Some economists expect the cessation of QE2 and tax cuts to cause a US slowdown in 2012 which will spread to China (with growth to slow to 5%). Others are more positive and expect booms in both the US and China.
Economic growth is the result of billions of individual decisions, some based on the laws of supply and demand, and some based purely on sentiment. Guessing the sentiment of consumers, industrialists, policy makers and politicians seems to be very difficult at the moment. The sharpest economists, even if they get the economic call right, don’t always get the markets right.
It’s important to remember that there is not necessarily a straight line relationship between the economy and the stock market. For example, US economic growth was approximately the same in the two 17-year periods: 1964-81 and 1981-98. However, the equity market went sideways during the first period and entered a bull market during the second. Remember that the second period, 1981-98 included a stock market crash, a global recession, crises in Asia and Russia and volatile interest rates.
Earnings
We continue to focus on the direction of company earnings and corporate balance sheets – both look solid. Citigroup recently edged up their top down forecast for earnings growth for 2011 to 18%. Also, it is estimated there is $2tn of cash held on US balance sheets and that so far this year share buybacks amount to over $200bn. This could increase significantly.
Clearly macro events can spoil the earnings story (as in 2008) but despite the problems in Europe and elsewhere, the earnings story has not been interrupted so far. I expect even good economists will be no better than anyone else at predicting how the European sovereign debt issues play out. Politicians continue to go round in circles and contradict each other.
I believe a firm statement that a restructuring will not be allowed prior to 2013 and that the ECB will buy government bonds in the secondary market at discounts would be enough to rally the markets, but this would require collective bravery and seems unlikely. So we continue to kick the tin can along the road in Europe.
Meanwhile, sticking with high quality equities with strong franchises and robust balance sheets and paying decent dividends seems as good a place as any to invest. But it could be a rocky road.
