Economic data released in the US was generally better than expected, with employment, manufacturing and retail sales all showing improvement. In China, manufacturing also rose for the first time in three months, as there were signs that the economy seems to be bottoming out. The European economic situation continued to be poor, with the Spanish economy contracting for the fifth quarter in a row and German business sentiment declining.
The latest set of quarterly profit reports from the US were in line with expectations, but sales figures disappointed. Companies across a range of industries reported poor sales, from IT (Microsoft and IBM), to industrials (3M and DuPont) and even consumer companies (MacDonalds) blaming slowing demand in Europe and Asia for weaker numbers. The month ended with super storm Sandy hitting New York, closing the NYSE for two days, the first time in over 100 years.
November saw the results of the US election, the unveiling of the new Chinese leader and Greece voting for crucial budget cuts which will determine whether bailout funds will be received from the Troika.
The fear of the fiscal cliff
November was a pretty poor month for global stock markets, continuing the trend seen in October although markets have begun to rebound.
The US election result has maintained the political status quo, with Obama re-elected as President and the House of Representatives remaining Republican. Investors have become increasingly fearful of the effects of the so called fiscal cliff at the end of 2013, and also of potentially large increases in taxes on dividends.
As a reminder, the fiscal cliff comes about as tax cuts that were put in place by President Bush expire, and spending cuts (as part of last year’s budget ceiling solution) are implemented. The combined impact is estimated to cut GDP growth by around 4%. Investors are worried that there will be no compromise between the Democrats and Republicans, causing a recession next year.
In our view, a solution to the fiscal cliff will be found with taxes for the wealthiest rising while tax cuts for the middle and lower classes will be maintained. However, there will still be a fiscal drag on the economy in 2013.
Problems continue in Southern Europe
While the Greek Government has approved further austerity cuts, it does appear likely that they will receive the next round of bail-out funds from the Troika (not receiving the funds would cause Greece to run out of cash and default).
However, splits within the Troika are becoming more apparent, particularly between the IMF and ECB/EU. The IMF will only lend further funds to a country when there is a sustainable solution for its debt levels in the future. Currently, the target for Greece is for the Debt to GDP level to be 120% by 2020. As per the most recent Greek forecasts, the 2014 Debt to GDP is forecasted at almost 200%. Clearly, there is little chance of reaching the 120% target and therefore the IMF essentially wants existing debt holders to take a write-down on the bonds they own in order to reduce the debt level to more manageable levels. Unfortunately, since the private sector does not really own Greek debt anymore, the burden of losses will fall on the ECB and other EU Governments, which will be politically very complicated.
The Spanish economy continues to contract further with unemployment rising, and President Rajoy yet to request a bail-out from the ECB. Bond yields are likely to rise further the longer he procrastinates.
The French economy also remains a potential time bomb with Moody’s just downgrading their bond rating from AAA.
Summary
Markets will remain in a volatile state until the fiscal cliff issue is resolved. It is possible that markets could sell off into the year-end if no resolution is forthcoming and investors sell to avoid potential tax hikes. Investors may also begin to worry about US fourth quarter earnings where estimates remain high, despite the risk that Super Storm Sandy may have disrupted demand, which could result in disappointing numbers.
