abounded during late-Q3) turning into a melt up.

- Falling Unemployment (and Rising Incomes)
It should go without saying that the best way for US households to repair the balance sheets and increase consumption is for them to be employed in jobs whose salaries are increasing!  With regards to the first part, Weekly Unemployment Claims still remain elevated by historical levels, but they have certainly declined from their peak.  This, coupled with hiring starting to edge up as the private sector gains confidence in the economy’s stability, has seen the economy start to produce net hiring over the last 6months.  While the numbers have been small, they have helped chip slowly chip away at the unemployment numbers.  While the second part of the equation has been quieter, Our Man think it’s fair to surmise real incomes are more likely to rise in a falling unemployment market than a rising one!

- China & an Asian soft landing
In much of a similar vein to last year’s Glimmers, perhaps Our Man remains just plain ole wrong on China.  Maybe they genuinely have built a better mousetrap in terms of this whole running an economy thing!  And if they haven’t, well they’ve shown a willingness and ability to throw money at problems whenever they arise.  While this may lead to longer-term imbalances and further misallocation of resources, it could certainly help 2011’s markets.

- Valuation
Like the prior note, it’s another repeat from 2010’s list.  Our Man continues to mutter that it’s an expensive market (and using longer-term measures it is) but if one only looks at short-term horizons (or uses current year P/E, or mutations of it….such as P/E based on Operating Earnings, or projected forward P/E, etc) then the market can look cheap.

- Constructive Government behaviour (in the US and Europe)
Stranger things have happened!  In the US, with a Democratic President looking to run for re-election in 2012 and the Republican’s having taken over Congress there is incentive for both parties to ensure the economy doesn’t suffer a reversal in the next year or two.  Who knows, perhaps they might even find their way to co-operating to do something constructive on Medicare/Medicaid and Social Security over the coming year or so.   In Europe, with Greece and Ireland having to be bailed out by their European partners, and Portugal seemingly next on the list, perhaps recent reports of a move towards investors having to take haircuts on their troubled bonds (i.e. reducing the debt burden, for those countries in trouble by making investors take a loss on their bonds) is the first step towards sorting out their sovereign debt problems.