THE two-month rally, since the bear market lows in early March, has been driven by signs that the steep collapse in economic growth in the early part of the year is moderating.
The UK and US economies shrank at annualised rates of over 6% in the six months following the banking crisis that erupted in September, 2008. The collapse in confidence that spread throughout the global financial system, in the aftermath of the bankruptcy of Lehman Brothers, seems to have led to a collective “emergency stop” response that has caused the world’s economies to go into freefall.
This freefall gathered momentum over the turn of the year, but the pace of adjustment appears to have slowed recently. There are indications that output was cut back more sharply than final demand, resulting in a drop in inventories. As the impact of lower interest rates, lower commodity costs and fiscal stimuli filter through to the global economy, their effects may be supplemented by stock-building, bringing forward a return to tangible economic growth.
The headwinds of rising unemployment, debt reduction and banks repairing their balance sheets seem likely to keep any such recovery weak, but anaemia is better than rigor mortis. There are differing views over whether this marks an economic turning point or a pause in a longer-term recession. Similarly, some believe equity markets have seen their lows, while others expect earnings disappointment to drag them back again.
The value of forecasts is lower than usual in such rapidly changing times, as evidenced by the International Monetary Fund (IMF)’s forecasts made in late November, 2008: they estimated that the UK economy would shrink in the fourth quarter (a period that was nearly over) at a rate of 2% and Japan’s by 1%. The outcomes were falls of over 6% and 12% respectively. So, if the IMF was unable to forecast the past, the rest of us should feel humble about trying to forecast the future.
The answers to both questions (about the recession and the bear market) are closely linked, since improving economic growth will reduce bad debts for the banks, enabling them to lend more freely and equity markets will benefit from the resulting improvement in corporate profitability. The opposite would clearly be the case if this proves to be a false dawn.
At economic turning points, it is common for signals to be mixed. We are likely to see an ebb and flow of data releases in coming months, and there are some near-term tactical obstacles in the form of the bank capital tests being applied in the US and the possible bankruptcy of General Motors.
However, ultimately, it seems likely that the concerted policy stimulus applied by governments and central banks will successfully avert a slump and usher in a gradual economic recovery. As this unfolds, investor confidence is likely to rebuild further and restore equity markets to a growth path.
However, with markets less oversold than in March, further progress now depends upon confirmation that the turning point of the recession has been reached, not simply that the economy is deteriorating more slowly. So, investors will be trying to judge whether the reported green shoots represent new growth or mould.
ANDREW BELL,
Head of Research,
Rensburg Sheppards
