Asset management

23 July 2012

Economist Insights Dip-licate

Recent US data have resembled the same weak pattern observed in 2011. In comparison with last year, there are some key differences in the drivers of the data dip. The global economy in 2011 was hit by a devastating earthquake in Japan and sharp increase in oil price. However, there are also a number of similarities: the Eurozone sovereign crisis and, more importantly, uncertainty linked to the US debt ceiling and the fiscalcliff. In this context, it is not surprising that firms andhouseholds cut spending, but recent experience suggests that this might be just enough to duplicate another soft patch. Joshua McCallum Senior Fixed Income Economist UBS Global Asset Management joshua.mccallum@ubs.com

Gianluca Moretti Fixed Income Economist UBS Global Asset Management gianluca.moretti@ubs.com

The ongoing recovery from the recession, if you can even call it a recovery, has been anything but smooth. Each of the last two years was interrupted by an episode of disappointing data and anaccompanying sell off in risk assets. This year now appears tobe duplicating that past trend of mid-year dips. Pretty much everyone has already accepted that growth in the Eurozone is going to be very weak. The IMF was the last organisation to be moderately optimistic about the UK, and it recently revised down its forecast for both this year and next year. China has confirmed that it is slowing down gently. Japan is growing at a fairly steady pace, and until recently so was the US. The recent wave of data in the US has been disappointing to investors. Most striking has been the very sharp drop in the ISM new orders survey for manufacturing, but the tone in other sectors has also been softer. Retail sales and new home sales came in well below expectations, and the labour market data show job growth has slowed drastically. So is this a downturn just like last year, or is it the start of something more ominous? Consider how this US data dip compares to the previous years dips. The flow of data (see chart 1) shows the central trend in the economic indicators shifting downward in an almost identical path. The key difference is that the indicators were notably stronger prior to last years dip than they were prior to the current dip. On the one hand, this tells us that our current starting point was weaker, but on the other hand it also demonstrates that the relative size of the slowdown is less.

How do the drivers of the data dips compare? The most obvious difference is that last year had an exogenous shock in the form of the devastating earthquake in Japan. Firms were not quite prepared for the degree to which disruption in Japan fed throughinto supply chain disruption elsewhere. This disruption was not enough in itself to justify the extent of the downturn. The dip persisted thanks to the damage to confidence from political uncertainty: a worsening situation in the Eurozone and the struggle with the debt ceiling in the US. There is a clear similarity with this year, thanks to the problems in Spain and Italy and the looming US fiscal cliff that will follow just a few months after the November election.
Chart 1: Triple roller coaster Range of survey indicators of economic activity in the US, normalised to match two-quarter US GDP growth 6 4 2 0 -2 -4 -6 -8 2007 2008 Outliers 2009 Central trend 2010 2011 2012 GDP Growth Qo2Q AR

Source: UBS Global Asset Management

This recovery was always going to be weak simply because of the deleveraging process and the historical observation that recessions caused by financial crises always have slower recoveries. Unfortunately, there are few economic problems that a big dose of political uncertainty cannot make even worse. Withvery little hope of any decisive political resolution in either the Eurozone or US over the next few months, it is no surprise that firms are putting off investment and employment plans, andhouseholds are cutting back on their purchases. The market, or at least market economists, have been consistently surprised by the tone of the data. Using a surprise index to measure the disappointment in the data (see chart 2), the last three years suggest that you should always be more pessimistic than an economist between March and June. If only investing was actually that simple.
Chart 2: Triplicate

One economist who may not have been as surprised by the recent data is the chairman of the Federal Reserve, BenBernanke at least in terms of the labour market. On26March, Chairman Bernanke said in a speech that the recent improvement in the labour market data was actually surprising given the state of economic activity. He outlined a few possible explanations. One was that the unemployment rate might be falling because discouraged workers are leaving the market. A second, and morelikely, explanation is that what we had seen was simply catch-up from over-firing during the recession. In that case, to use his words, further significant improvements in unemployment will likely require faster economic growth than we experienced during the past year. With growth doing the opposite of speeding up, he will not have been surprised at the slowdown in the labour market. This may be why markets were somewhat disappointed by Bernankes failure to signal further quantitative easing during his recent testimony to congress. Both 2010 and 2011 also demonstrated that a downturn in the data does not necessarily mean a recession. Some commentators are now worrying about a US recession. A recession is always possible (although often not for the reasons that people forecast), but there is one very important following wind that should support the US: lower oil prices. Last years dip in the data followed a sharp rise in oil prices, but this year consumers will beenjoying the pass through of the sharp drop in oil prices since the first quarter. Oil prices have risen again somewhat in recent weeks, but as long as that gain remains modest it is likely that thisdata dip will turn out to be a duplicate of the previous ones.

Citigroup economic surprise index (a rising index denotes data that is coming in stronger than expectations, a falling index denotes data that is disappointing expectations)
100 80 60 40 20 0 -20 -40 -60 -80 -100 -120

Jan Feb Mar Apr May Jun 2010 2011 2012

Jul Aug Sep Oct Nov Dec

Source: Citigroup

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