by Richard Croft
January thaw
Markets heat up the coldest month
February 3, 2012
Even as global manufacturing gauges turned upward in January, Canada’s economy seemed to deflate a tad, as GDP contracted in November and manufacturing dropped sharply in January. That didn’t seem to trouble stock markets too much, however, as the January rally climbed the proverbial wall of worry and pushed into early February, albeit with signs of fading momentum.

It’s an indication of just how influential the energy sector is to Canada’s economic output that a 2.5% drop in oil and gas extraction was the anchor that led to a -0.1% month-over-month contraction in Canada’s GDP for November. Statistics Canada reported that maintenance shutdowns at the big oil and gas facilities cut extraction in November. The energy sector isn’t all to blame for shrinking output, of course, as output in construction and utilities also dropped in the month, adding to GDP shrinkage. Still, on a micro basis, Imperial Oil Ltd. reported a 26% year-over-year increase in fourth-quarter earnings, with full-year income of $3.37 billion, 53% more than in 2010, and the second highest it’s ever reported.

With the Canadian economy showing relatively weak monthly growth so far for the fourth quarter of 2011 (zero in October, for example), it seems increasingly likely that fourth-quarter GDP expectations will be revised downward, to somewhere around 1.5% from earlier projections of 2% from the Bank of Canada.

As if confirming the pallid state of Canada’s economic growth, a key Canadian manufacturing index slumped in January. The monthly RBC Canadian Purchasing Managers Index fell to 50.6 in January from 54.0 in December. Any reading above 50 indicates growth in the manufacturing sector, so January’s reading landed perilously close to the no-growth threshold. And to compound the rather gloomy gauge, new orders grew only modestly, expanding at a considerably slower rate than in December. Worryingly, new foreign work orders dropped noticeably in the month, and about 20% of survey respondents reported lower volumes of new export orders. As a consequence, employment in the sector fell for the first time since the survey debuted 16 months ago.

Probably the wobbly datapoints will lead to the aforementioned slowdown and perhaps some short term bumps in the equity markets. But longer term, we see nothing in the numbers that would change Bank of Canada rate policy. We also think that investors have discounted a period of economic slow-growth and baked revised earnings expectations into their forecasts.

In the US, meanwhile, manufacturing appears to be on the upswing in a mirror image of Canada. The Institute for Supply Management’s Manufacturing Purchasing Managers Index rose to 54.1 in January from 53.1 in December. Inventory rebuilding was the catalyst for the increase, according to ISM, as the demand for equipment and new cars stimulates sales in response to pent-up demand. For example, heavy equipment maker Caterpillar Inc., which recently reported estimate-topping fourth-quarter and full year earnings, said it had an order backlog of a record US$29.8 billion at the end of last year. And Ford Motor Co. boosted US production by 14% on rising sales as it reported its 11th straight profitable quarter.

Despite these encouraging signals, the US economy remains fragile. Consumer spending stalled in December, climbing only 0.1% over November, even as incomes rose at their fastest pace in nine months. Most economists point to an increased savings rate as the reason for slower spending, the implication being that consumer spending is likely to remain tepid through the first quarter of 2012 as well. Still, fourth-quarter US consumer spending grew 2% compared with 1.8% in the third, lending support to the annualized fourth-quarter GDP growth of 2.8%.

Over in the eurozone, it looks increasingly as if fourth-quarter gross domestic product will register a contraction of between -1% and -1.5%, and unemployment rose to 10.4% in December, a 13-year high for the 17-member single-currency zone. That number is skewed, owing to the crumbling economies of the eurozone’s weakest members, like Greece, Portugal, Italy, and Spain. In contrast, Germany’s unemployment rate fell to 6.7% in January, while Austria registered only 4.1% unemployment.

Manufacturing in the eurozone still registered contraction in January, as the Markit PMI posted a reading of 48.8, a five-month high, and up from 46.9 in December. So while the manufacturing sector is still contracting, it’s just not contracting as quickly. That trend, at least, is heading in the right direction.

Eurozone leaders last week (again) announced plans for a closer fiscal union without specifying details about how such a union would work or how the touchy issue of private debt would be cleared up. Indeed, a German suggestion for strict third-party oversight of Greece’s budget was shot down amidst howls of outrage. It’s difficult to see how any agreement for a “tighter fiscal union” can be achieved given the strong nationalist sentiment that still prevails in Europe. Meantime, the leaders also signed off on a permanent bailout €500 billion fund, called the European Stability Mechanism, which replaces the current European Financial Stability Facility, a sort of slush fund for deadbeat countries. That gave some support to the euro and boosted European stock markets.

In Asia, factory output is also showing signs of life. China’s official manufacturing index rose to 50.5 in January from 50.3 in December, while the probably more accurate HSBC/Markit PMI climbed to 48.8, still below the growth threshold. Export, import, and employment indexes all showed declines within the PMI, implying a growing probability of a “soft landing” for China’s economy this year. In turn, China’s monetary policy is likely to become more accommodative in the months ahead, in an effort to support growth and prevent a complete collapse of the real estate market.

India continues to post strong manufacturing growth, as the HSBC/Markit PMI rose to 57.5 in January, up from 54.2 in December. Despite the pick-up in factory activity, most analysts still see slower overall growth in the cards for India in the first quarter. Meanwhile, inflation continues to be a problem in the manufacturing sector, limiting the central bank’s ability to ease monetary policy to cushion any slowdown in overall GDP growth.

Elsewhere in Asia, however, manufacturing growth has been faltering, particularly in South Korea and Taiwan as exports to the European Union have tumbled in the wake of the eurozone fourth-quarter economic contraction.

Despite these signs and portents of slowing global growth, North American stock markets closed January higher than where they started. Toronto’s benchmark S&P/TSX Composite Index advanced 4.2% overall in January, overcoming fears of softening prices in the commodity complex.

In the US, investors took the big indexes for a ride to the upside in January. The Dow Jones Industrial Average gained 3.4% in the month, while the S&P 500 Composite Index advanced 4.4%. Incidentally, the S&P 500 witnessed a technical move called the “golden cross” in January, during which the 50-day moving average crosses over the 200-day moving average in a rising market – a technical move that’s often viewed by chartists as a precursor of rising bullish sentiment. However, skeptics argue that markets are more likely to correct after such a strong month-long rally, and that this “golden cross,” coming as late as it does in an established rally, is a classic false signal.





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