US Economy – A Beacon of Hope

Possibly more so than at any other time in history, all parts of the world are simultaneously feeling the impact of what a globalized world we live in. The impact of the globalized economy to transmit shockwaves from one part of the world to another is unparalleled. As corporations have begun releasing their earnings for the first quarter of 2012, the markets are starting to get a sense of just where things sit with respect to the economy. As the economic recovery continues to wobble along, every negative eventseems to get magnified and ripples across the world.

Navigating a Sea of Opportunity

US Economy – A Beacon of Hope

– Quarterly Newsletter – Investment Compass

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more so than at any other
time in history, all parts of the world are simultaneously
the impact of what a globalized world we live in. The impact of the
globalized economy to transmit shockwaves from one part of the world to
another is unparalleled. As corporations have begun releasing their
earnings for the first quarter of 2012, the markets are starting to get
a senseof just where things sit withrespect to the economy. As the
economic recovery continues to wobble along, every negative event seems to
get magnified and ripples across the world. 
academic studies have looked at the idea of whether or not
international investing provides the diversification that it once
did. Most of them have come to the conclusion that about twenty years
ago, diversifying by country stopped providing the benefits it once
did. A large part of this is because of the increasingly global and
interconnected nature of the world economy brought about by the increase
in trade and financial flows. What is interesting is that while every
corner of the globe is impacted by the goings on in the other parts of
the world, each continent has its own challenges.

US Economy Leads the Way

North America is the first continent to bounce back after a global
economic slowdown. Said another way, it is the US that leads the world
economy back to growth mode. This time seems to be no different. When
the financial crisis ended, most market strategists seemed to be
hanging their hat on the idea that as long as the rest of the world
(primarily Asia) was able to carry the US towards economic recovery,
things would be fine. Two years later, hopes are being hinged
increasingly upon the US economy and its ability to assume its
traditional role of leading the world economy towards economic growth.


the US economy is still trying to achieve escape velocity from the
clutches of the economic slowdown, it is moving forward at steady yet
humble 2.2% annual growth rate. This is despite the fact that the
fiscal and monetary policy framework is providing all of the muscle it
The US auto industry has accounted for about 1.6% of
American economic growth as US consumers move to replace the US
automotive fleet which sits at a record average age of 11 years. Part
of the reason that vehicles as a whole have aged is because sales fell
sharply during the last recession to about 10.4 million units. For
comparison, US auto sales achieved a record in 2005 at about 17 million
cars and trucks sold. This record was in part achieved due to the
excesses in the credit markets which allowed consumers to increase
their borrowing and in some cases buy “more car than they could
afford”. As a comparison, the average age of vehicles in Canada is a
little over 8 years.
US auto sales are especially
important to Canada because about 80% of the cars manufactured in
Canada are exported to the US. In their most recent earnings
announcements, North American car companies stated that domestic sales
were strong but these were being offset by slowing sales in Europe.
from autos, housing is another major contributor to the US economy.
Recent data continue to add credence to the idea that US housing has
seen its lows. From here, it will take time but clearly US real estate
is on the mend and should be able to continue to underpin the US
economic rebound.
With the US consumer accounting for
almost 70% of the US economy and about 16% of the world’s economy, the
US consumer holds significant clout over the level of global economic
growth. It is worth noting that US consumer confidence has been
rising—defying a great many observers’ expectations.

US Companies Maintain Record Profit Margins

for other US industries, most companies have finished reporting their
first quarter 2012 earnings and on average they have managed to beat
analyst expectations.  Although the expectations that had been
beaten were lowered in advance by market analysts to reflect concerns
of the global economy.

One data point that is often forgotten
about in the earnings season crush is profit margins. Simply put,
profit margins can be thought of as the portion of each dollar of sales
left over as profits. As the shows, currently, profit margins as a
percentage of the economy are running at very high levels.
some point, as we have highlighted in the past, profit margins cannot
continue to rise at their current rate and will begin to revert back to
the long term average. According to market data provider FactSet,
analysts expect that 105 of the S&P 500 companies will see
revenues rise but earnings reduced this quarter due to higher costs.
The moderation in oil prices and many commodities in recent weeks may
help to offset the cost increases that are expected. 
important contributor to profit margin growth has been the ability of
companies to run lean operations and opportunistically use the weak
labor market to hold wage costs in check. But recent data shows that
labor costs have started to firm and productivity (output per worker)
has started to decline. In the first quarter of 2012, US government
data shows that the total hours worked was up 3.7%, outweighing the
growth rate in the economy. Unfortunately for the average US income
earner, it should be noted that it is not that wages that are rising
but instead the output per worker is falling, which means unit labor
costs are rising. 

Forecasted 2012 and 2013 GDP Growth Rates
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this chart

Europe: Confronting Challenges

the bulk of the European financial crisis, speculation had revolved
around whether or not Greece would be allowed to default on its
government debt payment obligations. This was thought to be the worst
case scenario. But as we had highlighted in prior comments, the market
had already priced in the default scenario. When Greece did eventually
negotiate a cut to its debt obligations, the markets marched forward.
addition, an injection of about €650 billion ($1 trillion
from the European Central Bank (ECB) into the financial markets helped
to bring the markets into line for a time. But it seems that a trillion
dollars does not go as far as it used to. Markets are once again
grappling with Spain’s and Italy’s debt issues primarily and sending
the yields (interest rates) on these countries’ bonds upwards. They are
the two largest members of the PIIGS (Portugal, Ireland, Italy, Greece,
and Spain) group of countries with the largest debt loads.
by some PIIGS nations to partake in austerity measures in order to
reform their economies have also seen bitter resistance by locals. This
culminated in recent elections in Europe that saw the governments of
Greece and France replaced by new ruling parties. Greece has seen a
rise in support for the far left and the far right; two political
fringes that have a common desire for Greece to stop the Franco-German
push for austerity. Germany has led the push for the weakest economies
of Europe to tighten spending and raise taxes.

The outcome of such a policy was rather predictable as most of
Europe is back in recession this year after a brief and feeble attempt
at economic growth. An economy that is not growing has little chance of
paying its debts – not to mention the political instability that comes
with double digit unemployment.

Europe’s Impact on China

We have written more commentary questioning the Chinese economy’s
foundation than almost any other topic.
too many people chase the same thing – in this case safety – the
paradox is that it is risk that they are buying.  Then it was
mainstream to talk about such things. Today, the issues and challenges
facing China are in fact mainstream discussion topics.

Therefore, equities continue to offer more upside than other asset
classes over the long-term. Investors will have to continue to be
patient but the rewards are there. When these long drawn-out cycles of
volatility and seemingly never ending crises end, investors who were
able to stay the course are rewarded. That being said, it is never easy
but history proves that “this too shall pass”.

years of relying on government directives to increase production and a
shadow banking system that was churning out loans that should not have
been issued, the Chinese leadership is trying to confront the problems
that years of strong economic growth were able to mask.

If that
were not enough, Europe’s plight is impacting China because of the
significant trade relationship that exists between the Old World and
the Middle Kingdom. According to Eurostat, the statistical office of
the EU, Europe imported about €290 billion of Chinese goods and
services in 2011. The slowdown in Europe and its return to recession
will therefore impact China. As an offset, the odds have risen of more
easing on the monetary and fiscal policy fronts by Chinese authorities
as they are becoming increasingly focused on growth once
Fixing longer term structural imbalances might have to wait .


believe that monetary authorities will continue to do what it takes to
continue the battle with a stubborn economic crisis but the political
leadership of the leading world economies must work together in a more
concerted, longer term effort. No nation is strong enough to confront
these challenges on its own. Equities continue to be fairly priced and
the mania for bonds has continued causing them to be bid up beyond fair
value. We continue to view government bonds to be a risky asset class
as they are quite expensive due to the fear that has induced investors
to abandon risky assets for so-called safe assets. We say “so-called”
because any asset that is overpriced becomes risky. 

Partners – Capital Management

a Sea of Opportunity


This report is for information purposes only and is neither a
solicitation for the purchase of securities nor an offer of securities.
The information contained in this report has been compiled from sources
we believe to be reliable, however, we make no guarantee,
representation or warranty, expressed or implied, as to such
information’s accuracy or completeness. All opinions and estimates
contained in this report, whether or not our own, are based on
assumptions we believe to be reasonable as of the date of the report
and are subject to change without notice. Past performance is not
indicative of future performance. Please
note that, as at the date of this report, our firm may hold positions
in some of the companies mentioned.

Copyright (C) 2012 Pacifica Partners Inc. All rights reserved.


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