Do Equities Just Correct or Collapse in 2015?

The question on everybody’s mind for 2015 is when will the stock market start to correct in value and will it turn into a 50+% collapse?

Over the last 15 years investors has been through a lot in terms of market volatility. From the 2000 tech bubble bear market and the 2008 financial crisis bear market investors are far from having their investment psyche scars healing and is for good reason. Many sustained 50+% loss in their portfolio value more than once and are not willing to do it for a third time.

A large group of investors exited the stock market and has never returned. Unfortunately those who exited have missed the seven-year bull market rally to all-time highs. Those who remain in the market are in constant fear that a new bear market will emerge.

The stock market has a tendency to move in a 6 to 8 years cycle. With the current bull market now lasting seven years and was several indicators signaling weakness within the equities market it makes logic sense that a bear market is about to emerge.

The stock market cycle and technical indicators are not the only causes the trigger a bear market. A rising Fed funds rate can cause weakness in the equities market and if you know what to look for you can escape the next bear market and profit from falling prices.

Question: if you could put your money in a guaranteed investment not to lose any principle and receive a 1% per annum return on investment or receive potentially 7% per year but with no guarantee on your principle, which would you choose?

Most people would choose the 7% return option because they understand financial rewards almost always require some risk. Over the last 90 years the stock market has on average returned 7% annualized gains.

Obviously not all years will have a positive gain, but when averaged over many years, it is reasonable to expect an annual return of 7% from the stock market.

What if I told you there is a way to improve on this? For example, if you simply moved your equity investments to a large cash position at the start of each bear market?

The chart below showing the gain from your would have has from 1995 to 2015 by selling all stock holdings when the US stock market topped during 2000 and 2007 avoiding the last two bear markets.

100% cash position during bear markets would have generated 635% ROI, which is a 31% average annual return. The numbers are staggering to say the least. But obviously you cannot pick the exact top and bottom, but even if your timing was way off and you only pocketed half of those gains you would still be way ahead of game.
 

You may be asking yourself: How do I avoid a bear market?

I believe for investors this is not that difficult because a major trend change takes time and because the moves are so large you don't need to be perfect with your timing.

Take a look at my analysis charts below. The first one shows the 10 year treasury price which is broken its short term resistance levels and is rocketing higher. We have seen this happen 6-12 months before the last two bear markets started.

Let’s take a look at the Fed rates. 

Not every rate rise turned into a recession, but nearly everyone has. Rising rates will lead to a market downturn.

Could the next bear market/recession occur when rates start to climb? After analyzing economic data provided by Brad Matheny I have a max rate at 2% over the next couple years. 

That combination of technical indicators, analysis above couple with the rising fed rate hikes had created the perfect storm for a bear market to emerge which I expect to last 1-2 years.

Bottom line, we are still in a bull market but only months away from a bear market. Do not ignore these warning signals.

Keep your eye on the 2 year treasury rates instead because they usually lead Fed funds, and will provide an earlier warning signal as to the markets down turn.

When rates start to rise, we may only be weeks, instead of months, before the stock market starts to collapse.

Article contributed by Chris Vermeulen from Market Trend Forecast

Gold vs. S&P 500

Gold vs. S&P 500 – Where is the Value?

This past week we received the final 4th Quarter GDP number which came in at 0.39%. The total 4th Quarter growth was terrible, plain and simple. Based on the performance in the equity markets that we have seen thus far in the 1st Quarter of 2013 investors would expect strong GDP growth. However, the only thing spurring stock market growth is the constant humming of Ben Bernanke’s printing press.

The real economy and the stock market are no longer strongly correlated. Essentially, they are meaningless. How do you evaluate risk when Treasury linked interest rates are artificially being held down by the Federal Reserve? How do you evaluate earnings growth estimates when most government based statistics are manipulated or “smoothed” to perfection?

My final argument to anyone who is a true believer that the stock market is representative of the economy is a very simple premise. If the stock market is the economy, how does the stock market evaluate small business earnings growth when most small businesses are not publicly traded? It is a simple question, but I have yet to find a sell side analyst that can work around it with facts.

To back up this information, here is a chart courtesy of www.zerohedge.com that demonstrates the S&P 500’s price action compared to economic data and overall macro risk.

The chart above clearly depicts the divergence between the macroeconomic data and the performance of the S&P 500 Index. Yet the sell side continues to scream that stocks are cheap, earnings are going to ramp up later this year on insane S&P 500 earnings growth expectations, and the consumer is going to remain strong even though payroll taxes have increased and the “wealthy” are paying more in taxes.

Even amid those concerns, no one knows for sure what the impact that Obamacare and the various new taxes associated with it will have on the business community. Again, the only thing driving growth is directly linked to the Federal Reserve’s balance sheet expansion. The chart below is courtesy of the Federal Reserve’s website.

On August 8, 2007 the Federal Reserve’s total assets were $869 billion dollars. As can clearly be seen today, according to the Federal Reserve the central bank’s total balance sheet has grown to over $3.2 trillion dollars. The increase is on the verge of rising exponentially. With QE, QE2, QE3, Operation Twist, Extended Operation Twist, and now with QE 4 in Perpetuity this trend is certainly unlikely to shift.

At this point in time the Federal Reserve is printing roughly $85 billion dollars each month to purchase Treasury securities with a focus on the long end of the maturity curve. As primary dealers of Treasury securities process these flows the money eventually finds its way into riskier assets that offer higher rates of returns through balance sheet machinations at large money center banks.
It has proven that the flow of the Federal Reserve’s printed monies are more important than the total money stock for a variety of reasons and inflation according to the government’s data is under control ex food and energy.

However, how are people supposed to survive without food and energy in today’s world? The last time I went to fill up my gas tank or to purchase food prices have gone up significantly. According to the 1990 version of consumer price reporting, real consumer inflation is running around 6% currently and shadowstats.com has the following comparison.

Unfortunately the 1980 based inflation numbers are even uglier, which based on Shadowstats’ data chart would place consumer inflation at nearly 10%. The calculations being used by Shadowstats.com are based on the government’s OLD ways of calculating inflation. The calculations were adjusted over time and today the data is completely manipulated by not including items that typically experience the largest levels of inflation.

Normally I talk about price action, probability based option trading, and technical information. However, before investors consider buying stocks near the all-time NOMINAL (non-inflation adjusted) highs, why not simply consider the backdrop of the total economic situation.
Central banks around the world are printing money at an alarming rate and their balance sheets are growing to levels not seen in human history. Interest rates are being manipulated to levels that are historically at record lows or near record lows based on real inflation data.

Macroeconomic indicators are issuing a cautionary tone with significant divergences showing up in many areas. Earnings expectations for the S&P 500 in the 3rd and 4th Quarter of 2013 are extreme and borderline ridiculous.

So before jumping headlong into equities based on some sell side analysts recommendation or even worse, a financial advisor who is more interested in his/her commission than they are about producing gains consider the following comparisons.

S&P 500 Index (SPX) Price Chart – 1 Year Price History

Gold Futures Spot Price Chart – 1 Year Price History

Clearly paper gold represented by gold futures is no substitute for physical ownership, but when one considers the fundamental backdrop for gold versus the S&P 500 Index, it should be clear which asset is offering the most value at current price levels. It does not require any inserted trendlines or oscillators, it should be clear which asset is expensive and which asset is cheap based on the real long-term economic fundamentals.

Article contributed by JW Jones from Technical Traders

SP500 Wave Pattern

Final Stages of The Advance on SP 500-The Wave Pattern

Over at our TheMarketTrendForecast.com service we have been projecting  a potential rally pivot at 1552-1576 for many weeks now.  The recent drop to 1485 although harrowing, was a normal fibonacci re-tracement of the last major rally leg to 1531 pivot highs.  We believe that this 5 wave advance 1343 pivot lows is nearing an end based on mathematics and relationships to prior waves 1-3.

At 1569 the SP 500 would mark a perfect fibonacci relationships to waves 1-3 for this final 5th wave to the upside.  In the big picture, we are still working higher off the 1010 pivot lows on the SP 500, and this rally takes 5 full waves to complete. We think we are near wave 3 highs, and wave 4 correction would be up next, followed by another thrust to highs if all goes well this year.

That all said, a multi-week correction and consolidation wave 4 pattern is likely once we pivot at 1552-1576.  We should expect this correction to retrace anywhere from 80-100 points on the SP 500, but one week at a time.

 

Article contributed by Chris Vermeulen from Market Trend Forecast

Gold, Oil & the SPX Trends and Setups

Over the past year my long term trends and outlooks have not changed for gold, oil or the SP500. Though there has been a lot of sideways price action to keep everyone one their toes and focused on the short term charts.

We all know that if the market does not shake you out, it will wait you out, and sometimes it will even do both at the same time. So stepping back to review the bigger picture each week is crucial in keeping a level trading/investing strategy in motion.

The key to investing success is to always trade with the long term trend and stick with it until price and volume clearly signals change of trend. Doing this means you truly never catch the market top nor do you catch market bottoms. But the important thing is that you do catch the low risk trending stage of an investment (stage 2 – Bull Market, Stage 4 Bear Market).

Let’s take a look at the charts and see where prices stand in the grand scheme of things for gold, oil, energy and stocks…

Gold Weekly Futures Trading Chart:

Last week I talked about how precious metals were nearing a major tipping point and to be aware of those levels because the next move is likely to be huge and you do not want to miss it or even worse be on the wrong side of it.

Overall gold and silver remain in a secular bull market and hav gone through many similar pauses to what we are watching unfold with them over the past year. As mentioned above the gold market looks to be trying to not only shake investors out but to wait them out also with this 18 month volatile sideways trend.

A lot of gold bugs, and gold investors of mining stocks are starting to give up which can been seen on the charts when reviewing the price and selling volume for these investments. I am a contrarian in nature so when I see the masses running for the door I start to become interested in what everyone is unloading at bargain prices.

Gold is now entering an oversold panic selling phase which happens to be at major long term support. This bodes well for a strong bounce or start of a new bull market leg higher for this shiny metal. If gold breaks below $1500 – 1530 levels it could trigger a bear market for precious metals but until then I am bullish at the current price.  I do think we could see another spike lower in gold to test the $1500- $1530 level this week but after that it could be off to the races to new highs.

Crude Oil Weekly Trading Chart:

Oil had a huge bull market from 2009 until 2011 but since then has been trading sideways in a narrowing bullish range. I expect some big moves this year for oil and technical analysis puts the odds in favor for a higher price.  If we do get a breakout and rally then $130 will likely be reached. But if price breaks down then a sharp drop to $50 per barrel looks like the next stop.

Utility & Energy Stocks – XLU - XLE – Weekly Investing Chart

The utility sector has done well and continues to look very bullish for 2013. This high dividend paying sector is liked by many and the price action speaks for its self… If the overall financial market starts to peak then these sectors should hold up well because they are services, dividend and a commodity play wrapped in one.

 

SP500 Trend Daily Chart:

The SP500 continues to be in an uptrend which I am trading with until price and volume tell me otherwise. But there are some early warning signs that another correction or a full blown bear market may be just around the corner (Selloff in May??).
Again, sticking with the uptrend is key, but knowing what could happen in the coming months gives you some time to start looking for some great shorting opportunities for when the trend changes. Your transition from long positions to short positions should be a simple measured move in your portfolios and not a panic reaction.

Weekend Trend Conclusion:

In short, I remain bullish on stocks and commodity until I see a trend change in the SP500.
The energy sector is doing well and looks bullish for the next month or so.

Gold and gold miners, I feel they are entering a low risk entry point to start building a new long position. Risk is low compared to potential reward so depending on how things unfold this week I may start to get active in this sector.

Keep in mind that when the price of a commodity or index trades near the apex of a narrowing range or long term support/resistance level volatility typically increases as fear and greed become heightened. This creates larger daily price swings so be prepared for some turbulence in the coming weeks while the market shakes things up.

If you like my work then be sure to get on my free mailing list to get these each week on various investments for investment ideas at www.GoldAndOilGuy.com

Article contributed by Chris Vermeulen

Gold in cyclical low

GOLD should be completing a cyclical low in February

Over the past 5 calendar years we have seen GOLD either complete an intermediate cyclical top or bottom in each February.  My forecast was for February of 2013 to be no different and for Gold and Silver to make trough lows this month.  With that said, I did not expect the drop in GOLD to go much below $1,620 per ounce at worst, but in fact it has. Where does that leave us now on the technical patterns and crowd behavioral views?

First let’s examine the last 5 years and you can see how I noted tops and bottoms in the chart below:

That brings us forward to todays $1,573 spot pricing and trying to determine where the next move will go. To help with that end, some of our work centers on Elliott Wave Theory, along with fundamentals and traditional technical patterns of course.  In this case, the recent action around Gold has been very difficult to ascertain, and I will be the first to admit as much.  With that said, one pattern we can surmise is a rare pattern Elliott termed the “Double Three” pattern.  Essentially you have two ABC type moves, and in the middle what is dubbed an “X” wave, which breaks up the ABC’s on each end of the pattern.  For sure, if we add in traditional technical indicators along with sentiment, we can see very oversold levels coupled with the potential Double Three pattern and probably start getting long here for a trade back to the 1650’s as possible:

Obviously this chart shows oversold readings in the lower right corner using the CCI indicator. That said we would like to see 1550 hold on a weekly closing basis to remain optimistic for a strong rebound.

Article contributed by David A. Banister of Market Trend Forecast

Consider our free weekly reports or a 33% discount by going to www.MarketTrendForecast.com

IMF 2013 global economic growth forecasts

The International Monetary Fund (IMF) slightly lowered its forecast for global economic growth in 2013 to 3.5% (versus 3.6% forecast in October), and in 2014 to 4.1% (vs. 4.2% in October). The growth rate in 2012 stood at approximately 3.2%. In reference to the expected moderate growth in the next year, said the chief economist of the IMF: “It’s clear that financial markets are ahead of the real economy. The question is whether they are too much ahead or not… What we know is that it always takes some time for financial markets’ optimism to feed to the real economy and at this stage there are still obstacles to it.

The IMF economists estimate that the Eurozone's economy will contract in 2013 by 0.2%, compared to the previous forecast (October) of a 0.2% growth. The IMF warned that the Eurozone still poses a major risk to global economy. Nonetheless, they predict that the economic situation will improve and that in 2014 the Eurozone's economy will grow by 1%.

The IMF economists slightly cut their forecast for the U.S. economic growth in 2013 to 2% (vs. 2.1% forecast in October), but, at the same time also raised their economic growth forecast for 2014 to 3% (vs. 2.9% forecast in October). The fund said: “U.S. politicians have to insure that the country gets through the debates regarding raising the debt ceiling without severe fiscal restraints. Politicians must agree on a credible medium-term fiscal consolidation plan, focused on entitlement and tax reform.
The IMF did not change their estimates regarding the Chinese economy - a growth of 8.2% this year and 8.5% in 2014. The fund's chief economist said that "It’s not the rates that we saw before the crisis, but these rates are long gone”, but added that things are generally fine.

To summarize the global economic situation we note the phrase that the IMF managing director, Christine Lagarde, has coined: "We stopped the collapse, we should avoid the relapse, and it's not time to relax".

Positively, we should note that most of the economic data published this week in the U.S., Europe and China were encouraging. We mainly note the rise in the Purchasing Managers indices in January (PMI).

Regarding the European economy, we note the significant improvement recorded last week in most of the expectation surveys. However, expectation surveys continue to show the expectations for further contraction of the European economy in the coming months, even if at a relatively moderate pace (compared to the anticipated contraction in the fourth quarter).

Highlights regarding Global economy

The U.S. Congress voted last week in favor of a temporary increase of the U.S. "debt ceiling", which will allow the government to continue to operate until May 19th. However, the debate about the future fiscal adjustments that has raged between republicans and democrats may increase uncertainty in the financial markets in the coming months (towards the decision to raise the debt ceiling permanently). In addition, if U.S. politicians will do not reach an understanding regarding the automatic budget cuts (sequestration), then transverse cuts of $110 billion will take effect in early March.

More on the positive side, the ECB announced last Friday that the volume of loans repayments granted within the Long-term refinancing operations (LTRO) auctions was higher than expected, further evidence for the improvement in the liquidity of the financial system in Europe. European banks have decided to return to the ECB 137 billion euros, out of a total of 1.04 trillion euros that the ECB lent in two LTRO auctions, compared with estimates for a repayment of 84 billion euros.

Economic releases and events of the week

• Monday: U.S. durable goods new orders
• Tuesday: January U.S. conference board consumer confidence, expectations for a slight decrease
• Wednesday: U.S. GDP for Q4 Quarterly rate (expectations for +1.2% vs. 3.1% in Q3), U.S. Fed rate decision, U.S. Personal Income and Spending (both for December), Eurozone Economic Sentiment Indicator and Consumer Confidence Indicator (both for January)
• Thursday: December Germany retail sales for, expectations for an annual decrease of 1.3%
• Friday: Eurozone employment data (expectations for a slight increase in the unemployment rate), U.S. employment data (expectations for stability in the unemployment rate and an addition of 160 thousand jobs in January), Purchasing managers' indices (PMI) of the manufacturing sector in the U.S., China, and the Eurozone

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Wrangling of debt limit continues

Republicans and Democrats continue to wrangle regarding raising the long-term debt limit. President Barack Obama called the Republicans in congress to increase the country’s debt limit without preconditions, and emphasized that another conflict regarding fiscal issues, may lead to an extreme response of the financial markets. In addition to that, Obama said that the Republicans shouldn’t expect a "ransom" in the form of spending cuts for their agreement to raise the debt limit. The White House stated that it has no backup plan to pay the government's bills so the meaning of the congress not raising the debt limit is leading the nation into default.  During the weekend, Republicans announced that on Wednesday they would vote for a temporary increase of the debt limit, and emphasized that raising the long-term debt limit would be possible only if the government performs an equivalent amount of spending cuts.
Rating agency Fitch has mentioned this week the importance it attributes to the way they handle the crisis. More they mentioned is that it seems like Washington elites haven’t yet learned the lesson of the last fight over the debt limit in August 2011, when the Republicans and Democrats hesitancy eventually damaged the business confidence.
Most of the data published this week was quite encouraging. The recovery trend in the real estate market continues, jobless claims fell sharply, and private consumption increased at a sharper rate than expected in December. Nevertheless, we negatively note the rising pessimism reflected by the expectation surveys regarding the future of the American industry and the drop recorded in the Consumer Confidence Index.
Regarding U.S. monetary policy, Fed Chairman Ben Bernanke spoke at the University of Michigan and did not say that the Fed intends to terminate or slow down bond purchases. Bernanke emphasized that the double role given to the Fed (stabilizing inflationary pressures while supporting the labor market) justifies using aggressive monetary measures.

Economic data from Europe and China

Europe: Eurozone economic data point to the contraction of the European GDP in the fourth quarter. A third consecutive monthly decline was recorded in the volume of industrial production in the Eurozone, the German economy contracted by 0.5% in the fourth quarter, and the volume of bad debts in Spain keeps breaking the record. Positively, we’ll note the increase in the Eurozone's exports in November (+0.8%). The relatively sharp appreciation of the Euro could harm the recovery of the European exports, as marked by the Eurogroup chairman, Jean-Claude Juncker, that the Euro currency is dangerously high. On the other hand, one of the ECB members said he believes the current level of the Euro is not expected to threaten the European economy.
China: the batch of data published over that past week indicates an increase in the rate of growth of the Chinese economy. GDP in the fourth quarter rose by 7.9% year over year, compared to expectations for +7.8%, and a growth of +7.4% in the third quarter. The recovery in the growth rate in the fourth quarter was driven by a jump in infrastructure spending by the government, which began to grow in mid-2012, when concerns regarding the depth of the economic slowdown started to grow. Exports stabilized towards the end of the year, and china's large trade surpluses contributed to the positive momentum.
Additional data released on Friday pointed to an increase of 20.6% in the investment in fixed assets in 2012, compared with an increase of 20.7% (annual rate) on the first 11 months of the year. The industrial production rose by 10.3% in December and retail sales rose by 15.2% in December, vs. 14.9% in November.

Economic releases and events of the week

Monday: Eurozone finance ministers Meet in Brussels.
Tuesday: EU-27 Finance ministers meet in Brussels, ZEW Germany Assessment of Current Situation for January, U.S. Existing Homes Sales December (both expected to slightly increase). Draghi speaks at in Frankfurt.
Wednesday: IMF to release world economic outlook update, Eurozone Consumer Confidence Indicator for January, expected to increase slightly.
Thursday: Preliminary manufacturing PMI for January in China, Eurozone PMI (expected to increase from 46.1 to 46.6), Eurozone Preliminary services PMI for January (expected to increase from 47.8 to 48.0).
Friday: Germany – IFO Business Climate for December, which examines the economic assessments of the business sector; current expectations are for a slight rise in business confidence.

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EU improvement is not reflected in markets yet

The improvement in Europe's financial markets has not yet been reflected in the real economy. Economic data regarding the Eurozone continues pointing to the recession prevailing in the continent, and expectation surveys indicate the further contraction expected. However, the deterioration recorded in these surveys has recently stopped, along with the sharp decline in the probability for the Eurozone's dissolution. The essentials of the data published were the following:

• The Eurozone unemployment rate continues to soar to new heights and rose in December to a rate of 11.8%.
• A sharp decline in German exports and imports in November (-3.7% and -3.4% respectively).
• A second consecutive monthly increase in the Eurozone's Economic Sentiment index. We'll note that the low level still indicates the expectation for further deterioration of the European economy.

Despite the recession, the debt yield of peripheral countries continued to fall sharply. The ten-year bonds yields in Spain and Italy fell by about 17 basis points and 13 basis points respectively. The ten-year bond yield in Spain fell this week to below the 5% threshold for the first time since March 2012. Among the reasons which supported further yield declines we note the Japanese finance minister's message that Japan will start buying European bonds (which will be issued by the ESM, European Stability Mechanism) and other Euro denominated sovereign debt, as part of the new government's strategy to weaken the Japanese yen while supporting the European economy.

Last Thursday, during the press conference following the rate decision, chairman of the ECB, Mario Draghi, said that the decision to leave the interest rate unchanged was received unanimous, as opposed to the differences that arose among the members of the committee in the previous interest rate decision, that the debt crisis continues to subside, and that the deterioration reflected in the leading indicators has stopped. Draghi noted that the positive developments in the financial markets are not yet reflected in the real economy, and that the growth forecast's risk is that it still tends to the downside. We note that towards the weekend the Euro strengthened (against the dollar) in light of the decline in the probability for an interest rate cut in the Eurozone in the coming months.

Improvement in the U.S. and China

Economic data from last week regarding the U.S. economy reveals a relatively sharp rise in the U.S. trade deficit in November, a fact that will detract from the U.S. GDP in the fourth quarter. There was a sharp decline in  exports in October, that increased in November by 1.0%, to a level indicating an annual increase of 3.3% (vs. an annual pace of +1.2% in October). Imports rose sharply in November by 3.8%, and increased annually by 2.5% (vs. an annual pace of -0.7% in October).

In China: the CPI (Consumer Price Index) rose by 2.5% in the past year, compared to an annual pace of 2.0% in November and slightly above expectations. On the other hand, the PPI (Producer Price Index) fell by 1.9% in the past year. In the Bottom line, it seems that inflation in China is stable and relatively low.
In addition, we note positively that the higher than expected increase in the Chinese exports and imports gave financial markets hope that the trend of moderation in the rate of Chinese economy's growth has stalled, and that in the near future the growth rate will reaccelerate. Chinese exports rose over the past year by 14.1%, compared to annual increase of 2.9% in November, and Chinese imports rose by 6.0% compared with annual stability recorded in November.

Economic releases and events of the week

Monday: Eurozone Industrial Production, expectations for slight increase 
Tuesday: N.Y Empire State Manufacturing Survey, U.S. Retail Sales
Wednesday: U.S. Industrial Production (expectations for slight increase), U.S. Federal Reserve Releases Beige Book 
Thursday: Philadelphia Fed Business Outlook Survey (expectations for a slight increase to a level of 5.6), U.S. Housing Starts, U.S. Building Permits for December 
Friday: Collection of important data regarding the Chinese economy, University of Michigan Survey of Consumer Confidence Sentiment for December

Congress passed the “Fiscal Cliff” short-term solution

After the drama surrounding the fiscal cliff (tax hikes and budget cuts that were scheduled to take effect in early 2013), the U.S. House of Representatives approved on Wednesday a bill that prevented the "fall off the cliff". We emphasize that the understandings between the Democrats and the Republicans prevented an immediate entry of the U.S. economy into recession and led to sharp increases in global stock markets immediately after the agreement announcement. However, it is important to remember that there is still much work to be done in order to solve the U.S. fiscal problem, since the agreement reached reveals several of problems.



The first problem is that spending cuts were postponed. Current agreement focuses mainly on taxes while tough government spending cuts decisions were postponed and U.S. leaders will need to discuss and solve the budget cuts in two months, since in early March lateral budget cuts of 110 billion Dollars will automatically take effect.

The second problem is that the "debt ceiling" was not raised. In a few weeks the U.S. government's debts would reach the limit allowed by U.S. law, $16.4 trillion, and the government won't have an option to continue raising money in the markets. We should note that the debate regarding raising the "debt ceiling" is expected to be severe. It is likely that the Republicans who "lost" the fight over the fiscal cliff exploit the "debt ceiling" issue to force further budget cuts on the Obama administration, especially in the medical insurance and social security programs. On the other hand, President Obama stated that the budget cuts will not be negotiated with the Republicans and in order to solve the "debt ceiling" he requires a tax reform rather than cuts.

The debate regarding raising the "debt ceiling" will be the fifth debate in the past two years concerning U.S. fiscal issues. In each of the latest discussions, policymakers reached a solution, though at the last minute.

Rating agencies reaction: after the agreement was reached, Moody's declared that further steps must be taken in order to keep the U.S credit rating at its current level. Moody's noted that "Our ratings stance is to wait and see what the outcome of all of this is in the next few months, before we make any decision on the rating outlook or the rating itself. This is an important step, but it is the first step only", and added that "a lack of further deficit reduction measures could affect the rating negatively". S&P noted that the deal reached does not affect the 'negative' credit rating outlook of the U.S., and policymakers have a lot of work on their hands.

 

Global Economy: improvement in U.S. & China, recession in Europe & Japan

Last week was characterized by the PMI (Purchasing Managers' Indices) published worldwide. The Global manufacturing PMI rose slightly in December to a level of 49.8. While the PMI indicates expectations for further industrial expansion in the U.S. and in China, in Europe and Japan it indicates expectations for further economic contraction. In addition to the PMI, we note below the main data released last week.

U.S.: most of the economic data published in the U.S in the past week were positive. The U.S. labor market data (NFP) for December indicated that the recruitment of workers in the private sector was not affected by the fiscal cliff concerns, as net funding in the private sector was relatively higher than expected. In addition, the number of orders to U.S. factories (excluding transportation) increased during the past three months at an annual rate of 9.9% (compared with an increase of only 1.2% last year), and the ISM Non-manufacturing increased sharply than expected to its highest level since February 2012.

Europe: economic data coming from the Eurozone continues to point the recession. The Eurozone final PMI estimate for the industrial sector indicated a slight decrease, to a level of 46.1. The corresponding index of the service sector actually increased relatively sharply in December to a level of 47.8 (vs. 46.7 in November), which supported an increase in the composite PMI of all sectors in the Eurozone to 47.2 (vs. 46.5 in November). Despite the increase, the weighted index continues to stay under the threshold of the 50 points for the 11th consecutive month, and its level indicates the expectations for further contraction of the economy in the Eurozone.

Economic releases and events of the week

A batch of important data will be published this week, such as:

• Tuesday: Eurozone Consumer Confidence Indicator for December (expectations for no change) Eurozone Economic Sentiment Indicator for December (expectations for a slight increase), Eurozone Retail Sales for November and the Eurozone Unemployment rate (expectations for a slight increase to 11.8%)
• Wednesday: Germany Industrial Production for November
• Thursday: ECB interest rate decision (expectations for no change)
• Friday: November Trade Balance data for the US and China, China's inflation data (CPI, PPI)

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Growth forecasts for 2013

For the last review of 2012, we will present the economic growth forecasts for 2013 by leading institutions. Generally, the latest forecasts present a gloomier picture of global economy than ones from prior months do. Worldwide economic situation does not seem to get any better as, per IMF, "prospects have deteriorated further and risks increased".

• IMF: the International Monetary Fund global growth forecast for 2013 was revised downwards to 3.6%. IMF’s Chief Economist, Olivier Blanchard, said in the annual IMF World Bank meeting in Tokyo: “Low growth and uncertainty in advanced economies are affecting emerging market and developing economies through both trade and financial channels, adding to homegrown weaknesses”. Note that the IMF emphasized that its forecast was dependent on two crucial policy assumptions, that European leaders will get the Eurozone crisis under control and finding a solution for the fiscal cliff by the end of the year. A failure in achieving one of the above would lead the actual growth to be much lower.
• OECD: the Organisation for Economic Co-operation and Development cut its growth forecast for 2013 (for the 34 member countries’ economies) from the 2.2% forecast in May to 1.4%.  Pier Carlo Padoan, OECD chief economist, warned that the risk of a serious global recession cannot be ruled out: “Over the recent past, signs of emergence from the crisis have more than once given way to a renewed slowdown or even a double-dip recession in some countries”.
• ECB: the European central bank cut its growth forecast for 2013 to -0.3%, (compared to the September +0.5% forecast), following a growth forecast of -0.5% in 2012. The ECB president, Mario Draghi, said that weak Eurozone activity is expected to continue into next year, as leading economic indicators reflect the weakness of European economy. At the same breath, Draghi provided a more optimistic outlook, saying that a gradual recovery should start later in 2013, due to the expected increase in global demand and the positive effects of low interest rates in European economy.

Why balance of risks tends down

All leading organizations foresee a lower than expected global growth rate in 2013. The question on everyone’s mind should be why the balance of risks tends to the downside, meaning the actual growth rates might be even lower. Several factors may impair the growth rate of the global economy in 2013 and endanger the leading organizations' forecasts in the coming year, including the following:

• Uncertainty regarding politicians' actions: governments around the world, especially in Europe, have taken action for the sake of the stabilization of financial markets. After world's central banks have provided some kind of "safety cushion" for investors, its time the governments will start implementing pragmatic decisions which should lead to the stabilization of global economy. In this context, we note the IMF's words that "A key issue is whether the global economy is just hitting another bout of turbulence in what was always expected to be a slow and bumpy recovery or whether the current slowdown has a more lasting component". According to IMF's economists, the answer to that depends on how policy makers in Europe and the U.S. will deal with their short-term economic challenges.
• The fiscal multiplier and governments' austerity policies: most developed countries governments (excluding Japan) committed to take budgetary austerity measures, which are expected to hit global growth. That is even when taking into account that the planned tax hikes and the budget cuts in the U.S. (fiscal cliff), scheduled to the beginning of 2013, will be delayed. The fiscal multiplier is a measure of how changes in the fiscal policy (such as spending and taxation) would affect growth. According to recent calculations conducted by economists at the IMF, it currently stands at 1-1.5, meaning austerity measures that amount of 1% of GDP, derogate about 1.0%-1.5% of that country's GDP. In addition, the IMF estimates that austerity measures in the G-20 economies in next two years will exceed those recorded at 2012.
• Further decline in household and companies leverage: firms and companies in the financial sector will be another obstacle for the growth of global economy.

Two main austerity measures approaches

There are two ways to approach the economic policy:

• The Keynesian approach wishes to increase public spending by increasing the deficit during recessions, in order to stimulate the economy. To encourage public spending the government would usually reduce taxes.
• The non-Keynesian approach argues that the most important step for future growth would be to reduce the government's debt by tough austerity steps in order to reduce debt yields in the financial markets and make it easier for the country to raise more debt since Lower bond yields reduce the cost of borrowing.

Which approach is better for managing the debts crisis? The new Japanese government's approach is based on opposite principles than those applied by European politicians (led by Germany) in their struggle against the debt crisis, a very expansionary fiscal policy in Japan compared with the strict austerity policy in Europe. It will be interesting to examine the results of Japan's new economic experiment against Europe's old one which hasn’t yet been proved successful.

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