Recent economic indicators give no cause for optimism. Although the state of the global economy does not seem to be the key determinant of investment decisions, the current climate certainly has dampened risk appetite. The brutal lowering of global trade and economic activity at the end of 2008 has triggered massive downward revisions of earnings forecasts. After getting off to a difficult start, 2009 will be marked by recession as the global economy contracts.
Although positive GDP growth is forecast in 2010, it is expected to be well below potential and apparently does not account for the full impact of the fiscal stimulus plans. However, statements by the US Federal Reserve and the G 10 group of major central banks are gradually showing more optimism. For example, Jean Claude Trichet, the G 10’s spokesman, has affirmed that global growth will probably be around zero in 2009 before picking up in 2010.
Investors however still seem unconvinced and are focusing on the bad news such as the situation in Eastern Europe and fears that some euro-zone countries may have difficulty funding their budget deficits.
Financial system still a concern:
The state of the banking system is more than ever the main subject of concern. Many commentators were disappointed by the US Treasury’s initial Financial Stability Plan presented on February 10, which they considered a bit vague. Although more information has been provided and the various measures of the Capital Assistance Program explained, there is still skepticism as some fuzzy areas remain. Upon completion of this program, which requires that banks “stress test” their capital using highly unfavorable economic assumptions, recapitalization measures will be implemented when deemed necessary.
The amount of time this will require (two months for the stress tests and then up to six months to raise more capital from private investors or the government) is making investors even more nervous, particularly now that leading US banks and insurance companies have had to turn to the government for bailouts. This has raised the spectre of nationalization, despite solemn statements by supervisory authorities that banks must remain in private hands.
Skeptical Investors and turbulent markets:
The US Treasury has taken the bull by the horns and its action should ensure greater transparency and could therefore restore confidence. From a macroeconomic perspective we feel its approach is appropriate particularly since it accompanied by highly accommodate monetary policy, credit lines from the Fed to support the market for securitized instruments (and especially those backed by consumer and car loans), a fiscal stimulus plan and special measures to limit foreclosures.
The scale of these initiatives in the United States is quite impressive and other countries have presented similar projects. However, over the past few weeks equity markets have once again shown that announcing new measures and plans is not always sufficient to convince investors to return to the riskier asset classes.
Markets are therefore likely to remain turbulent for a while, particularly as speculation and rumors about the stress tests intensify. Since this uncertainty and instability is likely to maintain volatility at a high level we prefer to reduce our exposure to equities for the time being.
A cyclical low or a bottomless pit:
Recent economic data provides no new insights at least as far as the developed economies are concerned. The pick up in leading indicators is still very weak and purchasing manager indices in the euro zone have even slumped back down. Although the trend in the United States is somewhat more favorable, particularly in the manufacturing sector, ISM indices are still consistent with recession. In Japan, GDP continues to drop sharply as exports plunge.
Many countries have now released their national accounts figures for Q4 2008. In the OECD area GDP fell by 1.5% in the fourth quarter, for the sharpest contraction since records began in 1960. In the United States, where figures go back to 1947, there have been only quarterly contractions sharper than that seen in Q4 2008, when output fell 1.6% q/q, for an annualized arte of 6.2%.
Not easy to be optimistic:
Growth forecasts for 2009 have once again been revised downward (see chart) albeit at a slower pace than from September 2008 to January 2009, when the US growth forecast plunged from 1.4% to 1.8%/e forecast for 2010 is now also lower than in January, except for Canada where there has been less deterioration of financing conditions.
Forecasters are clearly still some what skeptical as to the effectiveness of the aggressive economic policy measures announced by government officials. The Federal Reserve however raised its growth projections for 2010 and 2011 when it released its latest quarterly forecasts, pointing out that they included the impact of fiscal stimulus measures and its highly accommodative monetary policy. If private sector economists also raised their forecasts over the coming months this would send a strong signal to investors.
If most come to believe that growth hit bottom in Q4 2008 and Q1 2009 we could see confidence returning to markets including equities. However, economic data could still be quite volatile over the next few months and delay a consensus.