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The World Last Week

November 20, 2014

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[Last] week provided more evidence that the global economy is weak and that growth is diverging between the US and the rest of the world. GDP statistics out of Europe, though better than expected, showed only 0.6 percent real GDP and 1.0 percent nominal. Greece was the strongest economy in the region, posting its second straight quarter of growth. Italy fell back into recession and France only expanded on the back of unneeded inventory accumulation. Germany, the engine of growth for the continent, saw real GDP grow at an anemic 0.3 percent annual rate. Weak nominal growth makes it unlikely the euro zone will see any improvement in budget deficits or that the private sector will be able to pay down debt. The region will remain in a self-imposed credit crunch, much as has limited US growth since Lehman. QE in the region may increase liquidity, lowering interest rates and pumping up asset values, but it is unlikely to stimulate demand for credit in an already overleveraged world. QE buys time for other reforms to stimulate growth. In the US, reductions in state and local government spending freed some modest income for spending. Now lower oil prices are freeing up even more. Cheaper oil will help Europe as well, but less in nuclear dependent France, which remains a key weak spot in the recovery.

China saw another month of weaker than expected economic data, with industrial production, retail sales, fixed asset investment and fresh credit extension all below the consensus estimates. However, like the weakness in Europe, this is hardly news at this point. Everyone is aware of the weakness and expectations for growth have been ramped down. China appears committed to sticking with reform, rather than stimulus, as its solution to excesses and imbalances. The restrictions on credit are the clearest indication that the government is not willing to just hit the gas on the credit fueled portions of the economy again. Though growth is slowing, there is still strong growth by international standards–and it is led by the consumer as retail sales are significantly outstripping production. This is confirmed by the wide spreads between CPI and PPI growth rates, indicating strong margins for retail operations. Some read the trade deals between the US and China as a sign that China is trying to stimulate growth. We read it as the normal window dressing at a major international meeting, where China signs agreements to enhance positive press–just like signing big purchase contracts when leaders visit foreign nations. China signed agreements with Korea and others as well–and Xi Jinping even shook Abe’s hand (though silently) as a good host should.

Russian leader Vladimir Putin faced a wave of disapproval at the G20 meeting, with English speaking leaders from the US, UK, Canada and host Australia lined up to criticize him face to face on camera. Apparently Merkel, Hollande and others did so more discretely as well. New sanctions are being weighed due to Russia’s latest intervention in Ukraine–confirmed by NATO and denied by Putin. Hard to see how this leads to any improvement in Europe’s outlook in the near term.

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We believe the global economy is now in the healing phase, and that the effect of lower interest rates and lower energy prices will be supportive of somewhat better growth in 2015. The US and China are both likely to perform slightly better–though reported Chinese GDP may be softer. Europe, Japan and the emerging markets are also likely to improve, but that is a low bar as they are in or near recession now. In the US, healing is coming from reduced interest and energy payments in low income households–not from stronger spending in asset rich households. Wealthy households are simply reallocating asset classes, but saving rather than spending. The saving rate has barely budged as wealth has continued to concentrate in recent quarters. Meanwhile, freed income is being spent by lower income households–but not leveraged. Consumer debt growth is still modest, with student loans still the fastest growing sector. More income at the low end will continue to lift growth–but only modestly as we continue to see little appetite for leverage.

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The preceding is an abridged version of a commentary for McVean Trading and Investments, LLC and has been reposted here with permission of the author.

The ideas and opinions expressed in this blog are those of the author, and they should not be perceived as investment advice or as any other kind of advice.

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