LP L FINANCIAL R E S E AR C H
Weekly Economic Commentary August 13, 2012
China Has Already Landed Softly John Canally, CFA
Although it may be a stretch for China to reach our forecast of 8 – 9% real gross domestic product (GDP) growth in 2012 (first published in November 2011), we continue to expect a “soft landing” — growth between 7% and 8% — in 2012. As was the case when we first made our 2012 forecast for China’s economy in late 2011, our view on China’s economy remains below consensus. The consensus still expects 8 – 8.5% real GDP growth in China in 2012. The so-called “hard landing” scenario in China is for 5 – 6% growth this year. This forecast receives frequent attention in the financial media, even though the lowest forecast among 28 professional economists and market participants for China’s economy in 2012 is 7.6%.
Economist LPL Financial
Highlights We continue to expect a “soft landing” — growth between 7% and 8% — in 2012. Our forecast remains below consensus. Additional monetary stimulus in China (rate cuts and cuts in reserve ratio requirements) could happen at any time, and markets would welcome these additional steps.
Gradual Transition to Consumer-Oriented Economy
China’s exports to other large emerging market economies have accelerated recently, and we believe this will continue. Please see the LPL Financial Research Weekly Calendar on page 3
1 After Raising Rates From 2009 to Late 2011 to Cool Growth and Combat Inflation, the People’s Bank of China (PBOC) Is Now Cutting Rates Again 7.6
China: Lending Rate: 1-Year, % per annum
7.2 6.8 6.4 6.0 5.6 5.2
02
03
04
05
06
07
08
09
10
Source: People's Bank of China, Haver Analytics 08/13/12
11
12
China's economy, as measured by real GDP, grew by more than 10% per year between 2002 and 2008, before slowing to a “hard landing” growth rate of just over 6% in late 2008. For perspective, during the worst of the 2007 – 2009 Great Recession, China’s real GDP bottomed out at around 6.5% growth, and a return to that pace of growth would be considered a hard landing. A sizable portion of the 10%-plus growth seen between 2002 and 2008 was export oriented. But China is now slowly transitioning to a more consumer-oriented versus an export-oriented economy, and Chinese authorities have made it clear that the transition is likely to occur against a backdrop of much slower economic growth, likely in the 7.5 – 8.0% range. China's economy grew 7.6% between the second quarter of 2011 and the second quarter of 2012. The reading represented a deceleration from the 8.1% year-over-year reading in the first quarter of 2012, and it was also slightly below published expectations. The latest batch (reported last week [August 6 – 10]) of Chinese economic data (for July 2012) triggered more talk of a “hard landing.” The meager 1.0% year-over-year gain in Chinese exports in July 2012 versus July 2011 was especially disturbing. The slowdown in China’s economy this year can be attributed to several factors, including the lagged impact of monetary policy tightening by Chinese authorities in 2010 and 2011, the fiscal crisis and economic slowdown in Europe, and, to a lesser extent, economic slowdowns in China’s emerging market trading partners this year. Since late 2011, China has been taking policy actions to offset or preempt the slowdown but, thus far, the actions have not halted the deceleration in the economy.
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Monetary Policy Efforts
2 China’s Exports Have Slowed… 60
China: Total Cumulative Exports, % Change - Year to Year YTD, Mil.US$
40 20 0 -20 -40
02 03 04 05 06 07 08 09 Source: China Customs, Haver Analytics 08/13/12
10
11
12
In response to the impact of the global Great Recession in 2008 – 2009, China eased both monetary and fiscal policy in 2008 and 2009. But China was one of the first nations to emerge from the Great Recession, and surging commodity prices, leading to the threat of rising food prices in China, prompted Chinese authorities to begin tightening monetary policy in late 2009 and early 2010, to cool prices and economic growth. They continued to tighten policy — first via making Chinese banks hold more reserves against the loans (reserve ratio requirements) they made and later by raising the official lending rate — until mid-2011. As noted above, since late 2011, Chinese authorities have been in the process of reversing some of the tightening put in place between late 2009 and mid-2011. The People’s Bank of China (PBOC) lowered reserve ratio requirements beginning in late 2011 and began cutting official lending rates in June of 2012. To date, these measures have not had any appreciable impact on the Chinese economy, and the market is calling for more monetary policy in addition to a dose of fiscal stimulus to halt the deceleration in the economy.
3 …And Exports to Europe Have Turned Negative 60
Slowdown in Europe
China: Cumulative Exports to European Union, % Change - Year to Year YTD, Mil.US$
The slowdown in Europe has also impacted the Chinese economy. In recent years, roughly 20% of all Chinese exports have been destined for Europe. And with Europe in recession, overall Chinese export growth has slowed dramatically, to just 1.0% year-over-year in July 2012. In the first seven months of 2012, China’s exports to the European Union (EU) are running 4% below the same period of 2011. By comparison, for most of 2010 and 2011, China’s exports to the EU were running 20 – 40% higher than the previous year.
40 20 0 -20 -40
02 03 04 05 06 07 08 09 Source: China Customs, Haver Analytics 08/13/12
4
10
11
12
… But China’s Exports to North American Economies Have Held Up Well
60
Emerging Markets a Bright Spot
China: Cumulative Exports to North America, % Change - Year to Year YTD, Mil.US$
40 20 0 -20
02
03
04
05
06
07
08
09
Source: China Customs, Haver Analytics 08/13/12
10
To put the slowdown in China’s exports to Europe in perspective, China’s exports to Asia (year-to-date 2012 versus year-to-date 2011) are still running 10% above year-ago levels, and China’s exports to North America are 14% above year-ago levels and are accelerating. Chinese officials remain concerned about Europe and do not see European leaders making significant progress anytime soon, leaving a key source of Chinese export growth, and overall economic growth, a key question mark over the medium term.
11
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The deceleration in emerging markets growth (outside of China) is also a cause for concern for Chinese policymakers, but the outlook here is a bit brighter. Actual growth and prospects for growth in emerging market economies have come down this year. At the start of the year, emerging markets (including China) were expected to grow at around 6 – 7%, and at mid-year, those forecasts have come down to around 5 – 6% for 2012. China’s exports to the eight largest emerging market economies outside of China (Brazil, India, Russia, Mexico, Turkey, Indonesia, Poland and Venezuela) account for over 11% of its overall exports, and are growing at 10% versus a year ago. While they have slowed from much faster growth rates in 2010 – 2011 (30 – 50%), China’s exports to other large emerging market economies have accelerated recently, and should continue to
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LPL Financial Research Weekly Calendar
U.S. Data
Fed
Global Notables
2012 13 Aug 14 Aug
15 Aug
16 Aug
17 Aug
Small Business Optimism Index (Jul) PPI (Jul) Retail Sales (Jul) Business Inventories (Jul)
Japan: GDP (Q2)
Eurozone: GDP (Q2) Germany: ZEW Index (Aug) Eurozone: Industrial Production (Jul)
Eurozone: CPI (Jul)
China: Home Prices (Jul) Eurozone: Trade Balance (Jun)
CPI (Jul) Empire State Mfg. Index (Aug) Industrial Production (Jul) Capacity Utilization (Jul) NAHB Index (Aug)
Kocherlakota
Initial Claims (8/11) Housing Starts (Jul) Philly Fed (Aug)
Kocherlakota
University of Michigan Consumer Sentiment (Aug) Leading Indicators (Jul)
Hawks: Fed officials who favor the low inflation side of the Fed’s dual mandate of low inflation and full employment Doves: Fed officials who favor the full employment side of the Fed’s dual mandate
China’s Data: Unlike many other nations, China does not have a set schedule for the release of its monthly economic data, and Chinese authorities typically only provide a range of possible release dates for the data. Typically the bulk of the economic data in China is released between the 9th and 15th day of the month. For example, last week (August 6 – 10) saw China release July data on consumer prices (CPI), producer prices (PPI), new loan growth, money supply, industrial production, exports, and imports. There is another round of data releases at the end of each month (usually the last few days of the month), as China and private sector entities in China release the purchasing managers index (PMI) on manufacturing. On balance, the economic data in China is not as transparent as economic data in the United States and the developed world, and it is subject to a great deal of “political nudging” as well. Still, it is much timelier than most data in the United States, and financial market participants pay very close attention to this data.
People’s Bank of China (PBOC): Unlike most other central banks around the globe, the PBOC does not have set dates for policy decisions. It can change policy at any time, and often does. The PBOC has announced policy changes on the weekend and on holidays [Christmas Day 2010, Tomb Sweeping Day in China (April 2011)], and generally announces changes in the early morning hours (EST), after the end of the trading day in China and before trading begins in the United States. According to the PBOC English language website, in addition to setting monetary policy, the PBOC also regularly intervenes in Chinese money markets, draining and adding reserves as it sees fit. The PBOC is also charged with managing China’s currency, the Renminbi, and managing China’s foreign exchange and gold reserves. The PBOC is highly political, and at this point in its history, can be viewed as an arm of the Chinese government that merely implements monetary policy, rather than both formulating and implementing policy. LPL Financial Member FINRA/SIPC
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accelerate. Why? Most other emerging market central banks have also been cutting interest rates and lowering reserve requirements over the past nine months or so to stimulate growth. Monetary policy often works with a lag, so emerging market economies are likely to reaccelerate in the coming quarters, helping to lift Chinese exports, and the overall Chinese economy as well. On balance, markets will likely remain concerned about a “hard landing” in China for the foreseeable future. Additional monetary stimulus (rate cuts and cuts in reserve ratio requirements) could happen at any time (see box on page 3), and markets would welcome these additional steps. Market participants are also calling for additional fiscal stimulus from Beijing as well, to complement the additional monetary policy. With a transition to new leadership in China this fall, markets remain concerned that China will fail to live up to its promise of 7 – 8% growth over the long term. n
LPL Financial Research 2012 Forecasts
GDP 2%*
Federal Funds Rate 0%^
Private Payrolls +200K/mo.†
Please see our 2012 Outlook for more details on LPL Financial Research forecasts.
IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. * Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory. ^ Federal Funds Rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis. † Private Sector – the total nonfarm payroll accounts for approximately 80% of the workers who produce the entire gross domestic product of the United States. The nonfarm payroll statistic is reported monthly, on the first Friday of the month, and is used to assist government policy makers and economists determine the current state of the economy and predict future levels of economic activity. It doesn’t include: - general government employees - private household employees - employees of nonprofit organizations that provide assistance to individuals - farm employees The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Stock investing involves risk including loss of principal. International investing involves special risks, such as currency fluctuation and political instability, and may not be suitable for all investors. China CPI: In total there are about 600 "national items" used for calculating the all-China CPI. The list of items is revised annually for representativeness based on purchases reported in the household surveys. The number of items can change from year to year, but rarely by more than 10 in any given year.
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The Empire State Manufacturing Index is a seasonally-adjusted index that tracks the results of the Empire State Manufacturing Survey. The survey is distributed to roughly 175 manufacturing executives and asks questions intended to gauge both the current sentiment of the executives and their six-month outlook on the sector. The NAHB/Wells Fargo Housing Market Index gauges builder perceptions of current single-family home sales and sales expectations for the next six months as "good," "fair" or "poor." The survey also asks builders to rate traffic of prospective buyers as "high to very high," "average" or "low to very low." Scores from each component are then used to calculate a seasonally adjusted index where any number over 50 indicates that more builders view conditions as good than poor. The Michigan Consumer Sentiment Index (MCSI) is a survey of consumer confidence conducted by the University of Michigan. The Michigan Consumer Sentiment Index (MCSI) uses telephone surveys to gather information on consumer expectations regarding the overall economy. The Producer Price Index (PPI) program measures the average change over time in the selling prices received by domestic producers for their output. The prices included in the PPI are from the first commercial transaction for many products and some services. The index of leading economic indicators (LEI) is an economic variable, such as private-sector wages, that tends to show the direction of future economic activity. ZEW Survey is a main indicator of investors' confidence. It is calculated on basis of 350 analysts' and institutional investors' polling. The indicator reflects the difference between analysts who are optimistic about forthcoming economic development of Germany within six months and those who are pessimistic. The Survey is used for German economic prospects estimation. ZEW Survey growth causes the euro growth.
This research material has been prepared by LPL Financial. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity. Not FDIC/NCUA Insured | Not Bank/Credit Union Guaranteed | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit
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LP L FINANCIAL R E S E AR C H
Weekly Market Commentary August 13, 2012
Dog Days for the Dow Jeffrey Kleintop, CFA
The “dogs of the Dow” have best handled the heat of the dog days of summer.
Chief Market Strategist LPL Financial
The so-called “dogs of the Dow” strategy entails owning the highest dividend-yielding stocks in the Dow Jones Industrial Average (DJIA). Yield has been a rewarding theme in the markets this summer. In general, it has been the highest-yielding stocks and bonds that have outperformed their peers. For example, since the beginning of June in the bond market, High-Yield Bonds have trounced the returns on High-Grade Corporate or Government Bonds, according to Barclays Index data. And in the stock market, the highest-yielding sectors have outperformed. Over the past three months, the high dividend-yielding Telecommunications Services, Consumer Staples, and Utilities sectors of the S&P 500 have been outperformers. Specifically, the 10 dogs of the Dow stocks this year, led by strong performance among the Telecom carriers that are the highest-yielding stocks, have outperformed the DJIA during the summer months by over three percentage points.
Highlights As the dog days of summer draw to a close during the coming weeks, seeking yield with strategies like the “dogs of the Dow” may no longer be rewarding. The Federal Reserve (Fed) meeting at the end of the month may change the markets’ theme. In general, we believe investors can prepare by seeking out more cyclical securities in August that may offer more potential for price appreciation in the months ahead.
1 Treasury Yields Increased at the Start of Prior Bond Purchase Programs
4.0
10-Year Treasury Yield During Quantitative Easing Programs, Percent QE1, Left Scale QE2, Left Scale Operation Twist, Right Scale
3.5
4.5 3.5
3.0 2.5 2.5 2.0
1.5
-40 -20 0
20 40 60 80 100 120 140 160 180
Trading Days from Start of Treasury Purchases
Source: LPL Financial, Bloomberg 08/13/12 Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.
But as the dog days of summer draw to a close during the coming weeks, yield may no longer be the overriding market theme. The Fed’s conference in Jackson Hole, WY is coming up on August 30 – September 1. The Fed may use this opportunity to communicate its intention to pursue a third round of quantitative easing (so-called QE3), likely involving the purchase of Treasuries, Agencies, and Mortgage-Backed Bonds. Counter-intuitively, a look back at prior rounds of Fed bond purchases shows that Treasury yields actually increased following the start of bond purchases. In each of the three prior bond purchase programs — QE1, QE2, and Operation Twist — the yield on the 10-year Treasury increased almost immediately, as you can see in Figure 1. This is because markets are forward-looking, and investors quickly anticipated the beneficial impacts of the Fed’s bond buying on the economy. As yields rise, investors shed more defensive, yield-oriented investments in favor of those with more potential for price appreciation. During the summer months so far, the most likely beneficiaries of another round of quantitative easing by the Fed have not reflected an increasing likelihood of Fed action. This can be seen in yield-oriented stocks leading rather than lagging the market, bond yields not rising, the dollar not falling, and gold not posting gains typically seen when the market expects a new bond buying program from the Fed. The dog days originally were the sultry days when Sirius, known as the dog star, rose just before or at the same time as sunrise. The stars may no longer line up for dog stock investors as the calendar turns to September.
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In general, we believe investors can prepare by seeking out more cyclical securities, such as those in the Information Technology and Industrials sectors, in August that may offer more potential for price appreciation in the months ahead. n IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Names of securities mentioned herein are for informational purposes only and should not be considered investment advice or guidance, offer or solicitation, offer to buy or sell securities, nor a recommendation or endorsement by LPL Financial of the security or investment strategy. LPL Financial does not endorse or evaluate individual equities. Dividend paying stock payments are not guaranteed. The amount of a dividend payment, if any, can vary over time and issuers may reduce dividends paid on securities in the event of a recession or adverse event affecting a specific industry or issuer. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price. Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. Operation Twist is the name given to a Federal Reserve monetary policy operation that involves the purchase and sale of bonds. “Operation Twist” describes a monetary process where the Fed buys and sells short-term and longterm bonds depending on their objective. Dow Jones Industrial Average (DJIA): The Dow Jones Industrial Average Index is comprised of U.S.-listed stocks of companies that produce other (non-transportation and non-utility) goods and services. The Dow Jones Industrial Averages are maintained by editors of The Wall Street Journal. While the stock selection process is somewhat subjective, a stock typically is added only if the company has an excellent reputation, demonstrates sustained growth, is of interest to a large number of investors and accurately represents the market sectors covered by the average. The Dow Jones averages are unique in that they are price weighted; therefore their component weightings are affected only by changes in the stocks’ prices. Consumer Staples Sector: Companies whose businesses are less sensitive to economic cycles. It includes manufacturers and distributors of food, beverages and tobacco, and producers of non-durable household goods and personal products. It also includes food and drug retailing companies. Telecommunications Services Sector: Companies that provide communications services primarily through a fixed line, cellular, wireless, high bandwidth and/or fiber-optic cable network. Utilities Sector: Companies considered electric, gas or water utilities, or companies that operate as independent producers and/or distributors of power. Information Technology: Companies include those that primarily develop software in various fields such as the Internet, applications, systems and/or database management and companies that provide information technology consulting and services; technology hardware & Equipment, including manufacturers and distributors of communications equipment, computers and peripherals, electronic equipment and related instruments, and semiconductor equipment and products. Industrials Sector: Companies whose businesses manufacture and distribute capital goods, including aerospace and defense, construction, engineering and building products, electrical equipment and industrial machinery. Provide commercial services and supplies, including printing, employment, environmental and office services. Provide transportation services, including airlines, couriers, marine, road and rail, and transportation infrastructure. This research material has been prepared by LPL Financial. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity. Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit
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