Japan’s 9% of Global GDP Means Expansion Won’t Get Unhinged
The world economic recovery may be sturdy enough to withstand the double-whammy of Japan’s 9.0- magnitude earthquake and the surge in crude-oil prices triggered by tensions in the Middle East.
While Japan risks sinking into a recession and global growth might slow, the expansion likely has the breadth and momentum to last. Unemployment is falling around the world, company profits are rising and monetary policy is easy. The Group of Seven mounted its first joint currency intervention today since 2000 to limit the threat to Japan’s economy.
“The global economy should pass these stress tests and see continued prosperity,” said Edward Yardeni, president and chief investment strategist at Yardeni Research Inc. in New York. Investors will buy equities “if and when Japan’s nuclear problems are contained.”
Yardeni -- famous for coining the phrase “bond vigilantes” to describe investors who punish profligate governments -- predicts that global growth of about 5 percent this year will help spur a 15 percent rebound in the MSCI World (MXWO) Index of developed-nation equities from 1279.69 yesterday, and a increase in the Standard & Poor’s 500 Index of stocks to 1,500 by year-end from 1273.72.
Economists at Goldman Sachs Group Inc. and JPMorgan Chase & Co. also see the world economy bearing up in the face of the twin blows from Japan and oil. Goldman Sachs forecasts expansion of 4.8 percent this year, while JPMorgan predicts 4.4 percent, surpassing the 3.4 percent average of the past two decades.
“There’s a fair amount of resiliency to absorb this level of shocks,” said David Hensley, director of global economic coordination at JPMorgan Chase in New York and a former economist at the Federal Reserve Bank of New York.
Even as Japan copes with the worst nuclear accident since Chernobyl and destruction from earthquakes and a tsunami, the effect on the rest of the world will “probably be limited and small,” said Nariman Behravesh, chief economist in Lexington, Massachusetts, at research group IHS. He estimates the negative impact won’t be more than 0.2 percent this year. Japan’s gross domestic product has shrunk as a share of global output from about 18 percent in the mid-1990s to 8.7 percent last year, when it lost its rank as the second-largest economy to China.
Others, including Ian Plenderleith, a former executive director at the Bank of England, are more worried. They fear the accumulating risks will weigh on an expansion that still is coping with the aftereffects of the worst financial crisis since the Great Depression.
In addition to the natural disasters that may have killed more than 10,000 people in Japan, uprisings in the Middle East and North Africa have propelled the price of oil through $100 a barrel to its highest level since 2008, threatening to damage demand and spur inflation. Food costs jumped to record highs, and Europe has yet to solve its debt crisis.
“The world economy was beginning to recuperate,” Plenderleith, who is now chairman of Brevan Howard’s BH Macro Ltd. hedge fund, told a Bloomberg Link conference in London yesterday. “When you’ve got a patient that’s recuperating, it’s quite a good idea to avoid him being exposed to too many shocks, and we’ve had new shocks come at us,” he said. That “makes me nervous about how fast we’re going to recover.”
Even before March 11, when Japan was hit with its strongest earthquake on record, fund managers were becoming more concerned about the outlook, according to a survey published March 15 by Bank of America Merrill Lynch. A net 31 percent of 203 respondents, managing a total of $602 billion, anticipated stronger growth, a decline from 51 percent last month. Citigroup Inc.’s economic-surprise index for major economies, which measures whether data top or undershoot forecasts, is near its lowest point this year.
Now Japan’s crisis risks propelling fuel prices even higher, hurting investor sentiment and damaging the global supply chain. CLSA Asia-Pacific Markets estimates companies such as Tokyo- based Toshiba Corp. (6502) and Panasonic Corp. in Osaka provide 44 percent of the world’s audio-visual equipment, 40 percent of electronic components and 19 percent of semiconductors.
“In the context of a global economy that’s just starting to come to life after the worst recession and the worst crisis since the 1930s,” the question is “how sustainable” is the recovery, Stephen Roach, nonexecutive chairman of Morgan Stanley Asia, said on Bloomberg Television March 16.
The pessimism may be overdone from the point of view of worldwide growth, as the rebound from recession in 2009 becomes more entrenched, Hensley said. Among the signs of strength: His index of global manufacturing, based on international purchasing-manager indexes, rose to 57.8 in February, the fifth successive gain and just 0.1 percentage point below the record high in May 2004.
Labor markets are improving, with the Organization for Economic Cooperation and Development reporting this week that unemployment fell in January for a second month among its developed-nation members, averaging 8.4 percent compared with November’s 8.6 percent peak. Joblessness in the U.S., the world’s largest economy, dropped to 8.9 percent in February from 9.8 percent in November.
Corporate profits also are surging. Earnings from continuing operations of companies that make up the S&P 500 rose 36 percent last year, the biggest gain since 1988.
“Many businesses have never seen a profit cycle this good,” said James Paulsen, chief investment strategist at Minneapolis-based Wells Capital Management, which oversees about $340 billion.
U.S. companies aren’t alone. Of the 1,272 corporations in the MSCI index that have reported earnings since Jan. 10, 59 percent exceeded expectations.
While Japan is suffering in the short-term amid declining stocks, a surging yen, transport disturbances, power outages and the halting of production by companies such as Tokyo-based Sony Corp. (6758), economists say reconstruction could provide a spur. Nomura Holdings Inc. cut its forecast yesterday for growth this calendar year to 0.9 percent from 1.3 percent a week ago and raised its estimate for 2012 by 0.3 percentage point to 2.5 percent.
To combat volatility in the currency market, the G-7 nations agreed in a statement to sell yen today at Japan’s request. “We will monitor exchange markets closely and will cooperate as appropriate,” the statement said. The yen slid 3.4 percent versus the dollar as of 12:20 p.m. in Tokyo, limiting its gain since the March 11 temblor to 1.6 percent.
Asian countries that export to Japan may benefit when it begins rebuilding and also if the yen keeps appreciating, Nomura economists Tomo Kinoshita and Robert Subbaraman said in a March 15 report.
For now, Japan’s neighbors may suffer from supply disturbances, lost demand and a paring of last year’s $21.6 billion in investment by Japanese companies, the Nomura economists said. These countries bought $430 billion of Japanese goods last year, and more than 12 percent of shipments from Thailand, Taiwan, Korea and China go to Japan, they estimated.
Higher oil prices also pose a risk. An 85 percent to 90 percent annual gain in the cost of crude led a U.S. recession or growth shock six times since the early 1970s, according to Morgan Stanley. Brent crude has risen 40 percent since March 2010, ending yesterday at $114.90 a barrel for May settlement on the London-based ICE Futures Europe exchange.
Much of the increase this time has come from stronger demand, especially from emerging-market countries, mitigating the impact on the global economy. Only about the last $15 was driven by a supply squeeze, as turmoil in the Middle East disrupted exports from Libya and raised concerns about the political stability of other producers in the region, said Tim Drayson, a global economist at Legal & General Investment Management in London, which oversees about $570 billion.
Oil spikes may have less impact on world growth now than in the past because producing nations aren’t as likely to save the additional income, said Paul Donovan, a global economist at UBS AG in London. He estimates OPEC countries spent 66 percent of their 2008 oil revenue, more than double the amount in 1974, and the need to quell political tensions may encourage more outlays this time.
“Transferring money from oil consumers to oil producers does not induce the same shift in global-consumption patterns today as in past decades,” said Donovan, who cited crude this week in paring his expansion forecast for this year 0.1 point to 3.8 percent.
U.S. consumers have been somewhat sheltered from the rise in gasoline and food prices by this year’s $112 billion cut in payroll taxes, said Neal Soss, chief economist at Credit Suisse Holdings USA Inc. in New York.
Continued easy-money policies from the Federal Reserve also will help the U.S. weather the oil-price rise, according to Allen Sinai, chief global economist at Decision Economics in New York. Fed officials reaffirmed plans on March 15 to buy $600 billion of Treasuries through June and keep their benchmark interest rate near zero for an “extended period,” even as they declared that the recovery is on a “firmer footing.”
“The U.S. economy has sufficient momentum to ride out the Japan shock and the oil shock,” said Chris Varvares, president of St. Louis-based Macroeconomic Advisers.
While growth may ebb to 2.6 percent in the first quarter from 2.8 percent in the fourth, part of the slowdown would be attributable to harsh winter weather, he said. He pegged the underlying rate of expansion at 3.5 percent to 4 percent.
Emerging markets continue to provide impetus as well, even though data last week showed China’s unexpected February trade deficit was the biggest in seven years. Yardeni calculates that, adjusting for distortions caused by the weeklong Lunar New Year holiday, industrial production grew 14.1 percent in the first two months of this year, up from 13.3 percent in the same period of 2010. Urban fixed-asset investment accelerated 24.9 percent, he said.
“There are certainly some more problems, but our basic message is we still believe in the world economy and in risky assets,” said Michael Dicks, a former Bank of England economist and now the London-based head of research at Barclays Wealth, which manages the equivalent of about $240 billion. “The global recovery rolls on with decent growth.”