Global shifts: World events raise the stakes in financial investments
Senior vice president, Bayside Wealth Management, Portland
In mid-February, the S&P 500 hit something of a milestone when it reached levels that were double where it was in March of 2009, the depths of the “Great Recession.”
Even though this economic recovery has been weaker than past recoveries — the United States’ labor market has yet to truly turn the corner, the housing market remains weak and consumer deleveraging has been a headwind to economic growth — the stock market has still performed well in the past two years. After plunging 37% in 2008, the S&P 500 generated total returns of 26% in 2009 and 15% in 2010.
Looking ahead, there continue to be arguments for optimism: strong corporate profits and balance sheets, accommodative Fed policy to encourage growth and reasonable stock valuations, to name a few.
However, the escalation of tension in the Middle East and North Africa that began in February, and the human tragedy and nuclear crisis caused by natural disaster in Japan, represent significant near-term risks.
Initially, equity markets largely shrugged off the ratcheting up of unrest that began earlier this year in Egypt, but as tensions spilled into oil-producing states such as Libya, equity market sell-offs became more significant. More recently, the tragic events unfolding in Japan added to uncertainty and erased what had been a strong start in equity market performance in 2011.
Among the concerns that have shaken investor confidence is the price of oil. While recent concerns and supply disruptions have driven oil prices to slightly over $100 per barrel, it is unlikely to derail the global economic recovery. However, a more permanent move to $120 to $130 per barrel could bring the fragile economic recovery into question.
Although surging oil prices can pose a threat to economic expansion, bear in mind that crude prices are still a third below peak prices reached in 2007. While higher energy costs can reduce consumer consumption by effectively acting as a “tax” on spending, the impact may prove only temporary as tensions ease in the Middle East and other oil-producing states begin ramping up production.
Also worth significant note, payroll tax reductions are being phased in and will create an offset to higher oil prices. This could boost consumption or, at the very least, make up for some or all of the increases consumers have seen in their energy bills recently.
Most recently, investor focus (and world focus) has been on Japan in the wake of its record-setting earthquake. In addition to the human toll, critical damage was done to nuclear power plants and facilities in the region, causing uncertainty and debate about what the ultimate global economic impact of this event will be. Until the situation is under control and more efforts can be made to gauge the true nuclear damage, uncertainty will play a role in the psyche of investors. As with any significant uncertainty, it will create a headwind for equity markets that will likely keep them range-bound for the time being.
If we could assume no further deterioration at nuclear power plant facilities, the economic fallout may not be as bad as some fear. The damage to the major business centers of Japan was somewhat limited, as most of the destruction was focused on the northeast coast, which accounts for a smaller portion of Japan’s industrial output. The major business centers outside of the worst-affected areas are already moving toward normalization, and ultimately the reconstruction demand should boost economic activity to higher than usual levels in the second half of this year.
In 1995, Japan was hit with a 7.3 magnitude earthquake in its Kobe region. If the economic impact and recovery there can offer us any guidance, we would note several things: Following an initial decline in economic output, one month later economic output rebounded sharply. Also, the Kobe region accounted for greater industrial production than the north coast of Japan. That said, while the global economy may not be dealt a significant blow absent further deterioration in nuclear facilities, the challenges Japan’s economy has faced for the last 20 years will be exacerbated by these events. Japan’s debt level stands at more than 200% of GDP. Paradoxically, after two decades of deflation, if Japan can’t find buyers for its debt as it funds rebuilding, it could be the first developed nation where inflation rises out of control.
As the debt load of the United States and prospects for a weakening dollar continue to rise, some have become concerned about a similar situation unfolding in this country. When Maine business owners strategize about their own next moves in growing their businesses, Japan may provide a crystal ball’s view into how a similar inflation environment in this country could impact them. Some speculate it is why some businesses are choosing to not deploy cash that has accumulated on their balance sheets.
Analyze these events in the context of a personal financial plan, as well. The foundation of an investment strategy should not be built by individual market or economic events, but rather by your personal goals such as retirement, desire to leave your family a legacy and charitable giving. Using your investment plan to benchmark progress toward your goals can help you make better decisions around market events such as those described above.
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