THE END OF one year is always a time of reflection and to think and plan for what lies ahead in the coming year. Unfortunately, forecasting the shape of the investment landscape next year is a particularly hazardous venture, given that today’s uncertainties are much greater than normal. But we need to at least clarify the issues, sketch out as best we can the main contours of this landscape and work out the implications for us in Southeast Asia.
Global economy: More downward surprises
It is tempting to think of the positives in the global economy and persuade ourselves that the worst that can happen is a moderate slowdown followed by a pick-up in late 2012, as seems to be the consensus. In our view, there may well be a rebound in late 2012, but only because the slide in the early part of the year could be very bad indeed.
We say this because the weaknesses that are appearing simultaneously in different regions will feed off and reinforce each other, so producing a far-more dire scenario than if we assess each individual risk separately. The just-released Organisation for Economic Co-operation and Development lead indicators confirm that the outlook for most major economies is a material slowdown through mid-2012, at least. Add to that the following factors that we will discuss below, and it is clear that things can only get worse:
- Geopolitical risks are worsening, with implications for oil prices and risk appetites;
- The eurozone crisis has not been resolved and will get worse before it gets better. Tensions will build there until there is a crunch that finally forces its political elites to forge policies that resolve the crisis;
- The lead indicators point firmly and unequivocally to a simultaneous slowdown
- in the US and virtually every single other major economy; and
- There are internal stresses within Asian countries that increase their vulnerability to the external shocks that are certain to hit them next year. Asia’s challenges do not only come from a weak global environment.
Geopolitical risks: Watch the Middle East’s impact on oil prices
The rising tensions in the Middle East are not just something interesting to watch on the news. Political turbulence there raises the risk premium in oil prices and can drive up the cost of energy and transportation. We think this risk premium will rise and keep oil prices higher than they should be. There could even be occasional sharp spikes that could be debilitating for a global economy that is already slowing.
Syria and Yemen are on the brink of civil war. While they are not major oil exporters, their travails will probably hurt us all in 2012. Yemen borders key oil producers such as Saudi Arabia and overlooks major transportation routes for oil. Syria lies adjacent to Israel/ Palestine, Iraq and Lebanon — a regime collapse in Syria could destabilise these other hot spots. The situation in Syria looks alarming, with the pace of killings accelerating sharply in the past week.
The key oil producing countries in the Middle East are also more fragile than before. Saudi Arabia, which produces about 12% of world oil, bears watching as it faces neighbouring states that are unstable and internal problems over royal succession. In addition to Yemen, the Saudis also have to worry about Bahrain. Bahrain’s internal divisions between a resentful majority of Shia Muslims and a minority Sunni monarchy are heating up again, with Iran allegedly stoking tensions there. Bahrain lies adjacent to Saudi Arabia’s eastern province where much of its oil is produced — and where a largely Shia population turns restive whenever there are tensions in Bahrain. There are also risks associated with the royal succession. The highly respected 87-year-old King Abdullah, whose astute and moderate policies have kept Saudi Arabia stable, is not in good health. His 86- year-old half brother and the crown prince recently passed away and was replaced by a 78-year-old new crown prince with a reputation as a hardliner.
In short, too many stress points are turning critical at the same time: It is quite clear the risk premium will rise.
Eurozone: Economy in recession, policymakers stumbling their way to resolving crisis
There are some things that are quite clear about the direction the eurozone is set to take in 2012, and they are mostly negative.
The economy is weakening and it is virtually certain that the eurozone will be in recession in 2012. The lead indicators and the massive fiscal consolidation underway point clearly to this, and the recent trend in production and consumer spending validate the conclusion. As the economy worsens, budget deficits will be harder to bring under control, adding to financial market uncertainty.
Moreover, as ordinary voters actually experience job losses and the withdrawal of welfare benefits, a political backlash is inevitable — there will be more street protests and labour unrest. This will make the process of ratifying eurozone agreements to resolve the crisis all the more difficult. French President Nicolas Sarkozy faces a tough re-election battle: His main challenger, Socialist candidate Francois Holland, has made clear that he will seek renegotiation of the eurozone accords if he were elected.
Eurozone leaders are still unable to devise a credible package that comprehensively resolves the key stress points in the eurozone. The summit meeting in early December gave some comfort on longer-term issues such as devising a fiscal compact to ensure that there would be no recurrence of a sovereign debt crisis. But it fell short of giving what is needed to address the current crisis.
The key to a much more positive outlook for Europe is for the European Central Bank to commit to buying unlimited amounts of sovereign bonds. But it is unlikely to do so until the political and economic pressures are intense enough.
The US: Political gridlock and legacy of crisis threaten economic recovery
Expectations for the US economy have turned a tad more optimistic on account of improving data on consumer confidence and spending, emerging signs of a more stable housing market and a steadying labour market. Four years of painful adjustment in the US have produced some progress and it would be wrong to be overly bearish on the US. Nevertheless, it is also clear that the current optimism is likely to be reversed.
Some of the improvement in economic performance in late 2011 is due to growth being borrowed from next year. Consumer spending outperformed expectations because the household savings rate fell sharply. This is not sustainable — the savings rate will have to rise again in 2012 and that will slow consumer spending, which is 70% of the economy. Business spending on capital goods has also improved, but a good part of this is probably due to fiscal incentives that expire this month, which caused businesses to rush forward their capital spending from next year to this year.
No matter how one cuts and slices it, the fiscal stimulus of the past few years will turn into a fiscal drag. While political leaders will probably fashion a last-minute compromise on the budget, the most we can expect is that they will vote to extend some but not all of the expiring stimulus measures. The net result will be a fiscal impact that takes at least 1% of demand out of the economy in 2012.
In addition to a fiscal drag on the economy, there will be a political drag as well. President Barack Obama faces the toughest re-election battle of any US president since President Jimmy Carter in 1980 and there is a rising chance that he will lose. This creates great uncertainty for businesses regarding key policies that will affect them, particularly as Obama has adopted a more populist tone of late, bashing the excesses of the financial sector, in particular. The natural response of business in such cases is to postpone major spending and hiring decisions. That will slow the economy.
Of course, if Republicans and Democrats play brinksmanship again on the budget or other critical policy issues, this political drag will be much worse.
The one factor that could potentially turn around this downbeat assessment is if the housing sector recovers more quickly than we expect. The latest indicators do show improving homebuilders’ confidence and stabilising prices, with key drivers of demand such as affordability at multi-decade highs. The problem is that with mounting foreclosures and a massive overhang of surplus housing, buyers and the banks that fund them have little confidence about buying when prices could fall further. If the policymakers are able to come up with innovative policies that place a clear floor to home prices, we could see a turnaround in US housing that could kick-start the US economy through its huge multiplier effects. Our view is that such a turnaround is not likely until 2013 or 2014.
Asia: Internal challenges should not be underestimated
We explained in our previous column why we felt China would face some challenges in 2012 and would therefore not be as supportive of other Asian economies. The issue in China is not one of a hard landing — the government has the resources to respond to shocks to prevent a downturn spiralling into a hard landing. And expectations of easier policy will certainly help boost the financial markets. However, government responses take time to be implemented and in the meantime, the sharp slowdown in exports, unwinding of speculative bubbles, faltering informal lending sector and dangerously high local government debt will certainly interact with each other to create greater challenges than markets expect. Economic growth will slow sharply for one or two quarters and there are bound to be occasional episodes of financial stresses that alarm financial markets. In short, China can mitigate potential shocks but cannot avoid them.
A similar picture is taking shape across other parts of Asia.
In India, industrial production is falling, as seen in the just-released October data, and there are growing concerns over overleveraged Indian companies that may struggle to repay their foreign currency debt now that the rupee has fallen so much. In addition, it is quite clear that the ruling coalition is so burdened with its to provide the country with the leadership and reforms needed. Although India will probably end 2012 growing more than 5%, this will be a huge letdown from the 8% a year that it should be growing at were it not for political and policy failures.
Indonesia is in better shape than India. It is likely to enjoy an upgrading of its sovereign rating to investment grade soon and domestic demand remains firm. But because it did not use the good years to clean up its business environment so as to boost investment, and because it has not succeeded in reforming labour laws, it has failed to take advantage of China’s rising costs. As such, it continues to depend excessively on high commodity prices, something that is at substantial risk in 2012.
Vietnam continues to struggle with high inflation, large current-account deficits and concerns with excessive debt and weak banks. A global environment where its exports weaken and capital outflows intensify could create a significant challenge for its policymakers.
Several countries face groundbreaking political changes with significant implications for the economy. Taiwan’s elections in January could be make-or-break for relations with China. South Korea’s pro-business ruling party faces defeat in next year’s parliamentary and presidential elections that could result in a less business-friendly government. There could also be a general election in Malaysia that will show whether the ruling coalition can regain the support it lost in the 2008 elections.
Singapore will endure a sharp deceleration in economic activity. Because it enters this period with a higher cost base and a strong currency, there will have to be some painful adjustments to deflate costs and regain competitiveness in 2012/13, which will consequently be tougher years for Singaporeans.
The bottom line is, Asian economies have not decoupled from the ructions in the global economy and they have internal challenges that could amplify the impact of an externally induced slowdown. Nevertheless, as we approach the latter part of 2012, we will also see positives emerge — Europe will gradually put in place solutions to its crisis, Chinese policy reactions will start taking effect and there will be some signs of a turnaround in the US. Investors need to be cautious but they should also not be carried away by excessive pessimism.
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