False dawn or well-founded optimism?

Of course we want to be optimistic – it’s part of the human condition to be hopeful – but there remains the problem that there has been a marked and crucial divergence between what producers are saying – and more importantly what they are doing – and what consumers have been doing with regard to their own levels of expenditure. Certainly, the bulk of the recent “good news” with regard to the state of the global economy has come from industrial confidence indices, some of the industrial production data, and the labour market data in the US and to a lesser extent Germany. However, the actual consumer expenditure data produced by many countries has been much more circumspect in nature, or simply just weak. Even where data have been strong, such as in the US, there is a risk that February’s 1.1% rise in retail sales was in part just ‘catch up’ after a couple of particularly soft months and may reflect higher inflation. Indeed, US CPI deflated retail sales growth over the last three months has merely been in line with the average rate of growth of the last two years and this would seem to suggest that companies may be overly optimistic at present with regard to expectations of an imminent consumer-led recovery.

With a broader geographical focus, in Germany despite the stronger employment data, retail sales volumes were down by 1.7% in the three months to January. France’s retail data are unfortunately a month behind Germany’s, but its recorded rate of contraction is broadly similar while Italy’s data suggested a slightly slower but still significant rate of decline. In Japan, retail sales were up strongly in January, but the rise was limited to car sales and the data is still down by 2% on last year’s levels. Reports from China suggest that the retail environment is difficult while in volume terms Singapore’s and Korea’s sales seem to be falling. Hong Kong’s data have looked stronger, although this may be related to the timing of the lunar New Year. In Brazil, retail sector momentum is softer than it was.

Taken as a piece, the divergence between consumer behaviour and that of producers does look significant and global in nature, and one result is that inventory/shipment ratios remain at elevated levels.

In addition, there are issues of data quality and some of the (manufacturing) data will have been affected by the shift of the Lunar New Year into January and the extra day in February. Any seasonal adjustment efforts will have been made especially tricky by the timing and concentration of the global financial crisis into only a few months in the early part of a still recent year.

Whilst there are therefore doubts as to the scale and nature of economic recovery, we should soon be rid of statistical influences and also from any ’relief rally’ in sentiment and activity that may have followed the presumed resolution of the Euro liquidity/bank solvency crisis. We can expect that this is relevant from market behaviours following 9-11, when the US ISM index first dropped from 46 to 40 but then rebounded almost instantly to 52 in March 2002, from whence it then declined again. US retail sales growth on a three month basis was -1.4% in September 2001 but surged to 6% (i.e. 24% annualised) in October/November that year before slumping badly thereafter. While we obviously would not wish to equate the Euroland crisis with the awful events 9-11, there is clearly a precedent of a shift to initial caution when faced with a crisis, and then a swing back almost to euphoria as the outlook becomes less uncertain.

With these factors in mind, we can expect that data will tend to become more indicative of actual underlying trends over the next few weeks and we will therefore begin to see how the recent build up in inventories will be resolved. If the global consumption data improves, then we can suggest that the inventory overhang will be cleared in a positive way by increased shipments to customers but if this fails to happen, then producers will soon have to begin cutting production and we may assume employment levels as well. Even in the US, production per hour worked in the industrial sectors is still quite low and if production levels are scaled back as part of a global inventory reduction phase, then the labour market could weaken and this would clearly do much to undermine the confidence in a global economic recovery in the near term.

We anticipate that the next six to eight weeks will be crucial in determining whether the global economy has really begun to improve or whether the latest bout of optimism simply marks yet another false dawn, just like those of Q3 2009, mid 2010, Q1 2011 and even last September. This will materially affect market sentiment levels and the pricing of ‘risk’.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla