04-13-07
Science insusceptible
Logic so inflexible
Causally connectable
Yet nothing is invincible...
– The Police, Synchronicity
For the past few years, America has been seen as the "engine of growth to the world." The global economy, we were told, was like a jumbo jet with three stalled engines. The fourth engine—a booming US economy—was the only thing keeping it in flight.
From this point of view, the American consumer played the role of savior. In the face of a massive "global savings glut," as Ben Bernanke called it, credit cards and home equity loans saved the day. Without America's willingness to spend, the rest of the world would supposedly have closed up shop.
The subject is nothing if not controversial. Many observers, including yours truly, saw America's party-hearty ways as foolish and reckless. In regards to this, we have written extensively about Bretton Woods II, the pyramid & the pie, the debt liquidation trade, and other related themes. (You will soon be able to find all those odd-sounding topics, and more, in the ‘themes & trends' section of the Consilient Investor website.)
But for now, let's get back to that jumbo jet.
As subprime woes spread, home prices fall, and the effects of tighter credit ripple outward, the airplane metaphor takes on a new sense of urgency. Can the global economy fly on if the American consumer sputters out?
Some say yes.
BCA Research, a 58-year-old institutional research firm based in Montreal, Canada, believes that "desynchronization" will be a key theme going forward, as America and the rest of the world go their separate ways. More specifically, BCA writes:
The U.S. has slowed considerably, reflecting the combined impact of higher policy rates and housing woes. However, the rest of the world continues to show strength, led by the low-inflation boom in China and the rest of Asia. The net result will be a less volatile global business cycle, which should help prolong the equity bull market.
In anecdotal support of BCA's conclusion, the Financial Times noted last week that "Europe tops US in stock market value." The FT writes:
The rise of the euro against the dollar, growth of east European markets such as Russia and stock market outperformance spurred by improving profitability have seen Europe close a long-held gap with the US. Ian Harnett at Absolute Strategy Research, who identified the move, said this marked a "seismic shift" in markets.
If the rest of the world (often abbreviated as ROW by US-centric financial managers) is to maintain solid growth, it will need to wean itself from the American consumer's pocketbook. For Asia in particular, this means less reliance on exports and greater focus on domestic demand.
The main challenges of ginning up domestic demand are 1) weaning an economy off export-dependency, 2) developing credit mechanisms and payment systems to lubricate spending (like mortgages, small business finance and auto loans), and 3) getting consumers to spend without going overboard (always a dance between 'not enough' and 'too much.')
Emerging market governments have plenty of cash to throw at the problem. The "global savings glut" Bernanke spoke of is partly a function of exporters squirreling away funds. None of them wanted to get caught in another crisis like the "Asian contagion" of the late nineties, and huge stockpiles of reserves were the result.
As exports slow, however, these piles of emerging market cash can be turned toward domestic investment. Some even argue a pullback could be healthy for overheated exporters. The Wall Street Journal reports:
A mild slowdown in the U.S. could actually further [Beijing's] efforts to rein in growth. It might also encourage Chinese companies to focus more on serving domestic consumers than overseas ones—another shift China's leaders are trying to promote.
…And while exports are important, China's expansion is flying on more than one engine [that metaphor again!]. Much of its boom has come from massive building of new factories, highways and housing. While some investment does go into export manufacturing, more than half of such spending last year went to housing and infrastructure… the kind of investment that serves local demand, and doesn't depend on the vagaries of U.S. consumer spending.
Take it with a grain of salt perhaps, but emerging market optimism remains strong. After the Feb 27th crash, the lead indices for Brazil, Russia and China did more than just bounce back... they went on to register new all-time highs. (India didn't join the party, but the BSE Sensex had booked all-time highs earlier that month.)
Of course, economic strength doesn't always translate to bulletproof equity markets. Major market dislocations (and outright crashes) can and will happen, even when the foundations of growth are solid. The crash of '87 happened five years in to one of the longest bull markets in history, and didn't derail it. (Another mini-crash two years later, in 1989, was similarly short-lived—almost nonexistent—in terms of economic effect.)
The takeaway for investors? Learn to think like the emerging market leaders. Move away from an American consumer focus; recognize that iconic brands like SBUX, HOG and DELL are the growth stories of yesterday, not tomorrow.
Start thinking more about the developing world, and untapped domestic demand in far-flung points across the globe. What will these new consumers be buying? Who will they be buying it from? Where will they put their massive savings?
Which companies will benefit as developing world infrastructure, both physical and financial,gets ramped up? Which multinational juggernauts are well-poised to surf the wave of emerging market growth? Which nimble small-cap entities are set to make a killing on these trends... or get acquired at a huge premium by the big boys?
As three billion new capitalists enter the picture, there is a lot to think about.
Fortunately, that is pretty much what your Macro Musings editor does all day: read and think. (With the occasional time-out for a poker hand here and there... and, of course, writing to you with conclusions.)
We have only scratched the surface. But that should be seen as good news, because this is a lucrative topic indeed.
