The weak state of European banks has been a continued theme in our outlooks over the past year. The huge $2.6 trillion (2.0 trillion euro) balance sheet reduction over the next 18 months estimated by the International Monetary Fund (IMF) comes as little surprise to us. The IMF estimates that about 25% of this deleveraging will be accomplished by reducing lending, which is likely to dampen economic growth further. After improving for three months, the dramatic two-month falloff in the eurozone purchasing manager index (PMI) and continued reductions of economic forecasts indicate that Europe is likely to remain in recession territory and put some pressure on global growth.
European growth a continued drag
Source: Bloomberg. As of Apr. 24, 2012.
We believe the source of the recent downturn partly emanates from a further tightening of bank lending and we believe European banks, Spanish in particular, need additional capital.
China still has levers for growth
In contrast to Europe, China still has levers for growth and we believe a hard landing is unlikely. The manufacturing PMI remains below 50, but for a fast-growing economy, this means a weakening of growth, not necessarily a crash. Additionally, while economic growth in the first quarter of 8.1% was slower than expected, it certainly isn’t a disaster. The pace of monetary easing has disappointed the market, but the government may be pursuing a prudent strategy by allowing the air to come out of the economy a while longer, reducing imbalances in the structure of the economy.
The slowdown in the first quarter came primarily in two areas—exports and investment. While the Chinese government can’t do a lot to influence exports, it can influence investment spending. Property construction is likely to fall because the government is restricting growth. However, after a sharp falloff, there is likely an appetite to reaccelerate spending on infrastructure projects.
Contrary to concerns about too much infrastructure, in our opinion, China appears to be relatively underdeveloped, particularly in the inland provinces. The sharp increase in new loans in March is likely to reinvigorate growth, and we believe infrastructure spending is likely to benefit.
Surge in Chinese loans likely reinvigorates
Source: FactSet, Global Insight. As of Apr. 24, 2012. 1 quarter moving avg.
While second quarter economic growth could be weak again and hard landing fears are not likely to dissipate soon, sentiment is overly negative in our opinion. It is interesting to note that despite the rampant fears, the Shanghai Composite Index has outperformed over the past month.
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Important Disclosures
