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Cazenove's Jeffrey: will 2013 be third time lucky?

Cazenove's Jeffrey: will 2013 be third time lucky?

As world growth disappoints for the second consecutive year, will 2013 prove to be third-time lucky?

Current expectations remain relatively modest, for an improvement in world activity of just 2.5% in the coming year. A year ago, consensus forecasts were for an increase in world GDP in 2012 also of 2.5%, whereas the outturn looks like being around 2.2%. Lest you think I am about to say “I told you so”, I was at the more optimistic end of the range of expectations.

There was a relatively easy explanation for the undershoot in growth, versus earlier expectations, in 2011 – rising inflation and, behind that, an increase in commodity prices.

In nominal, or cash, terms, growth in 2011 was actually in line with what most economists had anticipated.

However, the demand destructive nature of rising prices became increasingly evident as the year progressed, depressing real growth. In contrast to this, we had expected a decline in world inflation during 2012 to make room for stronger growth. Evidently, this has not happened.

Weak domestic demand

The key to growth is domestic demand. While individual economies may show a growth stimulus from net exports (e.g. China and Germany), in a world sense, trade is a zero-sum game.

So why was it that domestic demand – made up of government spending, household spending, investment and inventories failed to kick in, despite lower inflation?

As ever, there is no single, common explanation for every economy.

For instance, it is evident that in the eurozone, the contribution to growth from households has been negative over the past year – unsurprisingly, perhaps. By way of contrast, household spending has been a strong contributor to growth in the US and better than many expected in the UK.

Nonetheless, there is one common theme evident in most countries: disappointing levels of fixed capital formation.

In the eurozone, capital spending has been a negative growth contributor for six consecutive quarters. In the UK, investment detracted from growth in 2011 and made a negligible contribution (0.1%) during the first three quarters of 2012. In the US, capital spending had been on a stronger path, but even there the growth contribution from investment has dropped sharply during recent quarters.

While credit conditions and the desire of companies to maintain balance sheet strength have undoubtedly inhibited capital spending, especially in Europe, uncertainty over the world outlook has also played its part.

The mere fact that global growth has been below expectations may be cited as the most obvious cause of this uncertainty.

Reasons to be worried

However, there are also more obvious reasons for heightened doubt with regard to future prospects.

In Europe, the lingering currency and financial crisis will have encouraged companies to put investment plans on hold. In the US, on the other hand, the presidential election followed by the threat of the fiscal cliff (and its consequences for the economy) will have caused companies to delay their capital programmes.

The problem in the UK would appear less specific, but general concern over domestic and international growth trends have clearly taken their toll.

So, what do we anticipate will happen in 2013? So long as politicians in the US are able to reach a compromise that limits the negative impact of the approaching fiscal tightening, then we would expect to see investment spending regain momentum in the first half of next year.

Significantly, perhaps, an improvement in the US housing market suggests that construction activity could soon become a more obvious contributor to growth.

In the eurozone, while domestic conditions may not improve significantly in the near term, signs that the Chinese economy has turned a corner (or, at least, passed an inflection point) may encourage exporters to boost their capital spend.

In the UK, it may be signs that the domestic consumer is becoming a little more active that helps spur stronger investment – along with improving conditions in markets overseas.

Against somewhat downbeat growth expectations for 2013, therefore, I will again position myself at the more optimistic end of the range of growth forecasts, on the basis that there is good reason to expect capital spending to surprise on the upside.

But in case we are tempted to get too exuberant in our hopes, this will be akin to finding an orange at the bottom of the Christmas stocking rather an a walnut. 

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