U.S. Capex: Beyond the Fiscal Cliff

Conditions are ripening for a modest bounce in U.S. capex, so long as the fiscal thrust in 2013 is manageable.

US Capex, Beyond The Fiscal Cliff

I t is now well known that U.S. capital spending has already been a primary victim of the impending fiscal cliff. In particular, uncertainty surrounding future tax policy has immobilized the corporate sector’s capital spending plans and various business surveys have highlighted that outlays are at least temporarily on hold because of government policy.

For example, the Philadelphia Fed survey of capital investment intentions is approaching a level that typically corresponds with recessions. The survey is a good leading indicator for overall non-residential fixed investment and suggests that investment will weaken further in the next six months. However, the ‘good news’ is that this oscillator is already near its weakest level (excluding the 2008 experience at the height of the Great Recession). There is historical precedent for a sharp snap back in sentiment, should the fiscal cliff get resolved in a mild manner (our base case is for a drag of 1.5% of GDP).

Importantly, fundamentals suggest that absent a fiscal cliff, the outlook for capex spending should brighten somewhat in 2013 relative to this year. Consumers are past the worst in terms of deleveraging, the Fed has further committed to aggressive monetary policy for an extended period and the corporate sector’s balance sheets are still healthy.

Bottom Line: There is potential for a ‘catch up’ phase in investment spending beyond the fiscal cliff.

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Precious Metals Consolidation

Near-term liquidation in gold is possible, but the cyclical bull market will remain intact.

precious metals consolidation

A ccording to our Commodity & Energy Strategy service, precious metals are trading more like liquidity plays than “safe havens”. Hence, speculative liquidation and a dollar bounce alone are sufficient to spark corrections in these metals.

Nevertheless, the staying power of any liquidation should prove limited beyond the next month or two. The underlying trends in gold and silver will be influenced by the continued low level of interest rates and central bank efforts to expand liquidity.

As long as interest rates remain far below historical norms, the dollar will have difficulty rising significantly and funds will continue to flow into precious metals ETFs. Moreover, platinum and palladium stand to benefit when the depressed global auto demand cycle normalizes – a process that should begin in 2013.


Cliff “Riot Point” Already Underway?

Financial markets have entered a more volatile period. Panic has not yet set in, but investors are reacting earlier to the fiscal cliff than they did to last year’s debt ceiling deadline.

T he re-election of President Obama suddenly focused market attention on the risk that gridlock could allow the country to fall off the cliff, at least temporarily. Indeed, Congress is extremely polarized by historical standards and the election has arguably aggravated the situation.

Concern about riot points led our U.S. Bond Strategy team to tactically downgrade spread product to neutral. Relative to equities or commodities, spread products continue to offer a better risk/reward balance.

Indeed, the longer-term outlook for U.S. spread product remains favorable based on the steady tailwind provided by easy Fed policy and a gradually healing domestic economy. However, gains are unlikely to be realized until policy uncertainty dissipates sometime after Q1 2013.

Bond Markets Are Mispricing Government Solvency

Bond markets are obsessed with the level of government debt. But solvency is not just about debt servicing costs.

A country’s solvency relies on an economy’s ability to generate growth, and its government’s ability to deliver primary surpluses. The U.K. government has a lower debt servicing burden than most of its European neighbors. But the country will face much stronger headwinds to future growth and it also has a poor record in producing primary surpluses.

Putting this together, it is clear that the solvency of the U.K. is not materially different to that of Italy or Spain – and considerably worse than the solvency of the euro area in aggregate. However, the bond market is not priced accordingly: 7-10 year sovereign yields trade at 1.5% in the U.K. compared with 5% in Italy and Spain and 2.5% for the euro area weighted average.

Until recently, there has been a very good reason for this polarization in yields. The U.K. sovereign has a lender of last resort – the Bank of England – which has been aggressively buying U.K. gilts. In contrast, the Italian and Spanish sovereigns did not have such a backstop, making them victims of a classic liquidity crisis. But with the ECB’s pledge to “do whatever it takes”, the mispricing of sovereign risks in Europe should now gradually correct.

Our European Investment Strategy service recommends a structural overweight position in euro area (weighted-average) bonds relative to U.K. gilts.

Can The Debt Supercycle Migrate Beyond The Developed World?

The Debt Supercycle is on its last legs in the developed world, but investors should not look for a full-on migration to the developing world.

Can The Debt Supercycle Migrate Beyond The Developed World

T he supercycle could not have become entrenched in the G7 if policymakers did not believe that it worked. A simple comparison of year-over-year changes in private indebtedness with year-over-year changes in nominal GDP growth suggests that it did: increased borrowing was associated with expansion across the G7.

Developing world officials wishing to replicate the supercycle in their own countries would be abetted by currently light debt burdens. Emerging economy balance sheets are relatively pristine compared to developed economy balance sheets, with narrower budget deficits helping to keep them that way. But more credit-reliant economies in EM are not a foregone conclusion.

As a group, emerging economies lack the income, infrastructure and credit culture to make full use of their apparent capacity. Moreover, the leading emerging markets need time to digest the acceleration in the rate of credit expansion that has already occurred. Investors should nonetheless expect financial deepening and an expansion of social safety nets as developing world wealth increases.

Long-term investors can best position for the waning of the supercycle in the developed world, and financial deepening in the developing world, by increasing exposure to emerging market financials and health care equities and debt.