This week’s thought-provokers for investors:
Posted on: 01 Jun 2012 by James Farmer

Another round of disappointing economic data from the US further heightened market concerns this week. Equities continued to dive, with Spain’s IBEX and the Italian MIB leading the field. Switzerland’s SMI proved to be more resilient, being close to unchanged for the week. For the first time, German two-year yields reached negative levels and are now close to 0%. Overall, government bonds were the big winners, except those issued by European peripherals. Gold stabilised above USD1550/oz. Crude oil dropped below USD90 and is trading close to USD86/bbl.

European economic confidence dropped to a 2.5-year low in May. The main economic sentiment indicator dropped from 92.9 to 90.6. Most of the sector indices fell sharply, but consumer sentiment improved slightly. The Netherlands, France and Germany also saw confidence decline. Meanwhile, the situation is becoming acute in the peripheral economies.
Policy makers are facing a hard challenge to turn the need-for-growth talks into real measures. If they fail to do so or are too late, expect the doom spiral to accelerate. Do not expect them to act before the market forces them to.

The Swedish economy expanded by 0.8% in Q1. This raises the annual growth rate to 1.5%. Household spending rose by 1.1% as the domestic recovery stayed on track.
Sweden is weathering the crisis in Europe pretty well. Household spending paints an encouraging picture, but compared to a year ago spending is much weaker. If the uncertainty regarding Greece continues, Swedish exporters are going to be hit hard by the unfolding European recession. This will lead to a bumpy ride for the economy.

Italian business confidence declined more than expected in May. The manufacturing-sentiment index fell to 86.2 from 89.1 in April. Economists were expecting a reading of 88.6.
The measures taken by Italian prime minister Mario Monti’s government are only starting to be implemented. Expect more of the same for the second half of the year when even further measures will put pressure on Italian businesses.

The US economy slowed in the first quarter. Growth in gross domestic product was 1.9% in Q1, according to the Commerce Department. The economy kept growing thanks to consumer spending at retailers and car dealerships, whereas business investment slowed. Initial jobless claims increased by 10,000 to 383,000 in the week ended 27 May, and US consumer confidence reached a four-month low at 64.9. Drivers of the decline were the current conditions index, which fell from 51.2 to 45.9, and the expectations indices.
The weaker US growth is in line with other global economies also struggling to keep pace. But growth inevitably has to do with some form of home or foreign-driven consumption. For the time being, the environment does not look reassuring for the consumer, who is faced with uncertainty in Europe and concerns regarding the job market.

The US index of pending home sales dropped by 5.5% in April. This is the sharpest decline in the last twelve months. Economists were expecting an unchanged reading. The report showed declines in three out of the four regions covered. Only in the Northeast of the US did pending purchases rise. More reassuring signs came from new-home sales, which climbed by 3.3% in April.
To see a substantial improvement, expectations of a further decline in prices of potential buyers must be capped. It is questionable how low yields have to drop to get to this point.

Brazil cut interest rates to 8.5%, the seventh cut since last August. The continued cuts are a measure to revive growth. The central bank sees limited risk for inflation, as the external sector contribution is deflationary due to the fragile global economy. Brazil’s economic growth dropped from 7.5% in 2010 to 2.7% in 2011 and is expected to be close to 1% this year. The rate cuts have weakened the Brazilian real.
At first glance, the weaker real is helping exporters. Yet further down the road the fast weakening of the real against the US dollar will penalise Brazilian companies holding debt in US dollar. More easing can be expected if the economy does not gain traction or if the turbulences in Europe continue. Yet it seems to be a risky strategy.

India’s economy slowed in the first quarter, with gross domestic product rising by 5.3%. This was the worst quarterly growth rate since 2003 and 0.8% lower than the prior quarter. Median expectations by economists were for 6.1% growth. Industrial production and exports contracted in April due to deteriorating global and domestic demand.
The European crisis is certainly taking its toll on demand for Indian goods, but for the last two years the main driver for India was its weak policy. Do not expect foreign investor confidence to come back soon unless parliament overcomes its paralysis and implements key reforms.

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