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I would have
thought that the decoupling myth between global economies would have been
completely discredited after the events of this past credit crisis unfolded.
Back in 2007 and early 2008, investors were very slowly coming to the
realization that the U.S. centered real estate crisis was going to
dramatically affect our domestic economy.
However, the
prevailing view at the time was that the global economy -- especially
emerging markets -- would be almost totally immune from any such slowdown.
But the truth was that emerging market economies took America's financial
crisis directly on the chin, causing the Shanghai Composite Index to drop 70%
in just one year.
Now investors
are being told that the worsening sovereign debt crisis in Europe will leave
the U.S. economy unscathed. The reason for the perma-bulls'
optimism is based on the fact that America doesn't have a strong
manufacturing base. In fact, manufacturing now represents just 10% of our
once diversified and vibrant economy. Wall Street is now hoping that since we
don't make many things to export to Europe, our GDP won't suffer a
significant decline at all.
What
investors have conveniently overlooked is the fact that 40% of S&P500
earnings are derived from foreign economies. And the seventeen countries that
make up the Eurozone have collapsed into recession. That wouldn't be so bad
if EU (17) wasn't the second biggest economy on the planet. Recent data
points illustrate that the worsening recession in Europe will continue to
bring down global GDP.
Credit
Default Swap prices on 15 western European countries shot up 26% in the last
month and Spanish banks now have over 8% of loans that are non-performing --
an 18 year high. European banks are keeping their governments afloat by
loaning them money, which they in turn borrowed from the ECB. That cannot be
a viable or sustainable situation. Many European economies will suffer
massive inflation and sovereign default -- just as was the case in Greece --
within the next two years.
But don't
rely on China to supplant falling demand from the Eurozone economies. China's
economy is still driven by exports, which represent about 40% of their GDP.
The problem here is that China's largest customers are the U.S., Japan and
Europe. The U.S. is mired in stagflation, while Japan's growth is anemic at
best and the E.U. is in recession.
The global
slowdown will put further pressure on the U.S. economy and the earnings of
multi-national corporations. Downward pressure on the U.S. economy is already
becoming apparent. Data on home sales, industrial production, jobless claims
and regional manufacturing surveys have all recently disappointed. U.S.
productivity has fallen from 4% during 2010, to just 0.4% during all of 2011.
S&P500 earnings growth has already plummeted from 14% during 2011, to
just a 3% annualized rate in Q1 2012.
The fact is
that we have a global economy that is intricately intertwined. And at this
juncture there is no such thing as decoupling. Because of this, it is my view
that equity markets will fall significantly this summer, as earnings fall and
PE ratios contract. That will be the primary catalyst that brings global
central banks back into play.
The Fed, ECB
and BOJ will most likely launch further quantitative easing later this year
in an effort to combat falling stock prices.
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