A Dash of Growth and a Pinch of a Plan

Two major developments Thursday seemed to go straight to the heart of some major investor concerns this year. US GDP growth was nicely positive when many had feared a recession redux. Likewise, there seemed to be some positive concrete developments in the eurozone debt arena.

US GDP growth accelerated to +2.5% (annualized) in Q3 from Q2—in line with recent estimates. In particular, strong contributions from consumption helped offset inventory drawdown. Business investment in equipment and software and export growth also had strong positive contributions. (For a complete analysis of the GDP announcement, see “US GDP Growth Accelerates in Q3.”) Keep in mind though, the number will be restated twice in the coming months (and can be restated again even years down the road.) Further, we remind folks the GDP’s construction is inherently a bit wonky and has a number of statistical quirks—seasonal adjustments and treating imports as a detracting factor, among others. That makes GDP a fairly useful snapshot of recent single-country output, but good or bad, it’s not particularly predictive of the period ahead.

However, there is absolutely value in the transparency of the underlying data. What’s more, the GDP figure paints a far better picture than many anticipated—marking the ninth straight quarter of growth. In fact, at this point, it appears real GDP is back to an all-time high. Now, Q4 could certainly slow again, but in our view, the fundamentals underpinning the global economy continue to be much stronger than many believe or appreciate.

Then there was news from Europe. After a long period of feet-dragging and politicking, it appears key eurozone leaders have finally agreed to a plan. We have no doubt working out the details will be a sticky process, but in our view, the agreements reached (a day late, after another delay) in the latest eurozone summit show a sincere commitment to creating a ballast for a major liquidity event for awhile to come. The main developments were:

• Bank Recapitalizations: Starting June 30, 2012, a 9% minimum Tier 1 capital ratio would be required of the 70 biggest eurozone banks. This would entail boosting capital buffers by about €106 billion. To reach this capital ratio, banks are required to use their own resources or exhaust private sector options before tapping government funds. The EFSF would only be used if governments are too strained to assist.
• EFSF Changes: The EFSF will be leveraged “up to four-to-five fold”—quite a bazooka—to give it greater efficacy. This will be accomplished two ways: First, the EFSF will provide an indirect guarantee covering initial losses (rumored to be the first 20%) that buyers of Spanish or Italian bonds would suffer in the event of a default. Second, the EFSF would seed a fund (along with contributions from other cash-rich investors, like China, and other sovereign wealth funds) to provide additional funding if necessary. It’s estimated the combined measures would boost the power of the EFSF to provide guarantees for around €1 trillion of debt.
• Greek Haircuts: Perhaps the most conclusive news out of the summit was an agreement for private banks to take a “voluntary” haircut of 50% on Greek debt and for Greece to reduce its debt to 120% of GDP by 2020.

Although folks complained the plan lacked details, that the eurozone has a plan at all is a positive (and stocks evidently agreed on Thursday). In a process that’s been plagued with politicking, getting the eurozone leaders to agree to even the broad strokes of a plan is a major step forward. Details will be forthcoming, and yes, we anticipate still more feet-dragging from here. Likewise, individual nations must still hold up their ends of the bargain. Whether or not this is a viable plan is to be seen, but it likely gives investors a much-needed reprieve from the bombardment of PIIGS news lately and—we hope—enables them to focus on quietly improving economic fundamentals worldwide.