Equity markets have rallied over the past month, sentiment has swung once again towards a more optimistic view of the prospects for the global economy, and concerns about sovereign debt defaults in Europe have eased.
Wall Street has recovered from the sharp sell-off in late-June, helped by some encouraging second quarter earnings reports; and markets in Europe have responded, with the UK market providing the best performance over the month. The worst performance amongst the major markets has occurred in the Japanese market because of disappointing economic news and increased political uncertainty after the setback for the government in the recent election.
The general improvement in the markets over the month is a welcome development. The gloom in April and May about economic prospects was clearly overdone. The US economy is performing as expected, and the Chinese authorities are clearly intent on preventing their economy from overheating.
The global economic recovery will therefore proceed at a slow pace. The sovereign debt crisis in Europe remains unresolved and defaults remain a real possibility. The risks have therefore increased in the bond markets, and this has provided support for the equity markets. So long as monetary policy remains supportive, the global recovery should eventually produce a sustainable improvement in bond prices; but some of the current uncertainties in the bond markets must be resolved before this can occur. The performance of the US economy remains the key factor is assessing the prospects for the equity markets. There has already been a request to Congress for additional spending programmes “to keep the economic recovery on track”, and although there has been no response so far, some action may become necessary. The excess gloom has disappeared, fears about sovereign debt defaults in Europe have eased, and there have been encouraging corporate results from a number of major companies, including Microsoft, Caterpillar, UPS, and Intel. Problems still remain in the banking sector, and have been reflected in the fall in earnings from investment banking at Goldman Sachs, Citigroup, Bank of America, and JPMorgan; but overall investors have been reassured that corporations are coping fairly well with the present situation. Mainland European markets have also recovered from the sharp falls. There has been encouraging news about the economic background in the euro-zone; fears about sovereign debt defaults have eased; and the latest “stress tests” have only revealed weaknesses in seven of the ninety-one banks that were included in the survey.
Euro Markets have therefore been able to follow the upward trend on Wall Street, and regain recent losses, despite the uncertainties that have still to be resolved.
Conditions are clearly continuing to improve in many areas of the euro-zone economy, and especially in
Germany, helped by the big fall in the value of the euro in the first half of the year, and the strong growth in many of the export markets in the developing world. German companies have taken full advantage of the competitive currency and the available export opportunities, and so, even though domestic demand has remained relatively weak, the German economy is now expected to grow by around 2% this year.
The situation is very different in Greece, Spain, Portugal, Ireland, and even in Italy, and these weaker economies are obviously acting as a drag on the overall performance of the area. The latest purchasing managers indices for both the manufacturing and services sectors of the area are higher, and argue against a pessimistic view of growth prospects; but for the moment we have left unchanged our modest forecasts of overall growth around 1.5% this year. The European Central Bank is clearly more optimistic about prospects. So far it has not raised its growth forecasts; but based presumably on the assumption that the recovery from recession is soundly based and self-sustaining, its reaction to the present situation contrasts sharply with the cautious view of the Fed. The president, Jean Claude Trichet, is arguing that further public spending cuts and tax increases should be introduced immediately, especially in Europe, but also elsewhere in the industrialised world. “Without the swift and appropriate action of central banks” he recently argued, “and a very significant contribution from fiscal policies, we would have experienced a major recession. But now is the time to restore fiscal sustainability”. It is not clear what the consequences of this view might be; but the central bank might even be encouraged to tighten monetary policy as the present programme of fiscal retrenchment develops.
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