By Claus Vistesen: Copenhagen
As we move into year's and perfectly in line with seasonal regularity we are flooded by a veritable tsunami of sell and buy side research on the big themes of 2009 and those to come in 2010. Now, we can add another to the list in the form of the latest quarterly review from BIS which is a whopper of a publication filled with interesting articles, data, and charts.
I have just scanned the "overview" and thus only scratched the surface but still, and in case you have spent the last 6 months on a beach, the first 10 pages provide a nice summary of a Q3-09/Q4-09 dominated by an outright risky asset rally as well as a rebound in economic activity driven by especially stimulus (and inventories) and the expectation that favorable policies will stay in effect well into 2010. They do mention Dubai, and while I agree that this was indeed significant I think we defer the importance of this for the time being since risky assets seem, for now, to have shrugged off the implications. (Update; I may be wrong though!)
From early September to late November, a steady stream of mostly positive macroeconomic news reassured investors that the global economy had in fact turned around, but investor confidence remained fragile. This was clearly illustrated towards the end of the period under review, when prices of risky assets dropped sharply as investors reacted nervously to news that government-owned Dubai World had asked for a delay in some payments on its debt.
Market participants expected the recovery to continue, but at times grew wary about its pace and shape due to uncertainty about the timing and speed of withdrawal of monetary and fiscal stimulus as well as the associated risks to future economic activity. The unease was compounded by the unevenness of the recovery among different regions of the world, which in turn was seen as increasing the risk that harmful imbalances could build, thereby adding to challenges for policymakers. In this environment, market developments continued to be driven to a significant degree by ongoing and expected policy stimulus, and in particular by expansionary monetary policy. As investors priced in expectations that interest
rates in major advanced economies would remain low prices of risky assets continued to go up. Equity prices generally rose, in particular in emerging markets.
Now, this is all well and good of course and while most of the charts and graphs passed by without further notice, as I scrolled the pages one in particular caught my glance.
Thus, in my capability of a part time analyst for a small consultancy shop I also have to perform a rudimentary forecasting exercise of GDP for the major economies of the world. Yesterday I did just that and as I really don't have time to develop an inhouse econometric framework to produce quarterly GDP forecasts I simply average over a number of big ticket research houses' forecasts (e.g. Citi, Soc Gen, Nomura, BNP etc). And wouldn't you know it, the graphs which sprung from my excel sheet looked very much like the ones above.
So my main question is. Do we really think this is a plausible outcome?
In my own report I found myself tying my argument up in knots qualifying and hedging my analysis to reflect the fact that only in the best of all possible worlds will be allowed to simply move on into a V-shaped recovery. Especially, and while I have no problem accepting the idea that emerging economies may continue to exhibit impressive growth rates, the story in the advanced economies will be different. Growth will be lower than before and in some cases it will be outright zero or negative for an extended period. In fact, it strikes me as quite odd that we are able to produce such forecasts when the data tells us that conditional on a withdrawal of stimulus the world is bound to look very different.
Allow me to offer just a few examples in the form of the very real risks of "double dip" recessions in Japan and in Germany as well as the mounting issue, not of if, but when we will see the next major sovereign default. On the latter point, Greece finds itself in the eye of the storm at the moment, but this is really a much more structural issue and as it becomes abundantly clear that ongoing fiscal deficits cannot be maintained for ever, growth will plummet in key economies and further exacerbate the structural problem. I mean, what you only have to do at this point is to pick Greece, Spain, the US etc and then substract the boost from government and monetary stimulus. What would be the growth rates you come up with. Well, in so many words, they would be grim! This is naturally precisely why policy makers have acted as they have but to use a well worn market metaphor; at some point the cyclical boost will have to give way for a structural recovery and thus as the proverbial tide rolls back, we will see who forgot to put on their swim suits (or who did not have money to buy one in the first place). In fact, the distinction between cyclical and structural factor are important now more than ever and even though this is basic market/economy research 1-0-1, it is worthwhile remembering it anyway. Tim Duy provides a timely example on how to master this distinction in the context of the US economy in his recent Fed Watch (hat tip: Mark Thoma).
In terms of the global forecast, I can only say that once we break the numbers and outlook down to its core it becomes clear that we are in a much more shaky position than current sentiment suggests.
But, for now seeing, it seems, is indeed believing.