Things seem to be looking up across the world.
In Britain, unemployment figures came in better than expected yesterday. And in the US, the Federal Reserve was a little more upbeat. It won’t be raising interest rates for a while, it said. But most of the Fed’s ‘special liquidity facilities’ – the various programmes set up to prop up the banking system during the crash – will be allowed to expire at the start of February.
Naturally, stocks took a bit of hit on this news. Why? Because any hint of an improving economy takes us one step closer to the point where money starts becoming more expensive again.
And investors are right to worry about that. Because when the cheap money is yanked away, we’ll quickly find that it’s pretty much all that’s been propping the economy up…
Take unemployment figures with a pinch of salt
Britain’s unemployment data was better than expected. The jobless total rose by 21,000 between August and October, to 2.49m. But this was the smallest increase in nearly two years. And the claimant count – the number of people claiming unemployment benefit – actually fell by 6,300 in November, to 1.63m. That was the first fall since February 2008.
All very encouraging. But you need to take it with a pinch of salt. As David Wighton points out in The Times, one of the things holding unemployment down has been weak wage growth. “Nearly half of private sector settlements have been pay freezes.” This makes it easier for companies to afford to keep people in jobs.
Also “much of the strain of the downturn has been taken by workers seeing their hours reduced. The number of people working full-time is still shrinking fast.” The total number of part-time workers is at a record 7.7m. And recruitment of new staff is clearly in the doldrums – the number of 16-24 year olds out of work also hit a new record.
The trouble is, these sorts of measures – low wage growth and reduced hours – are temporary. If the economy doesn’t improve strongly, there’s every chance that these inch-by-inch cuts will develop into full-blown job losses.
There’s a lot of pain to come in the public sector
More to the point, the public sector hasn’t even begun to feel the pain yet. In the three months to October for example, state workers received an average annual pay rise of 2.8%. That compares to 1.1% for the private sector, reports The Telegraph. And the public sector actually added 23,000 jobs over the quarter. Local councils, says The Telegraph, have had to start laying off staff, with the majority of the new jobs created by central government. For a government that’s meant to be focused on cost-cutting and sorting out our deficit, that doesn’t look like much of a squeeze.
Post-election however, there will have to be big cuts, regardless of which party’s in power. Alistair Darling’s not prepared to spell it out to us yet, but if he wants to cut the deficit in half any time soon then some departments are going to have to suffer deep spending cuts. And rising taxes – particularly the National Insurance hike scheduled to come in – won’t do anything to encourage private sector job creation.
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Britain’s conflicting unemployment picture illustrates a bigger problem which stretches across the global economy. The slashing of global interest rates and the printing of money by central banks meant that it became easier for consumers and companies to service their debts. It’s propped up the housing market very nicely, for example, as my colleague Dominic Frisby discussed yesterday. The banking system has also been propped up by a certain amount of fiddling with accounting rules.
It’s far too soon for a return to ‘business as usual’
Some people are already asking: “Was that it?” They’re looking forward to things getting back to ‘normal’. They’re not expecting any great fireworks next year, but they don’t expect things to get any worse.
But they are almost certainly being too complacent. The global economy is still very imbalanced. Governments have taken on a lot of the debt that the private sector once had. The big worry is that all this cheap money might just have been plastering over the cracks. As soon as it’s whipped away again, we’ll find that there’s nothing to hold up the underlying economy.
That’s why markets were very ambivalent about the Fed’s mildly upbeat tone yesterday. And the notion that the flow of cheap money might end sooner rather than later had risk-averse investors heading for the dollar again this morning. That of course wasn’t helped by the fact that Greece has also received another downgrade, this time from credit rating agency Standard & Poor’s. The more troubled the eurozone looks, the less attractive the euro becomes.
The coming year will be tough for stocks
We suspect that money will remain cheap for longer than markets expect. Central bankers, terrified by Japan’s lost decades, aren’t keen to press the button before they absolutely have to. But even that wouldn’t be especially good news for stocks. As the Financial Times’ ‘market eye’ column points out on its website this morning: “What investors should be really concerned about is if the Fed doesn’t feel able to raise rates soon-ish. That would suggest equity investors have priced in a much rosier economic scenario than will prove to be the case.”
So either way, the year ahead is going to be a tough one for stocks. We’ve said it before, but we’ll say it again: stick with defensives and look for a decent dividend yield, because those are the stocks that will hold up best in the year ahead. My colleague Tim Bennett looks at some decent prospects in MoneyWeek magazine this week, out tomorrow . If you’re not already a subscriber, subscribe to MoneyWeek magazine.
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