By Andy Headley, fund manager, Veritas Global Focus fund
The global economy remains weak. The build up of debt over a multi-decade period culminated in the global financial crisis of 2008 and since that time the recovery has been lacklustre. This should have been expected as the aftermath of credit bubbles has been studied and well documented. This time is no different: debt levels need to be reduced and in so doing economic growth will suffer. Government spending can alleviate the pain on households or businesses by affecting a transfer of debt to the Government’s balance sheet but as we are seeing in much of Europe this solution is no panacea.
While in 2012 attention has been focused on the policy missteps of euroland, 2013 has the potential to shape up as the year that US policy comes to the fore. With political partisanship running at extreme levels such that few policies get through both Congress and the White House monetary policy has been the only game in town. This may be exacerbated next year (depending on the outcome of the US election) as the US “fiscal cliff” approaches reality. The latest intervention by the Fed was the widely anticipated QE under which the Fed will print up to $40bn per month to buy mortgagebacked securities and will continue this until the labour market improves substantially. Indeed if the labour market does not improve substantially over the coming months the Fed has committed itself to undertake more QE. The theory is simple; QE should lower interest rates which will increase asset prices, which will increase consumption, which will increase employment. However, while QE has undoubtedly had an effect on asset prices the theoretical impact thereafter has been lacking. As Yogi Berra once said: “In theory there is no difference between theory and practice. In practice there is.” Perhaps QE will prove more efficacious now it is unlimited. While this could be the case in the short term, such monetary experiments in the past have often proved disastrous. We at Veritas are not macro-economists and do not aim to predict the macro-economic environment in five years, however we should invest bearing in mind that a) equity markets have become an explicit instrument of policy b) The Fed are determined to prove that QE “works” and c) nobody knows today what the aftermath of so much money printing will be in the future. Economic fundamentals remain weak and corporate earnings by and large are disappointing. Without revenue growth which is hard to achieve in a weak economic environment, earnings growth can only come from cost cutting. Unfortunately there is only so much cost cutting that can be done without damaging a business in the long term and with the easy cost cutting having been done over the past few years, earning growth from margin expansion will become increasingly difficult. In Europe, the Stoxx index has seen consistent declines in expected earnings such that growth in 2012 is now estimated at zero (as recently as June c.10% growth was forecast). However, largely as a consequence of money printing, the Stoxx index is up sharply since QE was first seriously mooted. This divergence cannot continue indefinitely since June earnings estimates have declined by 10% whereas the index has increased 17% resulting in a dramatic re- rating.
Comments