Although Economies Appear to Be Improving, Wait for Correction to Invest

Tuesday, 14 May 2013 10:14 AM

By Hans Parisis

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Speaking in Stockholm, Sweden, May 14 on the U.S. economic outlook and monetary policy, Philadelphia Federal Reserve Bank President Charles Plosser, known as a monetary "hawk" who is a non-voting member of the Federal Open Market Committee (FOMC) this year but will be a voting member in 2014, said the United States is now growing close to trend, which since 1970 stands at 3 percent, and he even said he expects growth to accelerate slightly to above trend next year.

Plosser expects labor market conditions to improve further this year, with an unemployment rate at 7 percent by year-end and below 6.5 percent by the end of 2014. And he believes inflation will remain at "moderate levels."

However, he also underlined the fact that fiscal uncertainty together with an unusual large deterioration of the balance sheets of households and businesses, as well as the fragile state of the global economy, continue to weigh on business investment.

In the conclusion of his prepared speech he nailed the developing U.S. situation very well: "Should labor market conditions and inflation continue to evolve as I project, then I would view ending the [Fed asset] purchases by year-end as appropriate. In fact, I believe the FOMC would undermine the credibility of its own statement if it fails to adjust the pace of asset purchases in response to economic conditions."

As a long-term investor and remembering that Plosser is a hawk, I would keep in mind his statements, and if he is right in his forecasts, the Fed could start tapering its quantitative easing (QE) program earlier than many speculators hope for today.

The Organization for Economic Co-operation and Development (OECD)'s composite leading indicators (CLIs) support completely Plosser's positive view on the U.S. economy, with a CLI ratio of 101.1 compared with trend, which is fixed at 100. This remains the best rating of all the important economies of the 33 member states of the OECD. For comparison: Germany came at 99.8; the United Kingdom at 100.7; France at 99.6; Italy at 99.8; Canada at 99.5; China at 99.9 and Brazil at 99.5.

Also, the National Federation of Independent Business' Small Business Economic Trends report shows that the small business optimism index in the United States rose 2.6 to 92.1 in April, which is above the average 90.7 index of the recovery so far, but still far below the 100 points where it was when the Great Recession started in December 2007. No, small businesses still have not returned to pre-crisis optimism yet.

Anyway, the moment the Fed starts decreasing QE "gradually," and it's not a question of "if" but "when," markets could go wild and easily exaggerate to the downside, as the perception of "money for nothing" would be cut back substantially.

Keep in mind that the actual "zero rate" Fed policy is increasingly troubling various Fed members.

No doubt, Fed tapering is not to be expected in the immediate future, but, nevertheless, I personally would give it sufficient attention and take my time for being prepared for when it starts.

Yes, QE tapering will have to happen in various stages. Along the (long) road to "normalization" there will arise long-term investment opportunities at much more attractive purchase prices than today is widely considered as possible.

I think as a long-term investor there should also be very small risk, considering U.S. interest rates are bottoming.

On the other side of the pond, Eurostat, which is the official agency that provides statistical information for the European Union, reported industrial production in the euro area was up 1 percent month-on-month, but down 1.7 percent year-over-year.

When we take into account that Markit's Eurozone Purchasing Managers' Index Composite Output Index came in at 46.9 (below 50 is contraction) in April, it is certainly not an overstatement to say the 1 percent improvement in industrial production is doomed to be short-lived, at least in my opinion.

That said, the results of Pew Research Center's survey of about 8,000 EU citizens on how they felt on the EU are very sobering. The approval rating of the so-called project of the European Union fell overall within one year from 60 percent to just 46 percent, while only 28 percent now believe economic integration has strengthened the economy, compared with 34 percent a year ago.

To me, the most worrisome results come out of France, where only 41 percent of the French versus 60 percent a year ago favor being part of the European Union. By the way, in Britain, only 43 percent see the European Union in a favorable light, compared with 45 percent a year ago. Of course, Germany remains in favor, at 60 percent, but that is also down, from 68 percent a year ago. The title of the 78 page report says it all: "The New Sick Man of Europe: the European Union."

No, the crisis in the European Union is not over yet, not by a long shot and what is most worrisome is that confidence is waning rapidly. Notwithstanding politicians, but also albeit to a much lesser extend the European Central Bank, continue openly denying reality as they have always done.

From my side on investing, I remain in waiting mode and will define my preferences once the coming correction takes hold. When that will be, only time can tell.

My preferred investment zones still remain by far the United States and the U.S. dollar. Gold is not on my agenda yet, as it will have to wait for a new analysis until we reach the $1,200 to $1,250 an ounce zone.

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