Investment Adviser – It is different this time round!
24 May 2010
One of the most dangerous phrases which any investor can hear is: “it is different this time around”. That is usually the justification given by a broker when trying to encourage someone to buy an expensive stock or asset – “it is different this time round”. However, not all cycles are the same, and economic recoveries do differ from each other. One year on from the end of the great 2007-09 financial crisis and global recession, we can see how different regions are performing as they clamber out of the hole, some rather more nimbly than others. Indeed, investors need to be aware of the hot spots and cold spots in the global economy, as these begin to have major implications in terms of policy tightening and corporate profits growth, causing some stock markets to out-perform or under-perform quite significantly.
Where are the hot spots? The casual observer would point to China, but indeed there are many other candidates, Australia, Brazil, India and Korea amongst the larger economies for example. The Chinese economy expanded a stunning 12% in the year to Q1 2010, in one sense a major achievement, in another sense not a surprise as the authorities allowed money supply to expand close to 30% last year. This locomotive is driving other countries, hence industrial production in Korea is rising about 20% a year or Brazilian exports up about 25% pa. The downside is that central banks are increasingly concerned about the inflationary pressures being seen in such countries. While western economies continue to hold to the mantra: “interest rates lower for longer”, their counterparts in Asia and Latin America cannot afford to do so. House prices in Australia, for example, are about 20% higher than last spring. Interest rates have already been raised in Australia, Brazil and India in recent weeks, with Korea widely expected to act into the summer.
If there are hot spots, there must be cold spots? Yes, they are easy to identify. Some economies are still in recession, and look set to remain there for some time. Most are in Continental Europe, suffering from the after effects of the financial crisis. Spain is restrained by the collapse of the construction sector, which at one point was amongst the largest in Europe. Unemployment there continues to edge inexorably higher, 20% on the official rate this spring. Ireland is taking the bitter medicine to try and make its economy competitive once again – a series of harsh budgets designed to lower the sizeable debt burden. Greece, of course, is about to go down this path, in return for IMF & EU funding – assuming that reform fatigue does not kick in down the line.
Other parts of the world economy are making steady if slow progress. First quarter data are starting to appear, flattered in some cases of course by the comparison with the very weak spring back in 2009 when economies were still suffering the harsh effects of the collapse in trade credit, mortgage funding and bank lending to many businesses. The US economy has grown about 2.5% in the year to Q1 2010, helped by Obama’s stimulus package, while activity in the UK, German and Japanese economies looks to be growing more moderately, about 1-2% a year into the spring.
These figures look low to a casual observer – and indeed they are to an expert as well! They are a good example of how different it is this time around. Coming out of most past recessions, there was quite a stimulus to economic activity from very low interest rates – households buying property, cars, and kitchens, with cheap finance, businesses buying other businesses, or investing in new equipment, with cheap finance. This time, interest rates are low by historical standards, but the availability of capital is very different from previous episodes. For example, many first time buyers face deposits of 25% of the value of a house before they can get a mortgage, and houses are still expensive on a historical basis. Small and medium sized firms still claim that they find it difficult to access credit from banks, banks that are wary about potentially adding to new bad debts over and above their existing ones.
All in all, the previous recession was very unusual in terms of its severity, length and nature. One broker has calculated that the level of world GDP is currently less than 1% above its previous peak back in Q1 2010. At this stage of previous recoveries, global GDP was typically about 5% above its earlier peak. On some estimates the largest emerging economies have been responsible for more than half of the recent growth in the world economy – not bad when the advanced countries traditionally make up about three quarters of the world economy.
If an investor reads the economic tea leaves correctly, does that make investing easier? Yes and no is the answer. Understanding the economic cycle is clearly necessary, but understanding what is priced into financial markets is even more important. One year on from the end of the crisis, some countries face a need to dampen down growth before social unrest appears. An example would be the many households in China unable to buy a house because prices are too high. At the same time, some countries face a need to stimulate growth before social unrest appears. An example would be businesses in the UK complaining that they are unable to access credit for new investment. The Chinese stock market is at a seven month low as investors price in further monetary tightening to restrain activity in specific sectors, rebalancing the economy. Conversely, investors in the UK or Europe need not worry about interest rate increases for at least several quarters, possibly well into 2011. Predicting how these hot and cold spots develop in the global economy will be important drivers for successful investment in the coming years.
Andrew Milligan, Head of Global Strategy, Standard Life Investments
This article was first published in Investment Adviser on Monday 24th May 2010.
