Decoupling, the New Buzz Word
2012 is about the US decoupling from Europe. The euro-zone debt crisis is unlikely to go away any time soon, which means that if the stock markets have hope for putting in a good year, they will want to see themselves as separate from euro zone debt and banking issues.
To some degree this has already happened. A Morningstar review of world stock market performance through mid December shows that the US ranked fifth out of 58 nations and regions, coming in at (-2.87%). Cyprus and Greece (-76.63% and -58.31% respectively) not unexpectedly brought up the rear. But 24 stock markets experienced bear market declines of over 20%. Germany was down 20.09% while Italy fell 26.76% during that time period. Only Iceland, Indonesia, the Philippines and Slovakia outperformed the US.
The US strong relative returns can be attributed, in part, to the turnaround in our economic data. 1.65 million more people are working today than were in November 2010. Jobless claims fell this past week to 366,000, supporting the trend of below 400,000 claims. And non-farm payrolls have been up for the last fourteen months, a positive indicator. Going forward it appears that the US is getting close to generating a decent level of job growth.
Consumer spending has also been favorable for much of the year, with year over year retail sales coming in at close to a 7% increase. However, spending growth has dipped in the past month, while still remaining supportive of moderately healthy spending habits. If the consumer continues to separate the angst over Europe from their own personal habits, spending could well continue to be the backbone of a moderate GDP growth for 2012. Other factors such as low inflation, pent up demand (especially for items such as autos) and improving credit conditions could also help deliver positive market returns.
Why are we doing so much better than the European Union? For one, we chose to actively address the failure of our banking system in 2008 through accommodative monetary policy and stimulus programs, and these policies continue today through low interest rates, payroll tax cuts and extended unemployment benefits. In addition, the Federal Reserve stands ready, alongside other global central banks, to provide further quantitative easing (liquidity) should global economic growth falter. While we have created longer term problems for ourselves, we have avoided some of the immediate dangers associated with limited credit availability. This reprieve has allowed our economy to slowly claw its way out of a serious recession, by ensuring there is enough money flowing through the system.
In contrast, the European Union has approached its debt crisis very differently. Instead of adequately addressing liquidity issues in the beginning by lowering interest rates and keeping them low, the European Central Bank has, until recently, increased rates. In addition, it has refused to backstop sovereign debt, which could build confidence to the markets and potentially allow countries time to address their deficit issues. We understand the logic behind austerity measures first and guarantees later and are sympathetic to the sentiment that countries need to accept responsibility for their profligate ways. However, the ECB's limited actions have served to extend the severity of the European Union's problems and have made a serious European downturn more likely.
For now it looks like Europe may be headed into another recession while the US may avoid one. Before we sound too smug, however, it is important to remember that decoupling is a concept not a fact. It is all too easy to say, "It is different this time," and buy into false logic as to why the markets should do well.
The globe is moving closer together and not further apart. Even if we can isolate ourselves, to a certain degree, from a nasty recession in Europe, we cannot rule out the dangers that lurk in the international banking community. Whether we admit it openly or not, our financial services industry shares risk with European banks, and as such, we will remain vulnerable to inadequate solutions to the euro zone crisis.
Back home, the dollar had a banner week as the world's reserve currency, offering the best liquidity in global markets. In a cautious environment, investors want to be able to sell quickly, and holding dollars allows them to do so. Gold used to be the safe haven of choice until this fall, when it passed that role off to the dollar. Gold was down 8.8% this past week and has slid close to 20% since September, although it has still been the best performing commodity of the year. Gold also suffered as a result of a selling spree by banks, which are cleaning up their balance sheets for a year-end review and have chosen to raise cash through the sale of their profitable gold holdings. In addition, gold is dollar denominated, meaning that as the dollar rises, the value of gold falls. Less gold is needed to achieve the same price value.
The rotation out of gold is unlikely to signal the end of the metal's bull market. It remains an alternative reserve currency and safe haven during global crises. However, it may have to give up some of its upside potential if it continues to be upstaged by the dollar.
SEASONS GREETINGS!: This will be the last weekly update of the year, so on behalf of everyone at StrategicPoint, we want to wish you and your families a happy, healthy and safe holiday season! We look forward to sharing with you our commentary once again in 2012.