Since October I have been saying that the US growth was probably going to decline for the remainder of this business cycle. In contrast, I have believed Europe would recover ever since data last June confirmed a broad based phase shift across the entire eurozone from worsening data to better data. The most recent data confirm this pattern becoming well entrenched. Some thoughts below
Yesterday, I wrote that US data are telling us that the 4% growth ideal from Q3 2013 is not going to be sustained. This chart is the key:
With consumption in the US at over 70% of GDP, wage pressure of this magnitude has to be felt in weakening consumer demand. To date, an incipient releveraging concentrated in auto and student loans has buoyed consumer spending. And the rise in house prices has underpinned recovery by pulling a large swathe of households out of negative equity. But the Housing refinancing boom is over and the institutional investors who were the big cash buyers in depressed markets like Phoenix are exiting the sector. I believe housing will not be a major tailwind going forward. And note that much of the auto and student credit is subprime lending which will be negatively impacted at the cyclical trough. I am saying 2% growth is all we should expect as a baseline from this – and that is as much a result of releveraging as anything given the decline in wage growth.
The inventory building in the face of this is problematic. If job and wage growth declines significantly over a six- to 12-month period while inventories are too high, the result is a loss of consumer demand that brings on an inventory purge which results in a downturn that can snowball into a recession. The ISM services data show that this is what we are seeing right now:
The employment sub-index is contracting for the first time in 26 months. While inventories are dangerously high. Right now, everyone is pointing to weather as the reason we are seeing this problem. But, what I see in the weekly jobless claims data tells me that the jobs picture is murky. Unless initial claims fall – as they did today (we just printed a 323,000 initial claims number), we will start seeing numbers about where they were a year ago by this spring. And given the income/wage trends, that is bearish for personal consumption growth. I believe there is a very real chance we see an inventory purge beginning which will be apparent in Q1 and Q2 data.
By contrast, Europe looks good. The latest ISM data shows good progress across the board. Optimism in Ireland’s service sector is at a decade high 65%. The seasonally adjusted business activity index is at 57.5. The UK services PMI came in at 58.2, showing the UK service sector expanding strongly. In the eurozone, the picture is similar if less robust. We are at a cycle high 53.3 on the ISM services now. That’s the best in 32 months.
Germany came in at a 33-month high of 56.4. Italy came in at a 34-month high of 53.4. And even though Ireland and Spain were down, they were still well above 50 at 55.0 and 53.8 respectively, higher than Italy. France remains the laggard with 47.9 showing a shrinking economy. Of the big four eurozone economies, three have numbers that are pointed up.
I expect this trend to continue.
The questions going forward relate to jobs and credit. The credit situation in Europe is still poor. And the same goes for the jobs front. We have hit bottom in Europe and are slowly climbing up. If and when the credit and jobs situation improves, the GDP growth numbers will as well. For European equities, which are priced at lower multiples than US equities, this presents an opportunity. The US growth rate is headed down and its equity markets are overpriced relative to European ones, where the economic growth rate is headed up.