What shape will an economic recovery take?
Jun 11, 2009
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Once again there is a major divide in investor opinion between those who believe the world economy will soon bounce back because of the scale of the money stimulus being thrown at it (the chart will look V-shaped); those who expect a rally to be followed by a relapse, but with recovery later (W-shaped); and those who gloomily expect a slump to be followed by many years of sluggish activity (L-shaped).
Of course it's also possible that the avalanche of money could produce another boom market in investment assets without generating the greater economic activity that it's supposed to.
The well-known London analyst David Fuller argues that, despite the grim economic background, the bear market in shares has come to an end and a new bull market is under way.
He says all the building blocks for a stock-market recovery are in place – record low interest rates, record reflationary efforts, record institutional investor cash on the sidelines, cheaper equities following selling panics, and very low inflation.
Replacing one credit bubble with another
In the opposing camp, David Roche of the investment consultancy Independent Strategy argues that there are several flaws "to Panglossian hopes for a bull market and a V-shaped recovery":
• Little has been done to reduce the excessive levels of personal debt that lie at the core of the credit crisis and global imbalances. Indeed, government action has made the situation even worse, by helping households to avoid reducing their borrowings.
Households must turn thrifty if the underlying imbalances in the US economy are to be resolved. That implies a rise in families' savings rate from 4% of disposable income to near 10%, with a consequent major fall in consumption.
• The authorities have failed to address the problem of excess credit creation that caused the crisis, and base their policy on very sanguine assumptions about a strong economic recovery next year.
Edward Chancellor, another respected commentator, says America "has not yet been cured of its addiction to debt.
"All that has happened is that excessive growth of household credit has been replaced by an even more extravagant expansion of government borrowing." A government-finance bubble has replaced the mortgage-credit bubble.
Bianco Research calculates that the costs of bailing out the US's financial system have now reached $4.2 trillion, or more than the inflation-adjusted costs of the Second World War.
Gillian Tett, the FT's brilliant columnist, says that while the efforts by central banks and governments may be enough to stave off economic collapse, it does not guarantee a dynamic rebound.
"The essential problem is that there is still a vast amount of deleveraging and restructuring that needs to be done after the recent credit bubble: and on current evidence, that cleansing process could take years.
"Europe's corporate landscape, for example, is currently littered with heavily-indebted companies in dire need of restructuring, but which are somehow still staggering on because their creditors are unwilling to pull the plug.
"In America, consumers remain laden with debt which they have barely begun to pay down.
"On both sides of the Atlantic, numerous banks remain neither dead nor fully alive, propped up by government support."
My view? I expect W-shaped investment markets, and a kind of crooked L-shape for the world economy as the Asian region delivers the lift that the US and Europe will no longer be able to provide.
• This article was written by Martin Spring in On Target, a private newsletter on investment and global strategy. Email
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