Global Economic Scenario
The last twelve months have been quite unprecedented in terms of volatility and absolute levels of interest rates. The bond market was whipsawed by events in Europe and Washington. Greece was the poster child for the debt crisis in Europe but it was merely the first country to feel the wrath of the capital markets. Portugal, Ireland, Spain, and ultimately Italy experienced difficulty accessing the cash markets to roll over debt. As the European debt crisis worsened, investors flocked to the US. The US markets were roiled by our illustrious leaders in Washington who were unable to agree on a long-term plan to reduce deficits and grow the economy. Additionally, in August, Standard & Poor’s downgraded the credit rating of the federal government from its AAA status and its downgrades for many countries in Europe continue.
Looking at the International Monetary Fund’s (IMF) forecasts for the gross debt-to-GDP ratio for the entire euro area economies show the ratio peaking at 90% in 2013, well above the Maastricht Treaty’s 60% limit but below the US ratio, which peaks at 115% in 2016. Unfortunately, consolidated ratio masks some very ugly numbers for individual countries with Italy’s ratio peaking at 121% in 2012, Portugal at 115% in 2013, Ireland at 118% in 2013, and Greece at 189% in 2012. The key fact is that these forecasts do not incorporate the fiscal austerity packages still under construction; however, they elucidate investors’ concerns about the ability of these countries to repay their debt. Funding markets are also being affected as European financial institutions look warily at their counterparty’s exposure to the afflicted sovereigns’ debt. The joint efforts of global central banks to support liquidity and reduce the cost of borrowing resulted in funding spreads remaining below their 2008 peak; however, with the value of sovereign-debt holdings declining, banks’ balance sheets are being negatively affected and in turn this is reducing the amount of loans they are willing to extend.
The ECB (European Central Bank) recently in order to ease the escalating banking crisis on the continent gave financial institutions for the first time an opportunity to borrow unlimited amounts for 3 years at record low rates. The ECB also informed that it would be willing to accept lower-rated assets as collateral for these loans, thereby helping to ease the effects of the credit crunch and supporting the overall European sovereign debt markets. This lending program is another attempt by the ECB which resisted becoming a lender of last resort. And it essentially should support the fragile European banking system as losses on sovereign debt mount and Eurozone banks continue to face doubts about the strength of their capital positions. The ECB likely hopes that pumping liquidity into the system will help relieve the near-term funding shortfalls that would have caused systemically important banks to collapse suddenly.
The US economic data for the month of Nov & Dec’11 has beaten expectations indicating that the economy has regained some momentum. The outperformance in the data reported in November’11 was broad based including industrial production, retail sales, housing stats and sales. An indication of an improvement in the labour market was evident, with the three-month average in nonfarm payrolls rising and the unemployment rate edging down to 8.6% in November’11. So overall optimism prevails.
The JP Morgan Global Manufacturing PMI rose to a level consistent with modest expansion and posted a reading of 50.8 December’11, it’s highest since June’11 at 50.8, and up from 49.7 in November’11. On the other hand, productivity in the private sector economy of the European Union deteriorated for the fourth consecutive month in December’11. At 48.7, the seasonally adjusted EU Productivity PMI remained unchanged from November’11, signaling a moderate decline in output per employee. There has only been one other sequence in the 14-year series history that productivity has fallen for a longer length of time which was during the global economic crisis in 2008. Productivity trends across sector groups within the European Union remained broadly unchanged since November’11.
Global Market Scenario
Emerging markets underperformed developed markets equities by 13% in 2011; the poorest relative performance since 2000. MSCI Emerging markets declined 18% underperforming MSCI US by 20%. US equities outperformance of Developed markets (DM) was the largest in 14 years. Brazil, Russia and India underperformed Emerging markets (EM) by 3%, 1% and 19% respectively in 2011. The US dollar CAGR total return for MSCI Emerging markets (EM) and MSCI World were 17% and 7% respectively.
Note: The above data has been generated from sources in public domain.