A
sticky patch ahead,
or
a sea of quicksand
THERE doesn’t seem to be any
doubt that investors are worried about the American economy. The most recent
data, such as the retail sales numbers or the
Consensus forecasts point to
a modest slowdown at best, with an annualised growth rate of 2.5% in the first
half of the year and 3% (around trend) in the second. But the consensus is
notoriously poor at predicting recessions.
What might push the economy
into a downturn? The impetus might come from either, or both, of two directions.
Most obviously, there is the sub-prime mortgage crisis. This has been generally
dismissed as confined to a small area of the mortgage market, the bottom 10%.
But these people are the marginal buyers, the ones who were forced to borrow
high sums to afford their first house or apartment.
If they lose their access to
credit (as rapidly seems to be happening), that must affect the housing market
as a whole. Paul McCulley, of Pimco, refers to first-time buyers as the plankton
of the housing market, the creatures upon which the rest of the food chain
depends.
It is easy to fill in how the
story might unfold from here. Weaker house prices have a wealth effect on
consumer demand, and lower consumer spending hits business activity. How will we
know if this is a realistic possibility? It really needs a couple of months of
clear data, unaffected by the weather; after an unusually warm January, February
in
A second possibility is a
sharp slowdown in corporate profits. Andy Lapthorne, of Dresdner Kleinwort, says
that corporate profit warnings have been unusually common in recent weeks; and
the annual rate of growth of business sales has slowed to 2%, a low rate by
historical standards. Margins could be coming under pressure, especially as
labour markets still look tight. Unemployment is just 4.5%. That might prompt
companies to shed jobs, a piece of unfortunate timing when the housing market is
already weak.
It is hard to say that the
market has yet priced in a serious downturn. Yes, the yield curve has been
inverted for some time (long bond yields are below short rates). This has
historically been a signal of recession. But most commentators are inclined to
ascribe low long-dated Treasury bond yields to the Asian savings
glut.
After all, if the economy
were heading for trouble, corporate bonds would surely be suffering. But,
according to Moody’s, the cost of insuring against the default of a typical
high-yield bond is currently below a 12-month average. And investors can hardly
be blamed for being sanguine: the historic driver of spreads has been the
default rate, and Standard & Poor’s says there was just one corporate
default in February, keeping the annual default rate at a little over
1%.
If equities have wobbled, the
sell-off has been mild, even by the standards of last May. Again, it is
difficult for investors to get too bearish, when every day seems to bring a
multi-billion-dollar bid for a Boots or an Altadis. In the late 1990s there was
supposed to be a "Greenspan put" that insured the markets; is there now a
private-equity put?
So it looks as if investors
are undecided at the moment—caught between worrying economic data, and the
strong technical position (good cashflows) of the market. When investors are
undecided, markets tend to move quite erratically. So the best bet for the
moment is that volatility will continue.
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