Why the global economy matters so much

I have posted a lot about the global economy because I believe it is very important.  Listening to a lot of the pundits on TV talking about decoupling just makes me laugh.  Just simply observing the markets and the economic data over the last decade makes it pretty clear the world is way more coupled then it has ever been.  If you don't believe that, then I suggest you do a little research on your own.  There is plenty of data on the internet these days.  Check out this chart.



Housing and auto manufacturing have become very small contributors to GDP.  Exports and equipment and software are now very big components.  So what happens when the global economy slows?  The first thing would be a decrease in export orders.  In http://traderbob58.blogspot.com/2012/08/export-orders.html earlier this month, I showed that export orders fell of a cliff.  That will definitely impact GDP.  However, it goes much deeper then that.  The most common response to falling business is for a company to cut expenses.  That usually takes the form of cutting travel budgets and other small things at first.  However, prolonged slow downs often end up in reducing capital expenditures.  And that my friends hits the next biggest contributor to GDP, equipment and software.  I think this next chart is pretty striking.



The output gap is unbelievably high.  You would think we were still in recession.  This means that businesses are producing much less then they are capable of producing.  If that is the case, then the incentive for capital expenditures to increase production capabilities are already low.  Profit pressures are now starting to be felt by many companies for the first time since 2009.  Since they did not hire back most of the people that were let go in the last recession, employment costs are lower then before.  It is possible that reductions in capital spending are likely to come faster then layoffs.  If that is the case what sector is likely to show problems?
I would think that would be technology since that sector supplies a lot of equipment and software.  Check out this next chart.



IBM has been a very strong performer in the DOW since the 2009 low.  During the big sell offs in 2010 and 2011, it actually held up very well.  It then recovered to new bull market highs before the Dow itself did.  Notice how it is lagging this time.  Outside of AAPL and its suppliers, there are many tech stocks also lagging.  Many in much worse shape then IBM.  I think the reduction in capital expenditures is already starting to happen.

With elevated food and energy prices, continued economic slow down seems inevitable to me.  I believe the economy is in much worse shape then people believe.  Most economic bulls point to the labor market as a sign the economy is doing good.  However, as I said before, the lack of hiring in this recovery likely means that layoffs will be the last thing to happen in this down turn.  By the time the layoffs start, the economy will be well into recession. 

Bob