Don't Be So Bearish
It’s time to remember Paul Samuelson’s famous quip “The stock market has predicted 9 of the last 5 recessions.”
The reason for the extreme bearishness is twofold.
First, global portfolio managers’ first instinct is to interpret the sharp decline in oil and commodity prices combined with uncertainties about China as a serious slump in global demand, when in fact the decline in oil prices is largely a positive supply shock.
Second, consider economic psychology. Whether you consider the effects of oil price declines from a global perspective or a US-only perspective, the negatives are very concentrated and clear and upfront—the oil producers get hammered and their capital spending plummets--whereas the positives are widely disbursed and seemingly small, with lagged effects.
It is human nature to emphasize the clear up-front negatives and downplay the cumulative positives. In a sense, it is somewhat analogous to the populist rhetoric against free trade: it is easier to pinpoint specific workers who may lose their jobs due to international competition, and harder to understand the broader but more thinly spread the benefits.
However unpleasant the sharp correction in global stock markets has been for global portfolio managers and policymakers, it has generated excessive bearishness for the global and economic outlook. Some are brashly calling a global recession. That is hard to see, since the dramatic decline in oil prices is an economic positive for net energy importers, including the US, Europe, Japan, China and India that, combined, account for 75% of global economic performance.
China is slowing and transitioning towards greater reliance on consumption and services and less on exports, but the probability of a hard landing is low. Europe and Japan benefit from weaker currencies as well as lower energy costs. And US economic growth will be sustained. Many commodity exporting emerging nations are getting hammered, with some spillover onto advanced nations, but overall we reject worries about recession.
In the US, domestic final sales continue to grow moderately while exports lag, a normal response to a stronger US dollar. Consumption and housing remain solid, driven by healthy increases in real disposable personal income, low unemployment and improving household balance sheets. Capital spending, which has been growing cyclically but softly relative to robust corporate profits and sustained by low interest rates, will now get hit by sharp declines in capital spending in the energy sector. However, capital investment in the oil and shale drilling sector constitutes less than 10% of total business fixed investment; its effect should last only several quarters; and business investment in other sectors is expected to hold up.
Consistent with this composition of GDP growth, data and surveys of consumption and housing remain satisfactory while those of manufacturing and exports have been notably weak. It’s important to put them into context. Consider the ISM survey of manufacturers, which has fallen below 50. Is this pointing towards recession? No. It is not uncommon for the ISM to fall below 50 and for the economy to continue to grow.
It would be a different story if, at the same time, tight monetary policy was pointing toward a slump in aggregate demand. That’s not currently the case, with the real Federal funds rate negative, liquidity abundant and the yield curve positively sloped. The ISM manufacturing new orders index has also dipped below 50, presumably reflecting weak exports and flat industrial production. But a comparison of the ISM manufacturing new orders index and the year-on-year percent change in real GDP, shown below, suggests slower growth, but not recession. The ISM non-manufacturing survey that covers the large majority of economic activity remains well above 50 and its sub-indexes for business activity, new orders and employment remain strong.
Consumers are benefiting from a significant boost in purchasing power and real disposable personal income is the best predictor of consumer spending. Businesses outside of the oil patch are benefiting from lower operating costs. Historically, sharp declines in oil prices affect household and business spending with a lag. It’s time to be patient.
Mr. Levy is chief economist, Americas and Asia at Berenberg Capital Markets LLC, and a member of the Shadow Open Market Committee at the Manhattan Institute.
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