“WHAT happens next?” is a poser taken from the good old days of A Question of Sport where the action in a sporting event is stopped and the panel has to describe what then happens.
It was usually some “entertaining” own goal in football or someone falling over a hurdle in an athletics event, etc., but with the unbelievable events of the last 18 months or so, the question could easily be applied to the financial markets, hopefully with better consequences!
Investors had a roller coaster ride through 2009 as fears of another Great Depression gave way to widespread expectations of recovery. Business surveys indicate that we are in the midst of a rebound in the world economy led by the industrial sector.
Yet there are doubts as to how far this can take us. Companies are currently increasing production to rebuild their stock levels, but once this process is complete, the question is: what will drive future sales growth?
The US consumer, for so long the mainstay of global demand, remains subdued and does not appear to be in a position to drive activity, given the pressure to raise savings and repair the damage created by too much borrowing prior to the credit crisis.
Following the fall in equity and property prices and with debt still close to 100% of Gross Domestic Product (GDP), many are expecting a period of weak spending and credit growth as households move to reduce their borrowing.
The UK has at last come out of the deepest recession since the Second World War, but it is more with a whimper than a bang. Already the UK has been slower to resume growth amongst developed economies with Germany and France emerging from recession over six months ago.
Indeed, it is possible that the figure could be revised down and in that case the champagne will have to be put on ice for another quarter. Even though it was a positive number at 0.1% growth in the final quarter of 2009, it was well below expectations again (about 0.5% growth).
The lacklustre performance of the UK economy reflects the nature of the current crisis that Britain was much more deeply embroiled in than most other major economies. The recession has predominantly been a financially induced downturn and the UK was in the vanguard in this respect, with its banking system behaving with reckless abandon that almost caused a complete financial meltdown.
As we now know, the banking system was effectively rescued via the taxpayer but the effects (both short and long term) are such that economic growth has been and will continue to be compromised.
Reluctance to lend
The banks are reluctant to lend as they seek to rebuild their balance sheets and as bank lending provides the oxygen via which the economy can grow it is continuing to restrict economic growth.
Indeed, this major constraint on the future growth profile for the economy has persisted despite the huge monetary stimulus provided by record low interest rates and the quantitative easing (QE) programme that has injected massive liquidity into the financial system.
The outlook, therefore, is for a muted and protracted recovery, whilst it is likely to be even more of an uphill struggle than had previously been supposed. For the stock market the weak showing of the economy is less relevant as so much of the UK’s earnings are derived from overseas (about two thirds).
Nevertheless, for domestic stocks it is clearly a negative factor and from a macro viewpoint it will make it more difficult for the Government to address the pressing issue of the large deficit and at a time when the amount of debt on its books, relative to GDP, is at a record high for peace time.
How the authorities are going to tackle this debt is something that has not been properly addressed yet, partly because we have an impending general election. However, there is some urgency in terms of needing a cogent and workable plan that will reduce our public borrowings while at the same time restoring the economy to an accelerating growth path.
If this is not done, the UK’s sovereign debt could come under the spotlight, just as it has in less stable and smaller economies (such as Greece) recently.
The start of a new decade seems to be an appropriate point to consider what might transpire over the next 10 years. The short-term answer depends heavily on how government and central bank policy stances are “normalised” around the world.
The effects of “zero” interest rates, quantitative easing and massive fiscal stimulus, combined with the temporary boost of inventory re-stocking seen since June, may well have given investors a false sense of security that the global economy is out of the woods.
Tight-rope
Policymakers are walking the proverbial tight-rope: if they tighten policy too early, activity could collapse; if they are too complacent for too long, inflation may well be stoked as asset bubbles form.
Many would not be surprised if markets see a period of consolidation, or even declines, as investors face the facts that underlying macroeconomic and corporate fundamentals are not as healthy as valuations suggest.
It seems implausible in the face of the massive shock taking place in labour markets and the bursting of credit and property bubbles that consumers will be able to contribute to growth to the extent to which they have become accustomed in the pre-credit crunch years.
The lessons of history are that after balance sheet recessions, inflation and economic growth both remain lower than many expect. This general picture is one which many expect to characterise the developed economies in 2010. In contrast, domestic demand growth is expected to maintain stronger growth in emerging economies.
Not immune
Despite emerging markets’ much stronger relative performance in 2009, they are still not immune from developments in the rest of the world.
Policies of QE have helped to stave off a deep downturn in economic activity, but markets are already looking to the exit from such policies; however, most commentators do not expect the exit to be a quick one. Any increase in interest rates is set to be small and slow.
Developed economies have experienced their worst financial crisis since the Great Depression and the aftermath will cast a long shadow over the recovery. That said, over the longer term, we can take solace from the compounding power of equities where a period of poor market returns is invariably followed by much better performance.
Fund managers who exhibit a disciplined and focused stock-picking investment approach can deliver results in excess of whatever the markets deliver, regardless of the underlying conditions. Investment is about long-term ownership of businesses and investors’ fortunes are inextricably linked to the underlying performance of the companies in which they invest.
bThe overall picture hides the fact that there are still some very compelling opportunities to buy a range of companies at incredibly low valuations.
In conclusion, we can only hope that those charged with making the major decisions don’t have an embarrassing fall at the first hurdle! A well-balanced, diversified portfolio has never been more important for investors.
- The author can be contacted at: Allchurch Bailey Wealth, 93 High Street, Evesham, Worcs. WR11 4DU; telephone 01386 442597, e-mail andrew.neale@abwealth.co.uk; www.abwealth.co.uk.
