August 8, 2011
The financial news from the US and Europe – the messy resolution of the US debt ceiling impasse and the related downgrade of US government securities, the sharply higher prices for Spanish and Italian debt after inadequate response to the latest Greek debt crisis, and the big drops in stock markets on Monday – will certainly weaken the economic growth prospects of both the US and Europe. We anticipated much of this two weeks ago, both before the US debt ceiling was raised at the 11th hour along with a makeshift deficit reduction plan (see my blog on July 28, 2011) and after the news of much lower US economic came out on Friday (see my blog on July 29, 2011). In fact, the resolution to the debt ceiling issue was slightly better than we expected (no default, and in interim deficit reduction that cut only $21 billion in fiscal year 2012 starting in October 2011) while the US economic outlook in Q2 2011 and earlier was quite a bit worse. The big surprise was S&P's downgrade of US securities from AAA to AA+. While that downgrade was not copied by the other rating agencies and in fact had no impact today on the prices of US treasury securities, it had a big psychological impact. Along with the bad news coming out of Europe after interest rates on Spanish and Italian debt spiked, the S&P downgrade triggered the 600 point or so drop in the Dow Jones Industrial index today, following a 500-point fall on Friday. The result of all these events at best will mean very weak growth in both the US and Europe in the rest of 2011 and well into 2012; at worse, it increases the risk of a renewed recession.
The impact on the US and global tech markets will be slower though still positive growth in 2011 (since half a year of good growth in 2011 is already in the books), and even slower growth in 2012. We are still working our forecast model to take account of the July 29 revisions to US tech investment in 2008 to Q1 2011 as well as lower expectations for growth in the US and other major tech markets. We are also still missing some critical data from the US Bureau of Economic Analysis, specifically, what caused 2011 and 2012 US software investment to be so much weaker than earlier numbers (or for that matter the growth rates shown in our tracking of US revenues of major software vendors or in the US Census Bureau's data on 2010 and 2011 revenue of software publishers). But at this point and assuming that slower growth but no recession actually occurs, our forecast is looking like 6% to 7% growth in US business and government purchases of IT goods and services in both 2011 and 2012, with 2012 growth lower than 2011 growth. Global growth in local currencies looks to be in the 7% to 8% range, with Asia/Pacific (except for Japan), Latin America, and Eastern Europe, Middle East and Africa growing better than that.
Sad to say, though, the risks of a US recession that spreads to Europe, Canada, Latin America, and parts of Asia have increased, to around a 30% probability. There are three reasons why this risk is higher.
- First, given the rancorous fight over the debt ceiling and the intense desire of many Republicans to make big cuts in Federal spending, there is little likelihood of any additional Federal fiscal stimulus to counter the slowing economy, and a low probability for extension of the small amounts of remaining stimulus beyond the end of 2011. Indeed, the Congressional supercommittee tasked with finding an additional $1.5 trillion in deficit reduction before the end of November is likely to adopt additional cuts in Federal spending in fiscal year 2012.
- Second, consumer spending – which makes up two-thirds of the US GDP – has been buoyed by purchases of the wealthy, who are the ones most likely to be spooked by the sharp drop in the stock market. Normally, stock market ups and downs have long and uncertain impacts on economic activity. But as an article in the August 4, 2011 issue of the New York Times (Stephanie Clifford, "Retail Sales Rise at Expensive Stores but Are Mixed Elsewhere"), retail sales at high-end retailers patronized by the well-to-do have been strong, while those at retailers used by the middle-class are struggled. With the stock market up 7.5% for the S&P 500 through mid-July – and over 30% from the bottom in 2009) – the wealthy have been feeling rich, and that has been reflected in their spending. With the stock market gains of 2011 wiped out in two trading days, unless the stock market stages a mighty rebound rally, the wealthy will soon befeeling poorer, and are likely to cut back or slow their purchases. If that happens, there are no other sources of growth to make up the slack.
- Third, if Italy and Spain are unable to regain market confidence and lower their interest rates, another round of austerity programs and delayed and inadequate responses to their debt problems could push Europe into recession, dragging the US in with it.
It's not all bad news, though.
- July employment growth at over 100,000 was decent, suggesting some positive momentum in hiring.
- Oil prices have been falling sharply today, approaching $80 a barrel, which is well off its peak price of over $110 in April.
- The US dollar, while a bit higher against the euro and British pound today, is likely to weaken, helping US exports.
So, odds still favor the US and Europe skirting the edge of recessions but not falling in. And if that is the case, the tech markets in the US and globally will continue to post mid-single-digit growth rates in local currencies, and even better measured in US dollars. Business executives have shown a high willingness to invest in IT in order to keep profits growing faster than revenues, even as they have been reluctant to add workers. Weaker economic growth and thus slower revenue growth means that business purchases of tech goods and services will not be as strong as earlier in 2011, but that is still better than the drop in tech purchases that would occur with a recession.