Growth slows, markets feeling good ahead of WEF meet in Davos

Much-feared worldwide panics from a collapse of the euro currency union have been avoided. China appears likely to remain an engine of global growth. Stocks are off to a running start in the New Year.

 

"There's a sense of relief that the worst didn't happen ... and I think that relief is probably justified," said Nariman Behravesh, chief economist at IHS Global Insight.

 

Davos is the venue for the World Economic Forum, an annual gathering of more than 2,000 decision-makers from nearly 100 countries and hundreds of companies that starts Wednesday. The WEF has taken "Resilient Dynamism" as the theme for this year's event.

 

Yet the global economy is expected to remain sluggish in 2013, with two of the biggest economies - the euro alliance and Japan - in recession. There's also a risk that the United States, the world's largest economy, may slash government spending - a step that could dampen the world economy. Few think global economic growth will even match last year's tepid 3.3 per cent.

 

Despite that, as fear of a catastrophe has eased, optimism appears to have taken hold among investors. The world's financial markets have surged. Both the U.S. Standard & Poor's 500 and Europe's STOXX 600 have risen 13.5 per cent in the past 12 months.

 

Fueling much of the improvement has been a flood of monetary expansion from the world's central banks. The U.S. Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank have purchased financial assets such as bonds with newly created money. The central banks have also slashed short-term interest rates to record lows - to near zero in the case of the Fed. The ECB has lent more than €1 trillion to banks at low rates.

 

The European Central Bank gave the eurozone its biggest boost when it offered last fall to buy unlimited debt of heavily indebted countries such as Spain and Italy. That action lowered their borrowing costs and eased fears that those governments would default.

 

Fears that the group of 17 European countries that use the euro would break up under the weight of its debt crisis faded throughout 2012. One factor bolstering the eurozone was the deal struck between Europe and the International Monetary Fund to stop Greece from being forced to default on its debts and abandon the euro.

 

As interest rates have dropped, investors have shifted money into stocks, real estate and other assets, driving up their prices. One of the biggest market jumps in 2012 came in Greece's own Athens stock exchange, where stocks catapulted 33 per cent. Even the yields on bonds sold by U.S. companies with subpar credit ratings - so-called junk bonds - have fallen.

 

Some pillars of the U.S. economy, like the housing, banking and auto sectors, have been gradually yet steadily recovering from the American recession, which officially ended 3 and half years ago. And relief was widely felt at the end of 2012, when President Barack Obama and the U.S. Congress cut a deal on tax rates and delayed the "fiscal cliff" of automatic cuts and tax increases.

 

Worries that China, the world's No. 2 economy, would suffer a sudden slowdown proved unfounded as the country's new Communist leadership appeared to signal its commitment to growth policies. Its leaders are trying to reduce China's reliance on exports by encouraging Chinese consumers to spend more at home.

 

Analysts caution that the still-sluggish global economy has little room for error.

 

IHS Global Insight predicts the worldwide economy will expand just 2.5 per cent in 2013, even less than last year's estimated 2.6 per cent. In the United States, unemployment remains elevated at 7.8 per cent. U.S. employers have held back on hiring and pay raises.

 

"There's lots of potential bad macroeconomic news," said Rabobank analyst Jane Foley. "And yet market sentiment seems to be very gung-ho."

 

Among the risk factors analysts cite:

 

-The heavy government debt loads in the eurozone, the chief concern from 2012, remain in place. Many worry that European leaders, facing citizen anger over government spending cuts in the midst of recession, will be reluctant to reduce debt and strengthen oversight of their banking system.

 

-A dispute in the United States over raising the government's debt ceiling, and dealing with automatic spending cuts, has only been postponed until early March. Even if the ceiling is raised, Republicans in the U.S. Congress will likely demand deep spending cuts as a price for voting to raise it. If U.S. government spending were slashed in the short run, it could slow the global economy.

 

-A potential conflict in the Middle East between Israel and Iran remains a continuing worry because it could disrupt energy supplies, driving up the price of oil and hurting growth. "That's the thing we just don't have a good handle on," said IHS Global Insight's Behravesh. "People haven't worried about it that much recently, but it's still there."

 

-Though China will likely continue to help drive global growth, its purchases and investments could increasingly favor Chinese companies, and "foreign companies and investors won't benefit," risk consulting company Eurasia Group argues. "We have to stop treating emerging markets as an asset class for outsized growth," the consultant said in its annual risk report.

 

-Some analysts warn that the cheap credit provided by the world's central banks has numbed markets to risk and could inflate the prices of some investments. The danger is that unsustainable bubbles in assets like stocks or real estate could eventually form, potentially leading to a devastating collapse in asset prices.

 

Rabobank's Foley says she fears that all the cash made available by central banks "has given people a license to turn a blind eye to the macroeconomic news."

 

Eventually, once economic growth accelerates, central banks will have to signal they're getting ready to withdraw that stimulus. Otherwise, runaway inflation could result from all the excess money pumped into the financial system. Yet that might not be until 2014 or even later.

 

Executives and finance officials arriving in Davos will have to get a grip on an uncertain economy that could end up causing surprise or disappointment. Now that it has dodged some major risks, Behravesh says the global economy might even outperform expectations.

 

"Is the glass half-empty or half-full?" he asks. "I think it's half-full. But it's nothing to cheer about either."