Bayer AG is taking a page out of corporate America's playbook by announcing the spin-off of its $10 billion dollar specialty plastic business, which is more capital intensive, more cyclical, and has lower margins than its pharmaceutical and consumer businesses. Great move! Others will follow.
3. The Middle East was a focal point last week as the framework for a deal with Iran over its nuclear development was reached with tremendous economic ramifications, providing the final plan is concluded and approved by summer. Secondly, the coalition led by Saudi Arabia with its Sunni neighbors included the creation of an armed force to repel the Houti/Shiite forces backed by Iran in Yemen. Where does the United States stand in all of this? Clearly our government wants to save face by reaching a deal with Iran, but at the same time Israel and the Sunni nations are against it. The United States is losing—if it hasn’t lost it already—its credibility and close relationship with many of its important allies in the region. Energy prices are caught between the potential of large additional supplies coming on the market from Iran and increased conflict between Sunnis and Shiites throughout the Middle East.
4. China continues to make additional moves to increase its status as a major player on the world scene. Last week we discussed the creation a large Asian industrial bank with many nation-partners to fund infrastructure spending in Asia to boost trade. Then, this week, China started making noises that the yuan should become a reserve currency in the world, further raising the country's stature with its trading partners. The country introduced deposit insurance in May. I’m encouraged that the Chinese government is making the right moves to support its economy and build a strong foundation for maintaining growth, around 6 percent, over the longer term.
Let's connect the dots to better understand where we are and what it means for successful global investing:
The domino effect of slowing U.S. economic growth to be felt in the financial markets will be a flattening in the yield curve; a narrowing of the interest rate differential with other countries; and a decline in the dollar, especially against the euro, but also against the yen. I would expect that the European stock markets might decline initially due to fears that their exports will be negatively impacted by a stronger euro.
Investors, looking in the rear view mirror, will fear that the U.S economy will remain weak. Interest rate forecasts will be reduced, as will be earnings estimates, and expectations for the first Fed Funds rate increase will be pushed back once again.
The economy will resume 2.5 percent to 3.0 percent growth or more in the second quarter, similar to what happened last year. Consumers, who comprise nearly 65 percent of GNP, will lead the way, followed by an increase in industrial production and capital spending. Individuals and corporations will remain lean and mean, which will prevent excesses from occurring, extending the recovery through 2016 at least. Earnings estimates for the remainder of the year and next year will be hiked, as corporations will have positive operating leverage as volume increases. But publicly, corporations will remain cautious, as it is better to beat rather than fall short of earnings projections. Commodity prices, including energy, will stay subdued, as demand growth will not outstrip growth in production.
The bottom line is that we will look back at this period as a pause that refreshes the economies and financial markets of the world.