Assessing the World’s Financial House: a 2011 Commentary
Written by Colin P. Kelley
The year of 2011 was filled with challenges for world economies and markets. European sovereign debt crises were the major contributors to the year’s economic and financial woes, but there were also global supply disruptions as a result of the prior Great East Japan earthquake and tsunami in March, as well as political unrest in the Middle East and Africa which brought oil supply shocks. For several months, Europe has failed to set forth actions to curb excessive national spending and borrowing. By the end of the third quarter, the economies of Greece and Italy began to collapse as they had fallen victim to a lack of strong fiscal discipline. Yields on government bonds in Greece, Italy, and Portugal skyrocketed, reaching beyond 30%, 14%, and 7% respectively. Other European nations have seen yields rise, most recently Hungary, after their bonds were cut to junk status by Moody’s. According to the terms of the European Union, member nations do not have the ability to freely print money. In the short-term, this has been a common method of easing national financial burdens. As a result, the European Central Bank worked over the third quarter and announced intentions to grow the ESFS’s rescue fund to over one trillion Euros in order to cut down enormous sovereign debt to GDP ratios throughout Europe. Although troubles in the European Union overshadowed fiscal problems in the United States during the third quarter, America could find itself in the same situation in the near future. The U.S. national debt surpassed $15 trillion, or a 102% debt to GDP ratio, during the quarter. In order to slow this massive increase in unsustainable debt levels, the Joint Select Committee on Deficit Reduction (“the Super Committee”) was given the task to cut $1.2 trillion from the deficit over the next ten years by November 23, 2011. As many expected, the Super Committee failed to come to a bipartisan agreement in time.
As a result of economic challenges, predominantly in the European Union, the IMF has forecasted year end 2011 GPD growth in the United States, the Euro Area, and other advanced economies to be 1.5%, 1.6%, and 3.6% respectively. These three figures have all been slashed in half from the 2010 GDP growth figures. China, India, and Brazil will see cuts in full 2011 GDP growth from 2010 figures also. Brazil will see the largest decline in economic activity, from 7.5% in 2010 to 3.8% growth at the end of 2011. Advanced economies are projected to see large declines in both imports and exports for the full year 2011. Imports will drop from 11.7% in 2010 to 5.9% by the end of 2011. Exports will fall comparably from 12.3% in 2010 to 6.2% for the full year 2011.
Weakening economic growth trends and sovereign debt issues have had enormous effects on equity markets. The S&P 500 experienced a 15% decrease over the third quarter. Major indexes worldwide followed suit. Investors sought safe havens during this time period, specifically U.S. Treasuries, gold, and high dividend yields. The utilities and consumer staples sectors were sectors that preformed relatively well, nearly breaking even for the third quarter. This performance was aided by a 5.4% increase in quarterly corporate earnings in those two sectors. The financial sector was the greatest underperformer of all ten sectors of the S&P 500, falling nearly 27% due to fears of exposure to European debt. Large downside surprises from Goldman Sachs and AIG more than offset positive earnings reports from Bank of America and Morgan Stanley.
Markets have recently started to recover as Europe’s leaders demonstrate stronger cooperation in resolving its financial crisis. The announcement of an updated European treaty which will focus on greater oversight over national budgetary actions was announced. In addition, news of the creation of the region’s permanent rescue fund, the European Stability Mechanism, by next year has lifted global markets by nearly 15% since the beginning of the fourth quarter. The dollar also continues to strengthen, appreciating nearly 13% since then end of August. However, these developments are considered short-term fixes and the underlying European sovereign debt issues remain. Until Europe’s “financial house” is stabilized, the United States and the dollar will continue to be viewed as the dominant and most sought after investment pair.