Has May Come Early?

What a remarkable month March has been so far. I am not sure that I can recall a time when so many unexpected events happened at the same time. For most world economy watchers and policymakers who are still mentally scarred from the 2008 financial crisis, not surprisingly, these events have the alarm bells ringing and are giving the financial markets one of their most testing times since the bull  market got underway about two years ago. March was expected to be a month in which the challenges facing the European Monetary Union (EMU) would be at the front and centre of attention, but it has been actually difficult to even find the time to focus on this.

If this was the month of May, I would have been quite tempted to say that all of this means the bull market is over until Autumn.  In the UK, there is a great phrase, “sell in May and go away, come back on St Legers Day” (a popular horse race in Doncaster in September).  This phrase has often characterized the seasonal pattern of relative equity market buoyancy from early November through late April, and vice versa, Given that it is late March, I can help but ask, “Has May come early?”

I suspect not, although we clearly have some clear reasons why it might. Through the remarkable doubts that we all suddenly have to face, there are three things I would cite for hope.

THE US RECOVERY.

First, and arguably the key marginal positive driver since November, the US recovery remains firmly on track. This week, the two most powerful coincident /lead indicators I track have posted very positive readings. Weekly job claims fell again and a clear trend for an improving job market seems underway. In addition, there was a gangbuster of a Philadelphia Fed business survey published and, while it has a tendency to be volatile, it has a good record as a lead indicator.

Despite some slight tweaking, the FOMC statement continued to demonstrate the Fed’s belief that their monetary support is in place.  So, the combination of a friendly Fed and an improving economy are both still present.

CHINA SOFT LANDING.

Second, in China, we have seen more evidence of slowing momentum with softening monetary and credit growth following earlier news of a surprisingly soft trade report and quite weak retail sales for the month of February. When speaking with clients, they often have significant concerns about Chinese inflation and overheating still.  But, in my view, much of the evidence suggests that these concerns are backward looking – at least for now. In addition, and partly because of the reported data, two key indicators that Goldman Sachs has developed are suggesting a slower pace of growth ahead. The GS China Financial Conditions Index (FCI) has tightened significantly.  This remains a very useful early leading indicator. Its movements are what persuaded me back in early 2009 that China would deliver a strong post-credit crisis economic recovery. Its current performance suggests that China’s growth is probably going to be softer in months ahead.  While there is no doubt that many China bears will seize on this if it happens, it would be a good development now. Along with the FCI, the coincident and actual lead economic indicator, the so-called GSCA-China Activity Index has also slowed. It is clear that this is what Chinese policy is trying to achieve, although of course, they don’t want growth to slow too much.

We finally saw the details of the next 5-year plan unveiled in the past week or so, and the government has stated a “target” of 7 pct real GDP growth. As I have written since the Autumn following a visit to Beijing, Chinese policy is now more about the quality of growth not the quantity

The other reason I would cite about the positive trends in China is the performance of the local Chinese equity market. Since Chinese New Year, the China A share market has been one of the better performing markets globally. While it remains fashionable amongst investors to prefer so-called “Developed” over increasingly inappropriately called “Developing Markets”, the China A share market is one of the strongest performing markets year-to-date. As of this week’s closing prices, it is up around 3.5 pct calendar year-to-date, one of the few markets still to be in positive territory. The only stronger markets are Italy and Spain, which is ironic in view of the EMU “crisis”. So, if China is still facing a major inflation challenge and a hard landing, how come the local investors aren’t as bothered as most others?

G7 INTERVENTION IN THE YEN.

My third reason for optimism is Friday’s news and development. Last weekend, following the earthquake in Japan, my Viewpoint suggested that the most critical development would be for the Bank of Japan to undertake bold monetary measures and to ensure that the Yen strength was reversed. At the time, I didn’t know what was going to follow on either this or the nuclear power uncertainties, but we got one better. Early Friday, the G7 countries issued a statement expressing their support to Japan and, in particular, their shared distaste of the Yen’s strength and volatility and that they would intervene.  Subsequently, they did as promised, and the idiotic strength of the Yen from earlier in the week was reversed.

This is the first joint intervention in the Yen for a long long time, and the first co-ordinated G7 intervention in more than 10 years.  While the statement specifically stated that the G7 would intervene on the 18th of March, I can’t imagine that they will just desist if the Yen were to strengthen again. As readers will know, I believe that the Yen strength had been unjustified for some time. Following this policy development, I now believe more confidently investors should act, and go with the stance of the G7.

Of course, there will be a limit to both the degree and time that the US will commit to intervention.  This is because one of their broader monetary goals – encouraging China to intervene less in currency markets – is a major priority. But special circumstances call for special measures, and the post-quake Yen strength certainly fits that category in my book.

In this regard, it is also interesting that this was a G7 step, and not the post-crisis all encompassing G20. In the context of these entities, this policy development shows that the G7 does still have a life and I suspect its members will be rather pleased about that. There is going to be an important monetary meeting in Nanjing at the end of March, and amongst many things, the mood about G7 versus G20 effectiveness will now be another interesting one.

THE NOT SO GOOD NEWS.

The reason why all of this was necessary was due to the lingering consequences of the Japanese earthquake.  In addition to the damage and the human loss of life, the lasting legacy appears to be an energy policy question, not just for Japan, but also for the rest of us. Due to their lack of domestic natural resources, Japan has been one of the leading nuclear power producers to serve its energy needs. With rising crude oil prices, and popular concerns about dwindling supplies and fears for global warming, nuclear power had become a great hope for many countries in recent years. This crisis has now sown some doubts about this. Many leaders have already suggested that they will need to review their strategies in view of the Japanese situation, including China.

One of the real dilemmas we all face when trying to think about this issue is, yet again, the interplay between modern communications and our emotions. Suddenly, our media channels are dominated with all sorts of so-called experts about what is happening at the troubled plants, and naturally, people worry.  Whether or not some of the external reporting is overhyped or not, until time passes and the truth becomes known, people will understandably be cautious.  How all of this impacts the planned growth of nuclear power around the world has yet to be determined, but the energy challenge just got trickier.

In this context, ongoing events in the Middle East are also not being overly kind. With the UN declaration of a “no fly zone” in Libya, that disturbance has just been stepped up one more notch.  Contrary to reports late Friday, there are no signs of a halt to fighting.  In addition, there are the worrying developments in Bahrain to ponder.

All of these issues have escalated the energy issues further and added the upward pressures on crude oil prices.  I have no idea where oil prices are going to go next, and as I remarked at a conference I spoke at last week, it is not impossible that they will fall sharply in the next year. However, what we do know is that if oil prices continue to rise, especially if financial conditions were to start tightening around the world sharply, then this will be a problem for the world economy. Luckily, markets have reduced their probability of both the degree and timing of central bank tightening in many places. Let’s hope this is right.

AND FOR THE REST.

One of these weeks, I hope to have chance to return and discuss the EMU issues and, all else being equal, I shall try next weekend. This coming week sees more important meetings of European policymakers and it was hoped that they will have a clear stable plan for EMU and its financing challenges.

There is one other rather important matter I shall leave you with and that is the Champions League. United versus Chelski, we are going to disappoint all their hopes en route to meeting up with Barca in May (well, I live in hope!)

Jim O’Neill
Chairman, Goldman Sachs Asset Management