Notes on the Week Ahead

August 13, 2012

In sharp contrast to the uplifting performances at the Olympics over the past two weeks, global economic numbers have been distinctly downbeat.
-David Kelly, chief global strategist, J.P. Morgan Funds

U.S. Stability in a Troubled Global Economy

In sharp contrast to the uplifting performances at the Olympics over the past two weeks, global economic numbers have been distinctly downbeat.  Chinese reports from last week were disappointing, particularly in terms of exports, and other major Asian economies including Taiwan, Korea, Japan and India have all seen a deceleration in economic growth. This week will see new numbers on GDP growth for the Euro Zone, with a broad expectation that the European economy contracted in the second quarter. Meanwhile, a drought in the United States and a bad monsoon in India hold the prospect of higher food prices in the months ahead.


Amidst all of this, the U.S. economy is moving ahead at a steady, if slow pace. This theme should be supported by a wide array of economic numbers due out this week including numbers on manufacturing, housing, employment, consumer spending and inflation. 


On manufacturing, Wednesday's Empire State survey could show a softer reading for August while Thursday's Philadelphia Fed index may improve from a very weak reading in July. July Industrial Production, due out on Wednesday, should show a healthy increase partly due to higher utility activity in the U.S.'s hottest month in record. However, the broad picture on manufacturing is one of only slow progress as a weak global economy is having some negative impact.


On housing, Wednesday's report from the National Association of Home-Builders could see a small pullback following very strong gains over the past year. However, the momentum in the housing industry should be confirmed by Thursday's Housing Starts report which could reveal the strongest starts numbers in the expansion so far.


Unemployment Claims will be watched carefully on Thursday for signs of any change in direction in the labor market.  An ominous increase in claims early this summer has been reversed but with just 1.5% real GDP growth in the second quarter there is a risk of claims beginning to rise again.


Consumer activity, as revealed by Tuesday's Retail Sales report should have been fairly strong in July following a string of weak months stretching back to February. While confidence remains negative, (as will presumably be confirmed in Friday's Consumer Sentiment report), both real disposable income and wealth have risen strongly in the first half of the year, suggesting stronger spending numbers in the months ahead.


Finally, inflation numbers should look benign in both the Producer Price Index on Tuesday and the Consumer Price Index on Wednesday. However, a recent rebound in gasoline prices, combined with much higher food commodity prices, suggests that inflation, in the United States at least, may be hitting its low point for the year.


Monetary and fiscal policy will get more press over the next few weeks with Governor Romney's selection of Congressman Paul Ryan as his running mate, the upcoming Republican and Democratic Conventions and Ben Bernanke's Jackson Hole speech at the end of the month.


The steady, if uninspiring growth in the U.S. economy combined with the extreme amount of monetary and fiscal stimulus injected into the economy over the past few years strongly points to a need to wean the economy off both low interest rates and high deficits. However, it is very important to do this in a balanced way. Currently, it seems possible that fiscal stimulus will be removed too quickly and monetary stimulus too slowly. Both policy-makers and politicians have the opportunity over the next month to let the public know that they recognize the danger.


In the meantime, while valuations do still favor equities over fixed income around the world, the general weakness of the global economy combined with the potential for over-active policy-makers to make further mistakes points to a paramount need for investors to stay balanced.