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ARTICLE · 06 AUGUST 2002

A Discouraging Economic Climate in North America

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North America

  • A number of discouraging economic reports in the United States has raised the spectre of a double-dip recession. The risk of such an outcome has increased.
  • The sharp fall in the Conference Board’s consumer confidence index may not be an immediate precursor of spending cutbacks but may indicate retrenchment ahead, if news on the job front and the stock market continue to be negative.
  • The labour market shows few signs of a healthy recovery. In July, the unemployment rate remained unchanged at 5.9%, but there was scant job growth and, more worryingly, the average workweek declined. The number of hours worked on average, per week, declined by the biggest amount in six and a half years. Evidently, firms are not hiring in sufficiently large numbers for strong growth to be sustained.
  • A sharp drop in the Institute of Supply Management’s index of manufacturing activity, in July, put the sector on the dividing line between expansion and contraction. In addition, the Institute’s index of non-manufacturing activity, which covers the largest sector of the U.S. economy, fell back indicating that the recovery is losing momentum.
  • Second-quarter GDP growth came in well below expectations, and was dramatically lower than first-quarter performance. As well, benchmark revisions to the data revealed three quarters of negative growth last year. The economy is more cyclical than previously assumed, though the recession was still milder than historical averages. All the same, the mildness may have been bought at the cost of a slow and difficult recovery period.
  • The revised data show a re-distribution of the composition of income from the corporate sector to households. Thus, profits were revised down sharply, in favour of higher disposable income. Growth benefited households more than it did the bottom line. Corporations engaged in fraudulent activities to hide the truth, while consumers had the means to continue spending.
  • Productivity growth has also been revised down and puts a damper on hopes for forward corporate profitability.
  • Most of the large corporations have already announced their quarterly earnings. So with the earnings season largely out of the way, investors will sharpen their focus on economic news. Volatility in the stock market is unlikely to die down.
  • With the U.S. economy weakening, the Bush administration is giving greater attention to the travails of several Latin American economies, including Uruguay and Brazil, whose slide may further threaten American economic interests. Bailout packages are on the way.
  • Political risk lurks in the background, as war against Iraq appears to be very much on the agenda. However, due to logistics, given that the U.S. may have to commit substantial ground troops, military action is unlikely before October/November.

    • Europe

  • The euro-area lead indictor is losing momentum pointing to a forward slackening of industrial production.
  • An appreciating euro and slowdown in North America is hurting exports and acting as a drag on economic growth. Many large European companies have substantial exposure to the United States via subsidiaries and export sales.
  • Data on the labour market and consumer confidence have been disappointing, which has a negative significance for consumption expenditures. However, low inflation will act as a countervailing force, encouraging spending.
  • The rise in the value of the euro has tightened monetary conditions. In the face of low inflation and slow growth there is room for an easing of interest rates, though the European Central Bank has traditionally been slow to deliver.
  • European stock markets are showing fairly high correlation with the U.S. market, shadowing its up and down moves. However, valuations remain more attractive in Europe.

    • Asia/Pacific

  • Japanese consumer demand is relatively stagnant and capital spending has still not revived. So exports remain an important source of growth. With the U.S. economy weakening, Japan will have to rely on increases in Asian domestic demand to make up the difference in export orders.
  • Slowdown in U.S. economic activity will have an impact on export-oriented economies in non-Japan Asia. But, domestic demand and inter-Asian trade will pick up some of the slack. Uncertainty over the outcome has led to a fall in stock markets, which appears to be overdone in some cases.

    • Bonds

  • Flight to safety continues in the United States, as investor demand for Treasuries remains high. The yield on two-year notes has been driven to 50-year lows, signalling higher risk aversion.
  • Yields on ten-year notes imply the expectation of lower real growth and inflation or lower stock market valuations.

    • Currencies

  • Residual buying has prevented the U.S. stock market from falling as far as European markets, despite more expensive valuations in the former. This has been dollar positive.
  • Hedge fund re-balancing may have been a factor in supporting the dollar, of late, versus the yen and the euro.

    • The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.

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