Tackle the future with confidence
Developed market recession is deepening
By Bevan Graham, Chief Economist & Head of Client Relations at AXA Global Investors
A potted summary of 2008 goes something like this: 2008 was the year in which the global financial system was brought to its knees; we questioned the basic tenets of capitalism and the developed world entered a deep and synchronised recession.
Latest GDP data confirms just how deep and synchronised the recession is. Fourth quarter GDP contracted sharply in the world’s major developed economies. The major economies in Europe have reported contractions in activity in excess of 1% for the quarter, while the initially reported quarterly decline of 1% for the United States, has now been revised to a decline of 1.6%
It is interesting to note that in some of these countries, even with the decline in production that has already occurred inventories are still building. That means we are still producing more than we are consuming. The recession has not yet hit the bottom.
Employment is also falling. The United States has lost 1.8 million jobs in the last three months and 3.6 million jobs in the 13 months since January 2007. This helps put President Obama’s plan of either creating or saving 4 million jobs into perspective.
Authorities are taking appropriate actions for now. Monetary policy is being eased and fiscal policy is easing aggressively at the same time. Where interest rates are already at zero and monetary policy can be eased no further, quantitative easing measures are being taken.
This essentially means central banks are printing money to buy debt, thereby reducing the quantum of debt in the market place. This will keep longer-term interest rates lower than would otherwise be the case.
Infrastructure spending is also playing a part in fiscal stimulus plans, so there is at least some element of investment in the fiscal strategies.
It is not surprising then that forecasts of economic activity this year continue to be revised down. The International Monetary Fund (IMF) is now predicting that GDP will contract on average 2.0% across developed markets this year. Emerging market growth is now expected to slow to 3.5%, down from 6.5% in 2008.
The combined result of this is global growth of 0.5% in 2009, the lowest rate of global growth since World War II.
The consensus view at this point is that we will see some recovery start to emerge late this year or early in 2010. That assumes that we will start to see some of the effects of the monetary and fiscal easing from about the middle of this year and that in the first instance, quarterly contractions in GDP will reduce in size.
While we can take comfort from the expected return to growth in developed markets, we remain concerned about the nature of the recovery that is expected to emerge in 2010. It seems to us that recovery will be largely driven by fiscal stimulus rather than any underlying economic robustness and could therefore be termed somewhat artificial.
This is not your normal developed market recession. What we are seeing now is payback for years of over investing in housing and over consumption on the back of unsustainable growth in housing asset prices. Recovery will be hard. This is not your normal ease monetary- policy-followed-by-recovery-in-consumption recovery. The years of cheap credit and over consumption are gone.
Households need to reduce debt and they won’t be able to grow consumption and de-leverage at the same time. Thankfully not all households are in debt, so we do expect some recovery in consumption, but not to the extent that we have seen in previous recoveries. In short the developed market recovery will be weak and probably subject to false starts. This will not be a “linear” recovery.
We are more optimistic about the recovery that will play out in emerging markets. While growth forecasts continue to be revised down, the expected pattern of emerging markets recovering more quickly remains intact. These countries do not have the same debt overhang of the developed markets so we are less concerned about any fragility to that recovery.
New Zealand and the global recession
By Bevan Graham, Chief Economist & Head of Client Relations at AXA Global Investors
Recession is becoming a way of life here in NZ. We’re in the second of two back-to-back recessions. The first was “the recession we had to have” – the payback for a number of years of housing excess, over-consumption and loose monetary policy. It’s the recession we were all resigned to having. Even when we were in it in the early part of last year, we were comfortable with the view that monetary policy would ease to around neutral and that stimulatory monetary conditions were not required.
The second stage is deeper. It’s the export led slowdown on the back of what looks like being the global economy’s worst growth performance since World War II.
December GDP (reported later in March) looks likely to contract around 1% in the quarter with further declines over the course of this year. There is a possibility of a return to economic growth this year, but that’s predicated on the assumption of some recovery starting to emerge in global growth later this year.
Like elsewhere around the world, monetary and fiscal settings are easing aggressively. The OCR is at 3% and will most likely ease further. We expect further rate cuts to take us to 2.5% by April.
Fiscal stimulus amounting to NZ$9 billion has already been introduced or is in the pipeline. As with most other countries, this is a mix of infrastructure spending and tax reductions – both appropriate in our view.
The government has been getting unfair criticism for not being sufficiently stimulatory. We need to be wary of our own global imbalances. We have run persistent current account deficits for the last thirty-plus years.
Our persistent current account deficits have been more palatable to the global market place in recent years given the bad news, the current account deficit was offset with some good news. The government has been running fiscal surpluses for the last few years and retiring debt as a consequence.
However, we are entering a new phase – a return to the bad old days of twin deficits: concurrent fiscal and external deficits. In the midst of a global credit crisis that has resulted in a significant repricing of risk, this is not the best time to go backwards.
This is part of the recent decline in the New Zealand dollar, which is now below our estimate of fair value. It is easy to argue for further downside in the New Zealand dollar: twin deficits, recession, lower interest rates. We need to remember though that any exchange rate story has two sides to it. It is easy to put the case for a decline in the USD as well. The one that falls the least actually rises against the other!
It is also the case that not all pressures on interest rates are down. At the short end of the yield curve, the official cash rate will likely be lowered further, but pressure will be upwards on bond yields further along the yield curve as the government issues more debt and those bond purchasers want to be suitably rewarded for the risk of owning sovereign debt in a country with a persistent current account deficit and a deteriorating fiscal position.
So what to do? Is there any way the government can reduce its need to borrow? There are a number. Obvious examples would be to reduce spending or increase revenue. Both would be counter productive to supporting aggregate demand.
In our view, contributions to the New Zealand Superannuation Fund must be at least reduced or, more preferably, cancelled for a period of time. If these contributions were cancelled for say three years, that would result in over $6 billion less debt over that period.
If you think the equity risk premium is going to be high enough it might make sense to issue debt to put money into equities. However in the midst of a global credit crisis, the priority must be to reduce upward pressure on interest rates and a lower level of debt will certainly help that.
But won’t that mean less to fund future retirements? Yes. That’s part of the process of adjusting our living standards to pay back the previous years of consumptive largesse.
The Government will angst over the politics of such a move. But households will increasingly be doing exactly the same thing themselves – focusing on maintaining living standards while retiring debt – which for many will mean saving less in the meantime and adjusting future expectations. Set in those terms – the politics is easy.
Long-term the answer for the New Zealand economy is to export more. All of our policy efforts and resources must be directed here – and the somewhat broader goal of raising productivity generally.
Can we export more? We simply have to. The only other alternative is a future of reduced wealth and lower prosperity.
Tackle the future with confidence
By Gordon Noble-Campbell, CEO Spicers Portfolio Management
Recently, I caught up with a former colleague who, like me and many of you, experienced the share market crash of 1987, the bond market crash of the 1990’s, the “tech wreck” of 2000, and the volatility associated with the events of September 2001.
As we reminded ourselves of our experiences in those times, in a light-hearted way, our conversation took a sudden serious tone when my colleague observed – “perhaps this time it is different”. In support of his comment, there’s no doubt that many of the statistics permeating the global media currently are of unprecedented and unseen magnitude in our generation.
These concerns are very real and directly impact on our perceptions of our financial well-being, with most investment portfolios bearing a negative (although in most cases unrealised) impact from this environment.
Having noted this, I’m also very much aware of the prevalence of investment clichés, for example, the conventional investment wisdom to “stay diversified” and to focus on “time in the market” rather than “timing the market”.
Importantly, investors must not lose sight of the fundamental truths which lie beneath these familiar phrases. In fact, I can’t think of a time in recent memory when these nuggets of truth have not been more relevant and valuable. At this time, I think that it’s also appropriate to test our conviction as to whether economic and investment fundamentals are still constant, or indeed if they have significantly changed.
Over recent months, we’ve often heard that current economic and market conditions are comparable to that of the “Great Depression” of the 1930s. A comparison of this nature needs to be put into the appropriate context. While market movements may well be in the same order of magnitude, the causes are different, as is the ability of global economies and markets to respond.
In this regard, it’s clear that the scale of the coordinated actions by central governments globally in response to recent events is unprecedented. But by the same token, the world of 2008 was much different to that of last century. The free and instantaneous flow of global information and capital has inevitably made financial market response to news (or rumour) more frequent and acute. This should also mean that any consequent period of adjustment is swifter, sharper and more transparent.
Regardless of the current environment, in my view, the economic foundations upon which global financial markets are built will continue to fulfill their purpose. Businesses will continue to generate profits, consumers will continue to buy goods and services, and people like you and me will continue to seek advice concerning the sensible investment of our capital.
The forecast will change
By Gordon Noble-Campbell, CEO Spicers Portfolio Management
As we move from summer into autumn, the seasonal change is usually gradual, but often sudden. While we know that winter will invariably be with us, we can’t precisely forecast when the weather will turn. While the current financial climate is decidedly wintry, it’s important that we continue to look for signs of change that herald improved investor confidence.
Economically, the fact that things are looking grim is no longer news.
Two specific news items over the past month stand out for me, for different reasons.
The first report noted that…
“…GDP across the 30 nations that make up the OECD fell 1.5% in the fourth quarter of 2008, the largest decline since OECD records began in 1960 (in Japan, the economy shrank over this period at an annualised rate of 13%, the most severe contraction since 1974).”
The second announced that…
“…AIG reported a US$62 billion fourth-quarter loss, the largest in US corporate history, on turmoil in the credit markets and massive restructuring costs. For the full year, AIG lost $99 billion after reporting a profit of $9.3 billion in 2007.”
That GDP has fallen so dramatically is perhaps not so surprising. In most OECD economies, ‘consumption’ (the amount that people like you and I spend on goods and services through the course of an ordinary day) comprises the largest proportion of economic activity (in financial terms.) When we’re fearful of what the future might hold, we tend to close our wallets on the premise that tomorrow might potentially be a financially worse day than today.
So, in many respects, the downward spiral from slowing growth to recession becomes self-perpetuating. We spend less, meaning that businesses have less demand for their goods and services; in turn meaning that they will produce less and need less people to produce their product. This can result in a rise in the unemployment rate, with the outcome that there will be less income earned in the economy; meaning there will be less consumption of goods and service by people – and so the cycle continues.
The second news story has less to do with our ability as individuals to influence economic growth and more to do with the specific causes which have led us to collectively become much gloomier about the immediate prospects for a rapid rise in the value of financial assets.
‘Millions’ no longer seems to be the scope of the issue when it comes to corporate under-performance. Rather, ‘billions’ or ‘trillions’ has become the new currency of financial collapse. I see the AIG result as a healthy sign that the credit-fuelled excesses under-pinning the current economic cycle are continuing to be exposed and disinfected by the sunlight of public scrutiny.
Financial markets will adjust to this type of news quickly. In my view, the more quickly the scale of yesterday’s problems is factored into today’s asset prices, the greater the promise of a return to renewed growth tomorrow.
Both markets and consumers require confidence in order to break the current cycle of gloomy news and sentiment. Both of these news items demonstrate to me that while currently in short supply, confidence will progressively be renewed through an inevitable change in the forecast for financial markets.
Your feedback is welcome
Financial Update is a regular publication published by Spicers Portfolio Management. It discusses topical investment and financial planning issues. A free copy of Spicers disclosure statement can be obtained by calling 0800 102 100 or visit www.spicers.co.nz.
Spicers is widely recognised as one of New Zealand's leading financial planning firms with a strong reputation for quality advice, integrity and delivering results. Established in 1987, the company has a network of 60 advisors throughout New Zealand and successfully manages more than NZ$1.5 billion on behalf of its clients.