Goldman Says Good Riddance to 2011

"Not many market participants will lament the passing of 2011" is how Goldman starts a brief note today looking back at a year full of adverse shocks in order to judge the year-ahead's potential to destroy forecaster's perspectives. The 'shocks' as well as the known unknowns are summarized effectively as the experience of 2011 suggests that the global economy remains at a delicate juncture as we head into 2012. They note that by definition, shocks are unpredictable. But slowing growth (and in places outright contraction), public sector cuts, and a renegotiation of the social compact between state and society in different parts of the world is an environment ripe for political turmoil, and this may well be a source of more shocks as the year progresses.

 

Goldman Sachs: Good Riddance to 2011, a Year Full of Shocks

Adverse Shocks Weighed on Global Growth in 2011

Not many market participants will lament the passing of 2011. Global growth is likely to end up at 3.8% for the year, below the 4%-plus growth rates that we and the consensus expected at the start of the year. Global equity markets are solidly in the red, with only the US really managing to stay flat on the year, volatility has increased despite a decent pullback in the last month, and bond yields across many Eurozone economies remain perilously high. And yet it was a year that promised so much, with economic indicators such as US jobless claims and global PMIs visibly improving and markets moving higher into the start of 2011, only to fall back as a series of shocks affected the economy and the markets.

 

The first adverse shock was an increase in oil prices linked to the disruptions in Libya and more broadly the “Arab Spring”. As we discussed in a Global Weekly back in June (Anatomy of the Global Slowdown, GEW 11/21), the cross-sectional pattern of actual PMI falls across the world were related to estimated changes in response to a 20% oil price shock (somewhat less than the observed increase in oil and gasoline prices between February and April).

 

Second, global industrial activity was also impacted by the disruption caused by the East Japan earthquake and tsunami. The impact on Japan itself was significant, with industrial production falling sharply along with most measures of demand – Japan is likely to end the year with a growth rate of -0.8% yoy versus +1.1% that we expected at the start of the year. The disruptions were also transmitted globally, primarily via reduced supply of key Japanese components to the transportation industry, producing a drag on growth in some advanced economies including the US.

 

Finally, there was the shock of the ‘manufactured’ US debt-ceiling crisis and the subsequent downgrade of the US sovereign debt rating by Standard & Poor’s. While it is unclear if this had a measurable impact on economic activity, there was a sharp fall in several confidence indicators coincidentally, and cyclical assets reflected the risks to growth to a much greater degree than sovereign credit risk per se. Our US Wavefront growth basket moved sharply lower through July and August, and following the political stalemate through much of July, the Philly Fed business outlook survey fell to -30.7 in August and consumer sentiment fell back to late 2008/early 2009 recessionary lows.

A Fragile Global Growth Picture for 2012, Still Vulnerable to Shocks

In addition to the adverse shocks described above, 2011 also saw the crystallisation of three important and arguably ‘known’ risks that we highlighted at the end of 2010. First and most obviously, the intensification of the Eurozone sovereign crisis has extracted a significant toll on markets and the economy and a second recession in the Euro area is now likely after 08/09. On this front, we continue to remain concerned that without more decisive policy actions most of the risks to our already downbeat European economic forecasts are still to the downside. Second, as Jan Hatzius pointed out in a US Daily last week (A Retrospective on “10 Questions for 2011”), greater fiscal restraint at the state and local government level and a more protracted private sector balance-sheet adjustment process have been more significant drags on US growth than we expected. And finally, while EM inflation did peak over the summer months as anticipated, the policy tightening stance has only recently begun to shift, and the weakness in EM cyclical data is a key risk going into 2012.

 

In sum, the experience of 2011 suggests that the global economy remains at a delicate juncture as we head into 2012. The dynamics of a post-bust recovery that we have highlighted in past research are reflected in a growth outlook that is pretty fragile to shocks. The inability of the private sector to generate strong growth even as the public sector retrenches, coupled with central banks that have very limited room to ease policy, paint a picture of below-trend growth in advanced economies. This means that even moderate shocks like those experienced in 2011 can push an economy uncomfortably close to renewed contraction. Emerging markets are better placed in most of these regards, but it will be important to see the degree to which cyclical activity here responds to a shift in policy.

 

By definition, shocks are unpredictable. But slowing growth (and in places outright contraction), public sector cuts, and a renegotiation of the social compact between state and society in different parts of the world is an environment ripe for political turmoil, and this may well be a source of more shocks as the year progresses. At the same time, with a number of important political transitions coming up in 2012 (in Russia, France, China and the US to name only a few), there is also the possibility of more thoughtful debate and closure on some of these issues.