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All eyes are still fixed on the European credit crisis, whose underlying issues are still in need of resolution. The crisis intensified in the second quarter as Spain and Cyprus became the fourth and fifth of the Euro zone’s 17 members to require bailouts from the E.U.
A necessary fiscal and banking union should include several initiatives: common European banking regulation, a Europe-wide deposit guarantee scheme, Europe-wide labour market reforms, and a harmonization of tax rates across Europe for both individuals and businesses. The outcome of the recent E.U. summit surpassed the low expectations of the market, after so many disappointing prior summit meetings, and on July 9th EU leaders will meet again to ratify the euro zone’s permanent bailout fund known as the European Stability Mechanism. Some erosion of sovereignty is now to be expected by countries in need of EU bailouts in exchange for more “burden sharing” by the more “virtuous” countries. Any legislation indicating an acceptance of short term Euro bills as a prelude to longer term Eurobonds would be seen in a positive light by the financial markets as a further step toward European fiscal integration.

Central banks worldwide will continue to increase liquidity in an attempt to boost economic conditions. The Federal Reserve is likely to stimulate investment through credit easing to boost industrial borrowing, which will have a much better impact on the economy than purchasing treasuries. A cut of 25 basis points in the European short term interest rate, now at 0.75%, will have a positive effect on the European business landscape and may help to weaken the Euro to the benefit of European exporters. China also cut its benchmark interest rate today by a third of one percent, while Brazil is likely to provide further monetary and fiscal stimulus to its own economy.

The “fiscal cliff” the United States is headed for in 2013 will probably cost between 1-1.3% of U.S. GDP unless it gets pushed out further in time. This is still being built in to the market. On the other hand, positive trends in the housing market and in energy prices are very encouraging. Some analysts predict that lower energy costs may amount to $1,000 of additional discretionary spending in 2012 per household, with additional savings expected for 2013 and beyond. Indeed, the burgeoning natural gas and oil industry in the U.S. may prove to be a blessing to the economy. Natural gas is eight times cheaper in the U.S. than it is in Asia, and the U.S. is positioned to become the lowest cost provider to China even after liquefaction and shipping. It is also four times cheaper in the U.S. than in Europe. As American exports of gas begin (despite congressional debate on the subject), longstanding trade imbalances, particularly with China, may begin to stabilize. The first natural gas export license was approved last year, with eight more projects pending review from the U.S. Dept of Energy, poised to export 12 billion cubic feet per day. It takes four years to build a major export gas terminal, so the positive benefits to the U.S. economy remain medium to long term, but important changes are now afoot. It is estimated that the shale gas boom is on track to support 1.5 million U.S. jobs by 2015.

Given the unfavourable trend in unemployment, economics will play a large role in the upcoming U.S. election. A Republican victory would most likely be welcomed with a Wall Street rally, benefiting the pharmaceutical industry (unwinding of “Obamacare”), the oil and drilling industry (less environmental regulation), and the financial sector (less financial regulation).
The biggest positive for stocks might be associated with a lower tax increase for the wealthy, which would benefit consumption, particularly at the high end.

Grant Rogers

Partner

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