Somebody- I don’t know who- created a wonderful expression to characterize the state of the world after 2008. “The new normal” refers to the current moment, where indecision and uncertainty prevail. It differs from before 2008 because, more than ever, nothing should be taken for granted in economic terms, and we have to be alert every day. There are those who believe that once we pass this period everything will go back to normal. I don’t know about that but I know that this will last for few years due to the situation in Europe, US and China. The uncertainty causes extreme volatility in the markets; it’s getting harder and harder to protect your assets from unpredictability. The old notions of portfolio management- buy good assets and hold, look for yield and wealth preservation- are under attack as it becomes increasingly difficult to identify what qualifies as a good asset. The downgrade of US treasury bonds didn’t change anything, and that is still the asset of choice in “risk off” moments. That is amazing, considering that the yield is smaller than the inflation rate. Those who are not aware of this change of pattern will be surprised by the loss of wealth. It helps if you have a vision of what is going on and which story to follow, and the ability to act accordingly with your investments.
As I have said other times I still believe that the US economy is the one to bet on. In the US, we find the country more divided than it has ever been before. It is very difficult to know who will be the next president and even if we could predict that, it is hard to say who will win the Senate and House. There are several possible combinations and most of them lead us to believe that we will continue to have a dysfunctional Congress - a Congress that doesn’t pass any laws due to the political divide. We will probably face the “fiscal cliff” which could lead to a double dip in 2013 or at least a slowdown in growth. Estimates of the impact are of 4% of GDP and will vary according to the combination that will win the election.
Last week Obama won two victories with the Supreme Court decisions on immigration and health law. Those wins will not translate in increasing his electoral chances, but they will change the debate. Romney will try to get more voters in order to repeal the law. Obama will remind Romney’s voters that Romney is a flip-flopper and implemented a law in Massachusetts that inspired the federal law. On Friday, the market celebrated the results of the summit in Europe, but as the saying goe, “the devil is in the details.” The short-term impact was positive but as the structural problems are untouched the question is how long this will last.
As an economist, people look at me and always ask, “Is the economy getting better?” I learned that nobody is looking for an answer with an economic analysis. What people want to know is if their income will keep up, if their wealth will go up and if the market will go up or down. Bottom line, people are thinking about the stock market and the Dow Jones. If the market is up, you feel better, if it is down, you feel things are getting worse. That is why people are so confused right now with the ups and downs of the market. In the beginning of the year, the market was up almost constantly, due to better American indicators and the measures taken by the Europeans. The Dow reached 13.300. However, in March, Europe started to produce bad headlines again and the American economic indicators started to deteriorate. The Dow Jones reached 13300 but then came as low as 12.100 in the beginning of June. What has changed in the second trimester? The European periphery had to pay higher rates to sell bonds, the American indicators were not so good and the analysts started to believe that the slowdown in China was worse than expected. Other economies, amongst them Brazil and India, worsened as well.
Speaking of Brazil, last week the government announced yet another set of policies aiming to stimulate growth. In the past few years, while Brazil was cruising along in terms of economic growth, several reforms essential for the sustainability of the economy in the long run were not made. The country was on automatic pilot, except for the second semester of 2008. Now that the global economy had slowed down, the Brazilian economy is suffering. I am skeptical in regards to the impact of the new policies. In very simple terms, when there is growth people go into debt, thinking that things will stay the same forever. When there is a slowdown, employment and income disappear but the debt is still there.
On Monday, the markets were already giving back the gains of Friday; on Tuesday the Dow closed higher at 12.944. Depending on the upcoming economic news , the developments in Europe in China and finally, the earnings seasons, the Dow could surpass 14000 or come back to 12.200. That is the new normal, make your bets.