2013: Glimmers of Hope

Traditionally, at the start of each year, Our Man looks at some of the major things that could help or hinder the economy and markets during the upcoming year.  As such, here are this year’s Glimmers of Hope (see here for an explanation of the thinking behind Fingers of Instability and Glimmers of Hope), which looks at some of the things that could help drive markets higher.

  

- QE-Forever Everywhere and (the lack of) Inflation 

One of the interesting things about crises is that people’s time horizon reduces dramatically.  The aim for folks (almost everyone) becomes to try and limit the impact that they’re feeling (or going to feel) from the crisis, and insulate themselves from the results of the crisis.  For those in power (especially Central Banks and Governments) this results in a string of short-term focused decisions, whose sole aim is to end the crisis as quickly as possible so they can declare their mastery over it.  The downside is that little is done to resolve the underlying problems and it can result in the economy lurching from one crisis to the next, with each ‘successful’ resolution leaving the system more fragile than before.  Some of this can be seen in 2013, which has started with the proponents of Central Banks beginning to declare victory; Mario Draghi has been cheered for saving the Euro, the Fed have publicly committed to continue the QE-experience until either it succeeds (and unemployment falls to an acceptable level) or it fails (and inflation rises to an unacceptable level), and it appears like the BoJ will bow to government pressure and increase QE in an attempt to escape their deflationary trap.  Like 2012, the Central Bankers of the world continue to press the 'sell your bonds, and buy risky assets' line of thinking!  This demand and its impact on the psychology of market participants could well once again prove very supportive to the markets.

  

- Can-kicking Government behavior 

For Government’s the politically optimal way of dealing with crises, is to find a simple quick patch for the problem that pushes the difficult decisions off into the future (and hopefully, onto other folks) even if it means making the long-term issues worse.  This means different things in different countries.  In China, where the ‘crisis’ surrounds the potential slowing of economic growth, the response to any crisis that hints at slower growth (even if it might result in the rebalancing of the economy, which is a longer-term aim) is to increase government-sponsored investment even if the cost is greater overcapacity and a less balance economy.  In Europe, where the crisis revolves around weak government finances, the response is to create ever more complicated and intricate ways to extend, encourage or ease funding to the countries in trouble even if the likelihood of getting a return on that funding is limited, rather than restructuring the debts that are unlikely to be paid.  In the US, with a tax regime that fails to generate sufficient revenues and a spending regime dominated by non-discretionary item (defense, medicare, etc) there’s plenty of scope for short-term fixes (like the fiscal cliff deal) that do little to help resolve the longer-term imbalances.

- Housing Market 

As we mentioned in 2012’s Glimmers of Hope, the housing market was a potential source of upside.  If you look back at historical housing crises, it takes 6-8years (on average) for the housing market to stabilize and start to improve again.  Given that prices peaked in the US back in late-2006, it would suggest that we’re in the neighborhood of seeing (continued) improving prospects here.  While it’s not clear that that Government’s & the Fed’s efforts to reduce the problems in housing are well-thought out, it’s equally clear that any continued stabilization in the housing markets would unquestionably help both socially and economically.

- Global Economic Growth 

Could 2013 be the year that we return more sustainably towards trend economic growth.  There are certainly some positive signs.  In the US, a fiscal deal was agreed and it appears we’re going to have less uncertainty around the debt-ceiling.  In Europe, Draghi has ensured that European government’s will be able to fund themselves and has bought further time for them to see if there are any fruits to the austerity programs they’ve been running.  Finally, in Asia, China has managed to helped stimulate its economy through aggressive bank lending and Japan is discussing a far more aggressive QE program to help try to boost growth.

- State and Local Governments 

One of the consistent drags on the US economy since 2008 has been state and local governments, which have struggled with their own budget woes.  Unlike national governments, they weren’t able to increase deficits as easily and thus were consistent cutters of spending and jobs.  Signs towards the end of 2012 suggested that this trend is approaching its end and while State/Local governments might not be positive drivers of the economy going forwards, they will be likely stop being drags on growth.

- Falling Unemployment (and rising incomes) 

Of all the economic data that's out there, these are the two things that Our Man cares the most about - do people have jobs and do those jobs pay decently.  While there’s many flaws in the data (and its computation), it’s also clear that jobs data in the US is consistently improving, albeit at a slower pace than everyone (I think) would like.   Now perhaps this improvement slows or reverses later in the year and there are seasonal biases benefiting the data currently, but the declining trend in unemployment, positive revisions and increase in hours worked (which will, hopefully, feed through into incomes) is unquestionably good for the economy!  With companies being in a relatively strong position, if demand continues to hold up well, there is potential for this favourable trend to continue. 

- China & an Asian soft landing 
China continues to stimulate their economy whenever there’s the risk of a hard-landing.  While the figures and data coming out of China may be questionable, perhaps they’ve just built a better mouse-trap for managing the economy than the rest of us…

- Valuation
This is a repeat from prior years’ lists!  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 an argument can be made that the market is cheap.