FocusPoint

Investment View - US decoupling debate important for risky assets, says ING Investment Management

•	Double dip fears for the US economy
•	Even if the US does not drag the rest of the world down, caution is justified

ING Investment Management (ING IM) warns double dip fears for the US economy are clearly on the rise. The downbeat labour and housing market dynamics, along with the depressed sentiment among households and small firms provide ammunition for a more cautious US outlook.

ING IM believes that without significant improvement on the sentiment front over the coming weeks, it seems unlikely that the fading policy and inventory pulses introduced by the US government will lead to stronger private sector demand growth.

Valentijn van Nieuwenhuijzen, head of fixed income strategy and economics at ING IM, comments: “More resilient data releases in the rest of the world have opened another chapter of the infamous ‘decoupling’-debate. The outcome of this debate will prove to be crucially important for financial markets. It basically decides whether the global economy will come to the verge of a new recession or will ‘just’ experience a period of slower growth with more pronounced regional weakness in the US. The two scenarios will have a materially different impact on the risk appetite among international investors.”

“A new global recession will almost certainly translate into significant price declines for all risky assets, while a US soft patch combined with more moderate growth in the rest of the world will probably result in persistent positive returns for “carry” assets that generate at least a part of their return through yield collection rather than being dependent on capital gains. Government bonds, credits and high dividend equities fall into this category. Still, assets with limited or no ‘carry’- support, like commodities or a large part of equity space, will most likely suffer in this scenario.”

Van Nieuwenhuijzen says two characteristics of the recent data releases in the US stand out: their downward tilt, in terms of change and surprise to expectations, and the remaining amount of collateral damage from the financial crisis in the labour markets. From an investor perspective the first element mainly increases uncertainty as it remains too early to tell whether this signals a period in which the US economy will decouple itself, in a negative sense, from the more resilient rest of the world. The alternative that is still very possible is that the US economy continues to be a ‘leading’ force in global business cycle that will cause especially Europe and Asia to follow its direction with a lag as a result of persistent trade, finance and confidence linkages.

Nevertheless, ING IM believes it remains difficult to read something positive out of this uncertainty. Cautious investors demand higher risk premiums and even the more benign ‘decoupling’ outcome would probably mean further downward pressure on (risky) US assets. Even if risk assets in the rest of the world outperform their US counterparts in this scenario, it remains dubious if they can print positive returns.

Furthermore, the current pressure on US labour markets increases the likelihood of underperformance in the US, as no other major economic block has experienced comparable damage to its labour market.

Van Nieuwenhuijzen concludes: “The US unemployment rate currently stands close to 4% points above its equilibrium level, which is assumed to be close to 6%. In other parts of the G4, the employment gap is between 1% and 2% points. This suggests that medium-term labour income growth might suffer more in the US than elsewhere, particularly if the current short-term cyclical benefits of lower labour costs do not generate a relatively sharp bounce back in US labour demand.

“For now the latter is certainly not happening and therefore recent US labour market dynamics have helped to increase uncertainty and point to more pronounced regional weakness in the US in the short term.”