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Developing World Loses Momentum but Stocks Rise

It was only a matter of time.

What else was there to expect beside a loss of recovery momentum from tightening monetary policies throughout the developing world and generally higher commodity prices? A flash purchasing managers’ survey for China’s manufacturing sector released at the start of the week said it all.

CNBC.com

The developing world is losing momentum and the risk is that this transfers to a loss of earnings momentum for the big internationals in the leading indices like the S&P 500, the DJ Euro Stoxx and the FTSE 100.

As for the euro zone’s sovereign debt crisis and the risk it poses for the banks, this troubling source of instability for equity markets is here to stay for a while.

Indeed, it has been here for a while already and not getting any easier for the likes of Greece.

It is not hard to be bearish when equity markets are reacting and when the major government bond markets need no prompting on where to go next. It’s bear market stuff.

But is it really? Sure enough, the loss of momentum is real and, clearly and painfully, so is the sovereign debt crisis.

Yet despite the volatility, none of this has prevented equity markets from climbing to new recovery highs this year.

Indeed, Wall Streethit a new recovery high only a month or so ago even though the developing world has been losing momentum for a while.

Bond markets have done well to get where they have but they now know from April’s FOMC (Federal Open Market Committee) minutes that the Federal Reserve has agreed an outline of how it will implement its eventual exit strategy.

They know too that the second round of quantitative easing, known as QE2, will end in June and, with the exception of Japan, they know that inflation is not only above target for the major central banks but also heading firmly upwards.

Surely, none of this is good for them! Of course, that is unless the attempted reflation of aggregate demand is doomed to end in failure. But is this likely? I don’t think so.

It doesn’t help if the banks aren’t lending but it helps to look at what may be possibly the most persuasive case in support of the outlook for a sustainable expansion.

The trend for US private sector non-farm payrolls looks to be decisively on the upswing. The employment trend for Germany is simply astonishing. Its climb to new and higher levels points to growth ahead not just for the economy but also help, more broadly, for the euro zone.

Even the UK economy, which is saddled by fiscal austerity, appears not to have totally lost its capacity to create full time jobs.

Job creation is surely the strongest reason for thinking that the reflationary effort has not gone just into commodity prices.

Clearly, the developing world’s hugely significant contribution to the global recovery has had much to do with boosting corporate profitability and now jobs.

In Germany’s case this is in spite of a euro that is nowhere near as competitive an exchange rate as the dollar.

However, when it comes to jobs, we are not talking just about the big internationals but also about smaller and medium size companies.

Not only do they tend to be more closely geared to the domestic economy but they tend also to provide the bed rock for job creation.

With the latter now underway, the case for believing that the reflationary effort undertaken by the developed economies is working to secure a sustainable expansion is more compelling.

It suggests that Japan’s bond friendly environment of deflation is unlikely to be replicated. Yes we’ll see some loss of recovery momentum from the initial upswing in the cycle. Some may say there has been barely any lift off to start with.

Maybe this cycle is different. It’s certainly not without its difficulties.

But the fundamental underpinning for a sustainable expansion is the job growth that boosts spending and provides the top line growth for companies that enables them to invest and create more jobs.

It is all part of the reflation of aggregate demand that policy makers intended and I see it as providing a supportive outlook for equity markets.

Sooner or later the bond markets are likely to come round to seeing it this way too.

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The author is Mike Lenhoff, Chief Strategist, Brewin Dolphin Securities