When you anticipate growth and predict it, the growth has to show up as some point or you will be both wrong and disappointed. To me, this is what has driven the markets since the start of Q3.
Let's do a quick market expectation timeline with accompanying rationalization.
- Q1 Growth is coming as the extension of the Bush tax cuts as well as the cut to withholding (and 100% expensing) will grow the economy by 0.5-1.0% faster and GDP should hit 3.0%. Initial GDP 1.9%, but will pick up steam.
- Q2 Growth is coming, but the Japanese tsunami/nuclear disaster, high gasoline prices and the renewed (Portugal) European debt crisis will put off strong growth until the second half of the year. Initial GDP should be the same as Q1 at 2.0%.
- Q3 June (released in July) employment data much softer than expected, global PMIs softening, US consumer spending falls for 1st time in 2 years and US GDP for Q2 much weaker than expected at +1.3% (vse +1.9%) with Q1 revised down to +0.4% (vsl +1.9%).
To this cold reality of rapidly slowing growth, we also had uncertainty generated by political events of a Greek austerity vote, new European debt plan and the US debt ceiling debate. Lastly, the coup de grace: US is downgraded by S&P.
From July 7th, the S&P 500 has dropped from 1356 to a low of 1120. From June 30th, the US Tsy 30 yr bond yield had dropped from 4.45% to 3.62%. This is not simply panic or speculation.
This is a rapid shift in market expectations for future growth and towards an increased level of uncertainty over global debt servicing.
There have been and will be official policy responses to the tremendous loss of value in the global stock markets. The European plan to change their bailout fund and allow borrowings by sovereigns for bank capital injections will eventually (when authorized) be a key component for stabilizing Europe. The European Central Bank aggressively restarting their sovereign bond purchases by including core countries of Spain and Italy has had a large, beneficial impact on reducing 10 year bond rates of those countries. Today, we await the FOMC and what policy response they will have as the market anticipates action. (And yes, crude oil at $80 a barrel should mean helpful lower gasoline prices for consumers.)
From policy makers, the markets are going to require strong stands on government policy with concrete plans such as President Obama backing specific austerity measures in the US like Bowles-Simpson or such as European governments quickly approving the new EFSF measures while agreeing to integrate further towards true monetary union. Markets are looking for central banks to provide a monetary bridge towards these policy islands and cool any market disruption until governmental policies can change.
Sadly, none of these can take the place of true economic growth and the essential growth level of 2.0%. The markets are going to require a showing of growth that meets expectations or exceeds them over an extended time frame.
Here's a few dates to start with:
August 12th July US advance retail sales exp. +0.5, UOFM preliminary confidence exp. 62.5
August 16th July IP exp. 0.5% and CU exp. 76.9%
August 18th US existing home sales exp. +3.8%.
Until then, the equity markets are in the process of pricing in 1% US GDP growth with a risk of recession and pricing in slower corporate earnings growth from 17% down to 8-12%. This repricing isn't over, but it should take a breather as the drop in value has already made long strides towards imbedding the new outlook into prices.
Andrew B. BuschDirector,