Global stocks continue to perform exceptionally well in 2013 … but you would never know it from the sad state of global economic growth.
Recent data from the Organization for Economic Cooperation and Development (OECD) shows the world’s major developed economies skidding toward recession in the fourth quarter of last year for the first time in over three years.
|Will the euro be the next currency heading to the chopping block?|
Indeed it’s clear that weak fourth-quarter U.S. gross domestic product (GDP) data was no fluke. Because, according to the OECD the combined GDP of 30 of its member countries contracted 0.2 percent between October and December.
It was the first coordinated economic contraction since the beginning of 2009, when the world was just emerging from the worst financial crisis since the Great Depression.
Meanwhile, standing in stark contrast to the downbeat economic data, the MSCI World Index of stocks managed to rally 7.4 percent higher since October 2012 in spite of the global gloom!
This just reinforces what I and others have long said: The economy and stock market are two entirely different things.
The stock market is a forward-looking reflection of growth prospects to come, while data such as GDP is backward-looking, in this case capturing global growth trends several months ago. Here’s the key takeaway: Don’t let gloomy economic headlines have an undue influence on your equity investment decisions.
Still, trends in GDP growth are a useful indicator for global investors to keep an eye on. This is true, perhaps not so much for what it tells us about stocks, but rather what it can foreshadow about profit opportunity in foreign currency markets.
Take a closer look at current global growth trends and you’ll see what I mean …
Coordinated Contraction in
Major Global Economies
The fourth-quarter contraction across the 30 OECD economies as a group was driven especially by weakness in the G-7 major developed economies. That’s no surprise considering the ongoing fiscal headwinds and government debt overhang in developed countries.
The German economy shrank 0.6 percent in the fourth quarter. Japan’s GDP declined 0.1 percent, a third straight quarterly contraction, while the U.K. shrank 0.3 percent. Only the United States among G-7 nations managed to avoid an outright contraction, with the OECD data showing a flat fourth quarter (see table above).
The euro zone as a whole contracted 0.6 percent after posting a smaller decline in the third quarter of 2012. And while economists are forecasting stability in the current quarter, it’s clear to me that Europe, like Japan, is mired in recession that may continue to linger.
And that’s where opportunities in global currency markets come into play.
Euro vs. U.S. Dollar:
Next Battleground in the Global Currency War
With the Federal Reserve engaged in apparently unlimited quantitative easing (QE) … aka money-printing … it’s no shocker to find the U.S. Dollar Index down 12.3 percent since the Fed first launched QE in 2009.
The Bank of Japan’s recent foray into another round QE has succeeded in pushing the yen sharply lower against the dollar, fanning fears about global currency wars in the process.
But the euro has also been a very big beneficiary of dollar weakness as QE by the European Central Bank remains on hold … for now.
In fact, the euro/U.S. dollar exchange rate has increased 12 percent over the past six months alone, but strength or weakness in foreign currency markets is a relative term. And two of the big fundamental factors affecting currency values relative to one another are interest rates, and economic growth prospects. Neither of these factors looks bullish for the euro at this point, as I’ll explain …
#1 Interest rate differential: Other things being equal, which they rarely are, global capital tends to flow into currencies that pay a higher interest rate. Today, however the major G-7 countries are engaged in a battle to the bottom — relentlessly pushing interest rates toward zero.
How low can you go … that’s the name of this game!
The Bank of Japan (BOJ) started the fight years ago in a desperate, and so-far futile, attempt to jump-start their economy from a two-decade plus bout with deflation.
Today, benchmark 10-year Japanese government bonds yield just 0.8 percent.
Undeterred by Japan’s lack of success at engineering inflation with near-zero rates, the U.S. Federal Reserve, Bank of England (BOE), and European Central Bank (ECB) all followed suit in pushing interest rates lower after the global economic crisis in 2008.
Today, benchmark 10-year German government bonds yield only 1.62 percent. Similar maturity U.K. gilts yield just 1.75 percent.
Meanwhile, in spite of the power of the Fed’s printing press relentlessly pushing interest rates lower in the U.S., our benchmark 10-year Treasury yields 2.01 percent today.
Interest rate advantage: US dollar!
#2 Economic Growth Prospects: Again, other things being equal, global investors tend to move money in the assets of countries with brighter growth prospects.
Whether you’re talking stocks, real estate or other assets … countries with higher growth rates generally produce a higher return on investment, so the thinking goes. Now, take another look at the OECD table above, and you’ll see the recent trend in GDP for the major G-7 economies definitely favors the U.S. (highlighted in green).
We are the one and only bright spot in an otherwise gloomy growth climate.
But this data is backward-looking, as I’ve pointed out. So how about a glimpse into growth prospects ahead? Again using OECD data, the chart below shows the organization’s composite leading indicators designed to be a predictor of economic activity going forward.
Just look at the trend in U.S. growth prospects (top panel). In spite of the disappointing fourth-quarter GDP report from the Department of Commerce, OECD data clearly shows U.S. economic growth is above-trend and getting stronger.
By contrast, look at the clear-cut down trend in growth prospects for Europe (lower panel). Although the OECD’s official forecast calls for the euro-zone economy to begin stabilizing this quarter, this trend is clearly not your friend!
Growth in Europe is well below trend right now and remains weak, in spite of a recent uptick. Meanwhile, U.S. growth appears to be rebounding from the fiscal-cliff slowdown late last year.
Economic growth advantage: US dollar!
If anything, U.S. GDP numbers are expected to be revised higher. And with a recession in the euro zone likely to persist, the U.S. dollar looks like it holds the key advantages in terms of higher interest rates … and stronger growth prospects … relative to Europe.
I’ll be keeping a close watch on these indicators in the weeks ahead, along with the trend in the euro/U.S. dollar exchange rate, and you should too. The Fed is all-in on QE already, so is the BOJ.
If the European recession persists, or gets even worse in the quarters ahead, you can bet the ECB will come under tremendous pressure to cut interest rates and engage in more QE (as the BOJ has recently done) seeking to push the euro lower and help boost European exports.
This could mean a big reversal of fortune for the U.S. dollar relative to the euro is coming soon. There are multiple ways to earn potential profits from this move including three ETFs worth considering:
#1: PowerShares US Dollar Index Bullish Fund (UUP). This ETF should benefit from a bounce back in the buck. Take direct aim at the euro with …
#2: Market Vectors Double Short Euro ETN (DRR), or …
#3: ProShares UltraShort Euro ETF (EUO)
Bottom line: Global currency wars are likely to remain in the headlines this year as the major developed economies attempt to devalue their way to more growth. It’s a race to the bottom alright, but each currency must take its turn on the chopping block.
The dollar fell 12.3 percent since 2009 in the first round of currency war …
Japan won the next battle with the yen plunging 16.7 percent just since October 2012 …
And the next casualty of the global currency war may well be the euro. Look out below!