September and October are coming, the months that traders and economists fear the most. Remember the Septembers and Octobers of 2008, 1987, 1973, 1937, 1931, 1929, and 1907.
So let’s finish Silly Season and get serious again. I’ll try and make some forecasts about future economic developments. Bear in mind that I’m, funda-mentally, middle of the road. I’m neither overly bullish nor massively bearish. So here come my thoughts about the most important markets and economic issues:
USA: The main problem now is the deleveraging consumers. Exhibit A:
The question that no one can really answer is, of course, how far has deleveraging to go? That may depend on whether the Ricardian equivalence theorem is correct, that is, consumers save in order to offset increased government budget deficits. Looking at the graph above (mind you the last data point is for 2010 Q1), it seems reasonable to think that we are more than halfway through the necessary adjustment. So, I expect US consumers to stop deleveraging sometime in 2011.
Meanwhile, banks are still having huge (potential) losses in their books. Exhibits B and C:
This, of course, is interconnected with certain households who have to get rid of debt and whose real estate equity is deep under water. In my humble opinion, US banks will need another two years to get back to (almost) normal, especially since the housing market is still deep in the doldrums.
Monetary growth is non-existent as Bernanke’s helicopter hasn’t been able to get off the ground yet. Exhibit D:
Money velocity, which might be an indicator of coming inflation spikes, is also at rock bottom, although now it shows signs of slight recovery. Exhibit E:
To conclude, the households and the financial sector still haven’t fully recovered yet. Overall, consumers are likely to be in better shape than banks next year. The important question is: will banks lend, even if many of them are still in danger of going bankrupt?
Bernanke has probably fired all his ammunition and the only policy option left to jump-start consumer spending is to make the “Slam Dunk Stimulus” (article from Morgan Stanley) happen.
Now to my expectations for GDP growth and the stock markets. In my opinion, the stock indices will go sideways until mid 2011, with several intermitting hiccups (probably a result from the never-ending European debt crisis). GDP growth will hover around 1 or 2%, just like in 2002/03. With the ‘Slam Dunk’, a full recovery to normal growth rates (over 3% p.a.) may come sooner, but only if the government lays out a credible plan of how to stabilize the national debt trajectory. Without the ‘Slam Dunk’, I expect a return to such growth rates in 2012, when banks will finally recover from their losses. Stock markets may strongly move upward from the second half of 2012 on, because of good expectations of the year 2012.
Now let’s look at Europe:
With the exception of the PIGS, European countries don’t have deleveraging consumers, American-style. Instead, they are known for turtle-speed growth at all times. When the export boom tapers off late this year, Germany and France will lead most of Europe into the slow-growth scenario that those countries are famous for. Expect less than 1.5% per year. It’s hard to tell what will happen to the PIGS, since this is also a political question. Anyway, it seems the PIGS are going to pull down growth rates across Europe, due to the interconnectness of the European banking system. In 2012 the PIGS crisis should be almost over, so that the rest Europe may raise its growth rate a little bit then. Stock markets should trade within the American cycle, as exports are the most important thing to Europe anyway.
Disclaimer: This is not a financial advice. I am not a certified financial advisor. I may talk rubbish stuff. The earth may fall apart in 2012. Bla Bla Bla. You are responsible for your own mistakes (Who’da thunk it!). Don’t listen to me, just do what you want. I’m just writing down my opinion, mostly for myself ;-). In case you were not able to read black on blue, the source for all the data shown above is: FRED, Federal Reserve Economic Data, from the Federal Reserve Bank of St. Louis.