Optimism of all the rage… in a dense fog

2018 has started on a confident note. After a very strong end to 2017, when global economic growth probably accelerated back over 4%, impressive indicators in early 2018 mean that there is no room for scepticism: growth looks like it is here to stay. There is plenty of evidence to support that view, including exceptionally loose monetary conditions at the global level, an upturn in business investment and international trade, a widespread decline in unemployment, and at least temporary support from the US tax reforms adopted late last year. To cap it all, wealth effects are increasingly visible, driven by exceptionally high valuations for financial and real-estate assets.

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The U.S. Economy: Far Too Early to Break Out the Champagne

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That markets are wildly optimistic about the U.S. economy is nothing new. What should draw our attention this time around is that such upbeat sentiment has rarely been harder to square with the numbers. For example, contrary to the dominant narrative:

  • The U.S. economy is doing worse than a few months ago, not better. Growth in industrial output is petering out, productivity has moved into negative territory, and employment data point to backsliding.
  • The economy’s ability to cope with higher interest rates simply can’t be taken for granted. Not only has consumer spending yet to pick up, but the real estate market has been derailed by the rise in interest rates since the start of the year.
  • While a change of course by the Federal Reserve may seem long overdue after five years of unconventional monetary policy, it makes no economic sense. This suggests that the Fed is very much in danger of jumping the gun.

Bright Spots in an Otherwise Lackluster Recovery

1-Auto Industry    2-Capital Investment in France   3-Consumer Spending in Spain

Although there are still legitimate concerns about the future of the euro area, the recession is definitely over. Like all such episodes, this one comes with a number of pleasant surprises. Here are the three main ones:

• The first and most significant surprise from the investor standpoint is a recovery in Europe’s auto industry, along with improved stock performance for the firms involved.

• The second—and much more surprising—surprise is that the indicators we track on the French economy show a brighter outlook for industrial investment in France

• The third, and possibly most important surprise—given the risks that Spain’s sluggish economy pose for Europe as a whole—is that spending by Spanish consumers is clearly trending upward.

While none of these surprises taken alone has enough weight at this point to convince us to make any major changes to our growth forecasts, they each help restore a modicum of confidence—perhaps even with unexpected repercussions.

The U.S. Economy: Don’t Count Your Chickens Before They Hatch

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Sentiment on the U.S. economic outlook has gone from a flurry of uncertainty at the start of the year to renewed optimism. Admittedly, there are grounds for being bullish. Growth has held up despite tougher fiscal and tax policies; the housing market recovery has continued; and the Fed has stuck to its easy money policy. But let’s not get carried away! The latest numbers are no more encouraging than those available at the end of last year. In particular, decelerating productivity growth, with all that it implies in terms of profit, investment, and job trends in the next few quarters, may well drag the U.S. economy back down in the second half of the year. And with a policy mix that is less accommodative than before, the key ingredients for a genuine recovery are still nowhere to be seen. All this has conditioned our analysis on several points:

  • We wonder whether a change in monetary policy is on the short-term agenda—and worry that the Fed may withdraw its support too soon.
  • While we aren’t overly concerned about trends in the U.S. bond market and the euro’s exchange rate, we do suspect that the stock market will be more vulnerable to disappointing macroeconomic data.
  • We have very little faith in the American economy’s chances of regaining its status as powerhouse of the global economy before the year is out.