As the global economic situation has shown signs of slow improvement in early 2013, recession risks are subsiding in the four major economies. China’s early-cycle recovery has helped to provide traction for the rest of the world. The U.S. is still in a mid-cycle expansion, despite persistent fiscal uncertainty. Germany and Japan remain in the recessionary phase of the business cycle, but these two export-driven economies may begin to move toward the early cycle as global trade picks up this year (see Recession risk scorecard, below).
Recent trends in major categories
The following is a more detailed look at developments in major economies around the world.
The U.S. economy remains in a slow, mid-cycle expansion. The initial GDP estimate for the fourth quarter of 2012 indicated a slight contraction, but the underlying trend of growth has not changed significantly. Consumption and new investment held up well during the fourth quarter, while inventory liquidation, weak net exports, and a drop in government defense spending dragged GDP lower. Final sales of real domestic product—which ignores inventory swings—registered a year-over-year growth rate of roughly 2%, where it has hovered during the past two years (see chart below). Moreover, the boom in domestic energy production has caused the petroleum component of the U.S. trade deficit to sink to its lowest level in more than 20 years of recorded history (see chart below). This suggests that fourth-quarter trade numbers will be revised up, and net exports will likely improve amid the gradual uptick in global demand.
While the U.S. economy remains steady, there have been some shifts among the drivers. Consumer confidence fell sharply at the start of the year—likely due to U.S. workers feeling the negative impact from higher payroll taxes—causing many observers to wonder if consumption would be dampened. However, core retail sales held firm, rising by 3.5% in January, and consumer confidence ticked back up in February, providing little evidence of broad-based consumer weakness.1 The Institute for Supply Management (ISM) survey of purchasing managers showed that manufacturing inventories rebounded in January, and new orders also rallied, making for a solid manufacturing environment.2
The fourth-quarter earnings season has been mixed. With 65% of companies reporting, operating earnings grew by 6%, and revenue growth of 4.1% also exceeded expectations. Yet results missed beginning-of-quarter earnings-growth expectations for the third consecutive quarter.3 Slowing productivity rates likely indicate that margin expansion will be difficult, implying a continued deceleration in profit growth. Meanwhile, unemployment claims remain near post-recession lows, and banks are generally maintaining or easing their lending standards, suggesting continued incremental improvement for macroeconomic conditions. The U.S. economy remains in the mid-cycle expansion phase of the business cycle, with most indicators pointing to further gradual improvement.
China’s economy has rebounded amid liquidity growth similar to the 2009–2010 credit boom, which was fueled and directed by the mostly state-owned banking sector. This time, however, the credit surge is driven by a number of “shadow” or non-bank and off-balance-sheet lending entities, making the financial landscape less transparent.4 Government-affiliated infrastructure and other construction projects have received much of the funding, with relatively little going to the private sector outside of real estate. Nevertheless, the recovery from the 2012 slowdown in China has provided a lift to the global economy, especially for Southeast Asian trading partners and global commodity prices. Financial conditions in emerging Asia (excluding Japan), which typically lead gains in real GDP growth, have recovered back to average historical levels (see chart right). China’s rebound has helped place the global economy on a more sound footing, but the credit surge may be exacerbating unresolved excesses, making the recovery’s sustainability questionable.
The German economy contracted by 2.4% on an annualized basis in the last quarter of 2012, dragged down by weakening domestic conditions and a flagging export sector.5 While still elevated, the risk of ongoing recession has fallen considerably since our December report as some gradual signs of improvement have begun to emerge. Though retail sales fell year-over-year in December for the first time since mid-2011, labor market conditions have remained healthy. Consumer and business confidence surveys appear to have turned the corner, with steady increases over the past couple of months, and the February German ZEW survey reported economists’ six-month growth expectations at a two-year high.6 Despite still-weak overall export levels, stabilizing global trade volumes suggest that external demand may be improving. Manufacturing new orders grew by 2.8% in the fourth quarter, and foreign new orders to euro-area countries—a critically important indicator—rose by 11.2%.7 Germany remains in the recessionary phase of the business cycle, but gradual improvement of the export and consumer sectors may be setting the stage for recovery.
Japan’s economy contracted during the last three quarters of 2012, but there are signs that the economy has troughed and the risk of ongoing recession has abated.8 Leading economic indicators ticked up for the third consecutive month in December, likely driven by increasing global trade volumes that have benefited Japan’s large export sector.9 In addition, consumer confidence took a big step up in January, with expectations for future conditions rising to levels last seen in 2006.10 Consumers seemed to welcome the new political leadership of Shinzo Abe, who came to power at the end of 2012 and has promoted more aggressive growth-oriented economic policies. During January, the Bank of Japan officially adopted a 2% inflation target, marking a significant shift toward monetary stimulus to reach that goal after nearly four years of below-zero inflation rates. Though still in a recession, Japan may move toward an early-cycle expansion as global trade improves and policymaking becomes more stimulative.
Overall, the global economy remains relatively weak but in a trend of increasing momentum. Of the world’s 37 largest economies, 47% have seen improvements in their leading indicators over the past six months, the most since June 2012.11 Global purchasing manager indexes show that the manufacturing sectors in 70% of the 30 largest economies are now in expansion territory, up from 54% in December.12 After 18 months of a synchronized slump in global trade and manufacturing, the deceleration is slowly beginning to reverse, but progress remains gradual and uneven.
Generally modest inflationary pressures continue to provide a supportive backdrop for the heavy monetary accommodation that exists across much of the globe. While oil prices have risen in recent weeks, most commodity prices have been roughly flat over the past year. Many developing economies now have inflation rates running below the levels targeted by their central banks, with the notable exceptions of India and Brazil, which are exhibiting some stagflationary pressures. Recessionary backdrops in Europe and Japan have put a damper on inflation concerns, and improving global financial-market conditions have further underpinned growth. As discussed above, the credit surge in China has spearheaded a sharp recovery in the financial conditions of emerging Asia. However, some large developing economies have seen bank loan growth decelerate from rapid levels, with Turkey, Brazil, and India receiving less of a lending boost than they did in 2011–2012 (see chart right). Global growth remains uneven and generally lackluster, but the trend is one of underlying improvement.
Summary and outlook
The global economy has continued to show signs of slow improvement. Chinese economic activity has rebounded, the U.S. economy has remained in an expansion and, while Germany and Japan are still in recession, both appear to be close to emerging from their downturns. Against this backdrop, the global economy has also enjoyed historic levels of monetary policy support and ample liquidity with low levels of inflation, which should create a supportive environment for economically sensitive assets over the next few months.
Systemic concerns from European and U.S. policy risks have continued to recede, but nearly all the largest economies face the need to implement structural reforms to improve trend growth prospects. The eurozone debt crisis is on the back burner, but greater fiscal, banking, and labor-market reforms will be required to improve competitiveness. Though some fiscal progress has been made, the U.S. continues to lurch from one deadline to the next. China has yet to rebalance its economy away from infrastructure-fueled growth and toward the consumer sector. Other large emerging-market countries such as Brazil and India also need to make structural reforms to reignite growth. Without greater progress on these reforms, the upside for global growth may be somewhat limited.
From an asset allocation perspective, the building positive momentum behind global growth is still favorable for the risk-reward outlook of more economically sensitive assets. Improvement in the non-U.S. cyclical outlook warrants more balanced geographic exposures. Recently strong financial market performance has made valuations somewhat less attractive, particularly for credit-sensitive fixed income assets, but most major stock market indexes remain below their long-term average price-to-earnings multiples.
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The information presented above reflects the opinions of Dirk Hofschire, CFA, senior vice president, asset allocation research, and Lisa Emsbo-Mattingly, director of asset allocation research, as of February 26, 2013. These opinions do not necessarily represent the views of Fidelity or any other person in the Fidelity organization and are subject to change at any time based on market or other conditions. Fidelity disclaims any responsibility to update such views. These views may not be relied on as investment advice and, because investment decisions for a Fidelity fund are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity fund.
The Typical Business Cycle depicts the general pattern of economic cycles throughout history, though each cycle is different and specific commentary on the current stage is provided in the summary and outlook section. In general, the typical business cycle demonstrates the following:
• During the typical early-cycle phase, the economy bottoms and picks up steam until it exits recession, then begins the recovery as activity accelerates. Inflationary pressures are typically low, monetary policy is accommodative, and the yield curve is steep. Economically sensitive asset classes such as stocks tend to experience their best performance of the cycle.
• During the typical mid-cycle phase, the economy exits recovery and enters into expansion, characterized by broader and more self-sustaining economic momentum but a more moderate pace of growth. Inflationary pressures typically begin to rise, monetary policy becomes tighter, and the yield curve experiences some flattening. Economically sensitive asset classes tend to continue benefiting from a growing economy, but their relative advantage narrows.
• During the typical late-cycle phase, the economic expansion matures, inflationary pressures continue to rise, and the yield curve may eventually become flat or inverted. Eventually, the economy contracts and enters recession, with monetary policy shifting from tightening to easing. Less economically sensitive asset categories tend to hold up better, particularly right before and upon entering recession.
2. Source: Institute for Supply Management, Haver Analytics, Fidelity Investments (AART) through Jan. 31, 2013.
3. Q4 2012 MSCI USA Investable Market Index earnings and revenue growth. Source: FactSet, Fidelity Investments (AART) as of Feb. 21, 2013.
4. See “China’s Reacceleration: Near-term Positive, Medium-term Concern,” Fidelity Leadership Series, February 2013.
5. Source: Statistisches Bundesamt, Haver Analytics, Fidelity Investments (AART) through Dec. 31, 2012.
6. Source: ZEW – Zentrum für Europa ïsche Wirtschaftsforschung, Ifo – Institut für Wirtschaftsforschung, Statistisches Bundesamt, Haver Analytics, Fidelity Investments (AART) through Feb. 19, 2013.
7. Source: Statistisches Bundesamt, Haver Analytics, Fidelity Investments (AART) through Dec. 31, 2012.
8. Source: Cabinet Office of Japan, Haver Analytics, Fidelity Investments (AART) through Dec. 31, 2012.
9. Foundation for International Business & Economic Research, Haver Analytics, Fidelity Investments (AART) through Jan. 31, 2013.
10. Source: Cabinet Office of Japan, Haver Analytics, Fidelity Investments (AART) through Jan. 31, 2013.
11. The major economies include: Austria, Belgium, Brazil, Canada, China, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, India, Indonesia, Ireland, Italy, Japan, South Korea, Luxembourg, Malaysia, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Russia, Slovakia, South Africa, Spain, Sweden, Switzerland, Taiwan, Thailand, Turkey, United States, United Kingdom. Source: OECD, The Foundation for International Business and Economic Research, Institute for Supply Management, Haver Analytics, Fidelity Investments (AART) as of Dec. 31, 2012.
12. Source: JPMorgan, Markit, Haver Analytics, Fidelity Investments (AART) through Jan. 31, 2013.