Standard Life Investments

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Financial Adviser - The fallout from the global financial crisis


The global financial crisis and its aftershocks have left a trail of economic and financial devastation in its wake. This sad reality can be seen in a number of ways. One is to compare the current level of global industrial production with the level that we would have observed had the global activity continued to grow at its average rate between the end of 2001 and the end of 2007 of 4.3%. That calculation reveals that industrial output is some 18% lower than its pre-crisis trend line. Some of that gap can be explained by the fact that the global economy was growing at an unsustainable pace before the crisis. But it is also testimony to the deep and long-lasting scars generated by financial crises themselves.

Another is to look at the performance of global equity markets over the same period. More than seven years later, the MSCI all-country equity index is still 2% below its peak in November 2007 and excluding the United States (US), it is 26% lower. The large gap between the performance of global equities when US equities are included and excluded highlights another important feature of the crisis – its effects have been highly asymmetric.

Although the current level of industrial production in emerging markets is just as far below its pre-crisis trend line as it is in the advanced economies, in absolute terms, emerging markets have done far better. Production in the emerging markets is some 31% above its end-2007 level, whereas production in the advanced economies is just 9% higher. Going further, while Chinese GDP growth has slowed in recent years, the nominal size of the economy has more than doubled since 2007. That has not been reflected in the performance of the equity market however, which is around 40% lower than its 2007 peak.

Looking at the advanced economies in more detail, our theme of asymmetry is illustrated even more starkly. Using the change in real GDP between the third quarter of 2008 (when the crisis hit) and the most recent observation as our benchmark, the best performing economy has been Australia, followed by Canada and the United States. The worst performers are all in the Eurozone, with Italy, Portugal and Spain particularly hard hit.

This analysis follows the convention of focusing on real growth rates without controlling for countries’ different population growth rates. The reason for that is straightforward: market participants tend to be most interested in how much the sizes of different economies are changing because that has the biggest influence on real returns. Yet, controlling for the variation in population growth rates is also important. Analysing per capita growth is more informative about how living standards and spare capacity are evolving, both of which also strongly influence the return environment.

To see how per capita comparisons can alter perceptions about relative economic performance, consider Chart 1. It plots the change in real GDP between 2008 and 2014 against the change in per-capita GDP over the same period for a sample of key advanced economies. In raw terms Australia’s relative economic performance since 2007 looks outstanding, while the German economy has grown much more slowly. Things change dramatically when we account for the fact Australia’s population has been growing much more rapidly than Germany’s. In per capita terms, Germany has actually grown at the same pace as Australia, helping to explain why German unemployment is actually lower than it was before the crisis. Japan is another country whose relative economic performance looks more favourable when measured in per-capita terms.

Countries whose relative performance is poorer when measured in per-capita terms include Finland, Ireland, Norway, the Netherlands and the UK. More generally though there is no way of measuring economic growth or welfare that can make the European periphery’s post-crisis performance look positive. The current levels of income per-capita in Greece, Ireland, Italy, Portugal and Spain are all more than 5% lower than they were at their pre-crisis peaks.

Debt booms and busts help to explain both why the global recovery remains so weak more than six years after Lehmann Brothers collapsed in September 2008 as well as the divergent growth experiences of the advanced economies since the crisis (see Chart 2). Almost all of the major developed economies experienced large increases in private sector leverage in the decade before the financial crisis. The biggest booms were in Ireland, Spain, Portugal, Sweden and Denmark, that all saw their private sector debt to GDP ratios more than double between 2000 and 2008. Besides Sweden, they are all among the worse economic performers since 2008, in many cases compounded by misguided fiscal austerity and too-tight monetary policy.

Smaller booms took place in Australia, Finland, Norway and the UK, which saw increases between 60 and 100%. The only countries where little or no leveraging took place were Germany, Japan and Switzerland. It is no surprise then that those three countries are among the economic out-performers. The US, UK and Germany are the three economies that have delevered the most since 2009, which is a key reason why we have more confidence in their recoveries going forward.

In equity space, the S&P 500 is up some 32% from its 2007 peak, a performance matched only by India over the period. German equities have also performed well, with the DAX just over 20% higher than in mid-2007. Capturing the middle ground are countries like Australia, Canada, Japan and the UK, where equities are currently trading close to their 2007 peaks. At the other end of the scale, the Greek equity market has collapsed some 85% since its peak; Italian equities are 57% lower, Irish equities are down almost 50%, while Spain’s market is around 35% lower.

Besides India, where optimism surrounding the new Modi government’s reform agenda is very high, the performance of equities in local currency terms in the large emerging markets has mostly been disappointing since 2007. Equity markets in Russia, Brazil and China are all more than 25% lower than their pre-crisis peaks. However, this is less a function of the immediate effects of the crisis in 2008 as it is their more recent struggles. China faces a long, hard road of trying to rebalance its over-leveraged economy; Brazilian growth has faded with its terms of trade and its inability to keep a lid on inflation, while Russia’s economy is folding under the weight of western sanctions and the recent collapse in oil prices.

What are the key lessons from our survey of the economic and financial landscape since the crisis hit? The first is that the deleterious effects of crises last for many years after they hit. The second is that the scale of imbalances built up before the crisis hits are an important determinant of how deep the impact will ultimately be. The third is that policy matters. The European periphery’s economic problems since the crisis have been compounded by inadequate fiscal and monetary policy responses, as well as flawed institutional designs. Finally, although equity markets are not only an expression of relative economic performance, it is almost impossible for a country’s market to perform well against a backdrop of economic decline.

Jeremy Lawson, Chief Economist, Standard Life Investments

First published in Financial Adviser – February 2015