World economy and risk appetite
It seems world markets are starting to price in a recovery in global growth. It is possible that the solid rally in equities, commodities and risk currencies this month is related to relief behaviour after dramatic falls in the exchanges in the past year, but the nature of the rally appears to be one of early positioning for a recovery by the more aggressive investors.
Are investors justified in dipping their toes in the still turbulent, dark and cold waters of risky assets? The answer is yes as most assets offer value, but only provided the world economy doesn’t go through years of Japan style contraction and stagnation. That the global economy is having its worst recession in a generation is a fact, but the odds are stacked in favour of a quick recovery.
The reason growth may snap back next year and go back to trend by 2011 is that governments have been very active and forceful in sorting out the banks and stimulating the economy. The US Government’s initiatives in that respect are too many to mention and are worth around a third of national income. All central banks have lowered interest rates to about as low as possible and have implemented further money printing measures to boot. Governments have ramped up spending and in many places have announced tax cuts. The sick banks have been recapitalised and in many cases semi-nationalised, so that lending can resume. Many measures are still in the early stages of implementation, so the effect is yet to be felt.
The good thing about how things are going is that all Governments and manner of authorities are working together, even if there are some differences in the size of stimulus depending on the particular economic circumstances. Further, the coordinated government efforts are not going unnoticed and there are already some signs that sentiment is starting to stabilise and maybe even to show signs of recovery. The recovery in growth should come from the US, which is furthest along the way in its recession and has done the most to fix it.
As the financial system is purged and straightened up and the reduction in economic output has been violent and quick, there are good reasons to expect a snap back in activity before very long.
The more negative scenario is that consumers decide to tighten their belts and save up and prepare for similar shocks, maybe of even larger magnitude, further down the line. Moreover, households have lost a large chunk of wealth in the past year as property and pension values fell, while unemployment soared and inflation ate into incomes and cash balances, so savings may need to be replenished over time.
Unemployment will rise further and while that will hurt consumption, it will be temporary unless households understand what is happening and change their attitudes and align consumption to their likely future incomes and wealth, which will be lower than in the past fifteen years. Governments have been quick to react and transfer much of the immediate economic burden to the future by increasing debt, and by possibly eroding savings by setting the stage for more inflation. It is hard to say if consumer behaviour, most notably in the US and the UK, will change in a fundamental way as the policy response has been fast and sizeable to offer a decent cushion to the economy, but it is likely that households will largely go back to their old ways.
Thus, while still early to say for sure, it seems investors are making the right move in starting to accumulate riskier assets. Any rise in stocks and other assets won’t be a straight line move, so the lows in prices may be seen again, but markets may now end the year higher.
Nikola Mirtchev