The Organization for Economic Cooperation and Development’s composite leading indicators (CLIs), which are designed to anticipate turning points in economic activity relative to trend, point to an easing of economic activity in most major OECD economies and a more marked slowdown in most major non-OECD economies.
While the CLIs for the U.S. and Japan remain above the long-term trend, both continue pointing to dissipating momentum.
For the eurozone, the CLI continues indicating economic below long-term trend activity, with Italy signaling stronger slowdown. Also the CLIs for China and India point strongly to a slowdown with economic activity falling below long-term trend.
Federal Reserve Bank of San Francisco President John Williams confirmed in some way the OECD CLI for the U.S. by saying: “We’re really right at that edge, if economic data continue to come in below expectations and if our view is that we don't expect to make progress on our mandate, then I would think we need more accommodation.”
He also warned about the risks associated to the “fiscal cliff” as federal cutbacks could be more dramatic than expected. Unless Congress acts, a number of other large tax increases and spending cuts will start up automatically at the beginning of 2013.
A recent Congressional Budget Office report suggested these additional measures could knock about one and a half percentage points off economic growth in 2013, which would mean the U.S. economy would barely expand, and hopefully not worse, next year.
So, for the long-term investor there is certainly no reason whatsoever for taking on some risk in the foreseeable future. The bottom still isn’t on the horizon.
In my opinion, long-term investors (as well as the entire world) are facing three systemic policy risks that, besides geopolitical risks of which Iran remains in pole position, will probably dominate the second half of 2012 are, but not limited to:
1. EU member states’ parliaments delay or even reject their leaders’ proposed partial banking union.
2. China’s easing cycle proves too timid to revive Chinese growth.
3. Anticipation of the U.S. “fiscal cliff” pushes U.S. growth well below 2 percent into year end.
In the context of all the above, Eric S. Rosengren, President of the Federal Reserve of Boston, said “recent data from both the U.S. and China are consistent with a slowdown in economic growth, and it looks like Europe is in a recession, with some European countries experiencing sharply negative growth."
He also said that "while a large financial shock would impact the global economy, global banks have the potential to amplify that shock … it is particularly important at this time to reduce the probability, and mitigate the severity, of any potential financial shock.”
So far, I don’t think it’s an overstatement to say it now looks like summer 2012 is evolving sadly similar to 2011.
The difference I can see between this year and last is that investors enter this summer quite long dollars rather than short.
While the U.S. and the dollar are probably the best place to be “located” in a bad neighborhood, my preferences, for the time being at least, remain pointed to highly liquid and safe “cash equivalent” U.S. dollar instruments.
Europe doesn’t inspire confidence to me and I can’t be sure yet if emerging economies can survive a serious financial shock to which various Fed presidents have referred to these days.
But please don’t get me wrong, for me it remains “safety first.”
I fully agree with Federal Reserve Bank of St. Louis President James Bullard, who said the U.S. fiscal position is as weak as some euro-area countries and lawmakers must take “dramatic” measures to tackle it and restore confidence.
On gold, nevertheless, I still expect lower prices as the dollar could strengthen further.
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