Combing through last week’s data, searching for trends, two things caught my attention. First, various indicators shedding some light on corporate investment behaviour are suggesting that a meaningful acceleration of investment is either underway or imminent. That is important and very positive. For the recovery to become self-sustaining and more firmly based, investment is exactly what we need. It will create jobs and income growth, which will support spending growth.
A second development I want to highlight is that industrial activity has gained momentum, particularly in advanced economies, but that inventories have risen in the US. While this is most likely a deliberate action on the part of US corporates, it implies that US production growth may ease a little in the short term allowing demand to catch up. If this happens, doomsayers will undoubtedly resurface and preach that they had said so all along and that the recovery was no more than a dead-cat bounce. They would be wrong in our view.
Last, I want to make a few comments about my experience in Asia last week as I visited Singapore, Taipei and Hong Kong, presenting to clients.
Corporate investment gaining momentum in advanced economies
Most commentators argue that corporate investment has disappointed in the current recovery. Falling investment has been a sustained drag on economic activity in many European countries. And while it cannot be argued that investment has been very weak in the US in recent quarters, it has not exactly been strong either. Last week’s November industrial production data for the eurozone were encouraging in this respect. Total production was up 1.8% mom, while the October data was revised up from -1.1% to -0.8%. On a yoy basis, industrial production was up 3%. More importantly, output of capital goods rose 3% mom. Bear in mind that this series is volatile on a monthly basis, but the yoy growth rate, which is relatively stable, accelerated to 4.4%. We may be hopeful that this development will be reflected in actual investment spending within the eurozone.
In the US, where corporate investment has been much stronger than in Europe, surveys suggest that corporates have been cautious in recent months due to uncertainty over fiscal policy. That uncertainty has now lifted to a large degree, so we are anxiously searching for signals that investment spending growth is picking up. A couple of weeks ago, the November durable goods orders report was encouraging. Last week, the NFIB (National Federation of Independent Business) survey of confidence among small businesses provided further encouraging evidence. We must bear in mind here that the sample of this survey is small: the December issue is based on a mere 635 ‘usable responses’. Nevertheless, it is one of the more timely measures of an important sector in the economy. Overall confidence continued to crawl higher, but there were some remarkable details. In particular, the subseries on “actual capital expenditure” rose sharply: 64, versus 55 in November. The December reading was the highest since 2005. This rise could easily be partially reversed early this year, but when you are scrutinising the data for indicators of stronger investment spending because that is what you expect to see, this is encouraging.
Also positive, though not directly related to capital expenditure was the surplus registered by the US federal government finances in December: US 55bn. While this was helped by dividend payments from the GSE sector, the trend of the budget deficit is very positive. For calendar-year 2013 as a whole, the Federal deficit amounted to USD 560 bn. This is some 3.3% of GDP. As the states and local authorities probably kept their finances close to balance, the overall deficit is now lower than nominal GDP growth, which means that the government’s debt ratio is declining. Particularly striking in the data was that Federal spending fell 5.2% in 2013. This is in nominal terms, so in real terms, spending fell more. As a European taxpayer I can only look at that with envy and utter frustration.
Less encouraging last week was the data on the US housing market, which shows that the rise in borrowing costs is a headwind for the recovery in housing. Perhaps that is not a bad thing as house price increases were gaining meaningful momentum last year, giving rise to concern that a new bubble was developing. Retail sales were also not particularly impressive in December as sales growth numbers for the previous two months were revised lower. Having said that, core retail sales data was stronger than the headline.
Coming back to the theme of capital spending in advanced economies, machine orders in Japan fell by 5.8% mom in November, but they had risen 16.4% in the previous two months and the trend certainly suggests that investment is strengthening. So overall, there are indicators in all three main blocks of the advanced economies that corporates are becoming more daring.
Output growth taking a breather?
Industrial production growth has strengthened in most advanced economies in recent months. That is great. However, short-term fluctuations in output growth are part of a normal cycle. To assess these fluctuations, one needs to look at inventory data. Unfortunately, the detail and quality of the inventory data is poor in most economies. The US is the exception. US national accounts data shows that the build-up of inventories has contributed strongly to overall GDP growth in 2013. GDP expanded at an average pace of 2.6% in the first three quarters of the year. Simple back-of-the-envelope calculations show that 1%-point of that was accounted for by inventories. This certainly overstates the real effects as inventory growth often comes from imported goods, but it provides a reasonable gauge of the importance of the inventory cycle. Data for the fourth quarter suggests that the inventory build-up continued, though that does not necessarily mean that it contributed positively again to growth. Anyway, experience suggests that a period of a significant positive contribution of inventories to GDP growth is followed by a period in which this mechanism reverses and becomes a drag on growth. The result will be that output growth will ease a little in order for overall demand to catch up with supply. I think this is a natural part of the cycle and that the rise of inventories in recent quarters has been largely intentional as companies, correctly, thought that demand was likely to increase. That increase has not disappointed, but output has simply got ahead of itself a little. As the overhang gets worked off, indices of business confidence may soften a little in the US. This is nothing to worry about. Before too long, stronger demand growth will lead production higher again. The situation in the US is probably not representative for Europe, but this mechanism is harder to assess on this side of the Atlantic.
Good news from Spain
Moving away a little from the themes of capital spending and industrial production, I would like to note that developments in Spain are particularly remarkable and positive. Improved competitiveness and, perhaps who knows, the reforms implemented in recent years, are starting to bear fruit. Spain registered a current account surplus of EUR 7.9 bn in the first ten months of 2013, which is over 2% of GDP, the largest surplus since this series began in 1969! These developments have led to renewed interest from overseas investors. The combined surplus on the current account and capital imports are very important for Spanish banks as these flows provide a basis for an increase in bank deposits, allowing the banks to reduce their reliance on central bank liquidity. The labour market is likewise turning. While various indicators are not all consistent, the economics ministry reported a 61K drop in the number of unemployed in December. Over the summer, the Spanish labour market improved, but it was felt that was the result of the good tourist season. Recent data suggests there is more to it than that. Industrial production continues to rise as well.
The improvement in Spain will hopefully put pressure on Italy and France to make reforms too and improve competitiveness. Last week’s speech by French President François Hollande, in which he announced meaningful tax cuts, was encouraging, though lacking in detail as regards timing and funding. This is all great, but there is no room for complacency on the euro crisis. Last week’s industrial production data for Greece showed a further decline. This is a worry.
My Asian trip
I met with many private banking clients in Asia last week as I visited Singapore, Taipei and Hong Kong. What struck me most was how negative clients were about economic developments in Asia. That was the first time in several years. Their (relative) pessimism seemed mainly based on worries about China, where policymakers are trying to get, or stay, in control of the credit mechanism. We think the authorities will be successful and we also think that Asia will benefit more than our clients seem to think from the pick-up of industrial activity in the advanced economies and world trade growth this year. Perhaps their (relative) pessimism is also caused by the disappointing stock market performance in Asia during the last couple of years and 2013 in particular. This underperformance has made Asian equities outright cheap, so perhaps it is the wrong time to be pessimistic. On the other hand, as the US Fed turns off the money tap very gradually, it is hard to say how capital flows will develop this year. I thought that in this environment, Asian investors might regain some interest in Europe. Over the last ten years, I have seen their interest (and even respect) for Europe more or less collapse. My efforts to generate some enthusiasm for European investment opportunities by way of diversification did not seem too make much impression. I am afraid I was a lone voice in the wilderness. Perhaps that is good for Asian markets as it did not suggest that a big capital flow from Asia to Europe is imminent.