Stimulus: The Exit Strategy and the road ahead

Although the economists still can’t agree on the real quantative  impact of various stimulus packages that were adopted by economies from around the world  but one cannot dispute the fact that the size of the stimulus did matter and did  work in most cases.

To investigate this further let us look at the various stimulus packages that were adopted during the CRISIS.

Obviously by the sheer size and percentage of National GDP China’s US $ 586 billion stimulus Package which accounts for above 12.9% its GDP stands out from the REST. It is possibly followed by Saudi Arabia, Malaysia, and the mother of all STIMULUS thrown by United States under its American Recovery and Reinvestment Act of 2009 which is the largest by any measures (US$ 787 billion). 

At the time there were market pundits who were debating the pros and cons and some even doubted if the stimulus packages will deliver and I am glad to admit that some of us including myself had a different view. Based on my judgement and commonsense I concluded in a piece that I wrote in March of 2009 titled “ Getting the Patient Out of Intensive – The Economy “ that it should deliver and put the US and the world economy back to growth. But having said we should have no illusion that the road ahead is still bumpy and uncertain.

In comparison to other economies most European countries with the exception of Germany and France have been reluctant to throw a bigger stimulus package (mostly because of their fiscal position ) with sizes between 0.3% of its GDP  in case of Italy and 1.3% in the case of the United Kingdom. Germany clearly stands out with its two fiscal packages summing up to US $ 110 billion (approximately) which is  2.8 % of its national GDP hence it is no coincidence that Germany and France were the first EU nations among the EUROPEAN UNION countries to get out of RECESSION.

I think it is interesting and also probably important to point out that an unloaded stimulus with mostly tax breaks as the first wave  of stimulus didn’t do much as evident from the one off tax rebate under the American Recovery Act of 08 of Bush Administration. It looks like the additional money was clearly used by majority of the Americans to pay off the existing debt. Also the experience of BUSH administration’s 2001 tax cut bill clearly shows that rebates generally wind up as savings or as debt repayment.

So taking the above into consideration economies like the US, Germany, Australia ,Spain and others who initially clearly favored tax cuts over  spending in their  respective first wave of stimulus packages in 08 decided in favour of an alternative measure that included more expenditure loaded plans in 2009 in combination with other incentives.

According to the IMF the total stimulus amounts to US $ 2 trillion ( approx) which is around 1.4% of the  world’s GDP still below the IMF’s recommendation of 2 % of world GDP, however, only 15 per cent of the overall fiscal stimulus was really allocated for 2008 and the remaining 85% to be allocated over a two year period  2009 and 2010 with 48 per cent and 37 per cent, respectively. Also an important point to note is that while most of the Asian and other economies focused on their fiscal expansions in 2009, China’s and also the US the fiscal stimulus will only reach its PEAK in 2010. It is hard to accurately estimate to which extent the stimulus will be implemented in 2010 especially as the economies are stabilising and getting back to growth. And the recent downgrade of countries like Greece, Ireland, Spain and Portugal also means that going forward the economies will start focusing more on fiscal consolidation or else they run a huge risk of being punished for their inaction.  The bond vigilantes are clearly BACK and they have all the reasons to be WORRIED. 

Let us look at a list of top five debtor nations to get some perspective

1. Ireland – External debt (as % of GDP): 1,267%
External debt per capita: $567,805
Gross external debt: $2.386 trillion (2009 Q2)
2008 GDP (est): $188.4 billion

2. Switzerland – External debt (as % of GDP): 422.7%
External debt per capita: $176,045
Gross external debt: $1.338 trillion (2009 Q2)
2008 GDP (est): $316.7 billion

3. United Kingdom – External debt (as % of GDP): 408.3%
External debt per capita: $148,702
Gross external debt: $9.087 trillion (2009 Q2)
2008 GDP (est): $2.226 trillion

4. Netherlands – External debt (as % of GDP): 365%
External debt per capita: $146,703
Gross external debt: $2.452 trillion (2009 Q2)
2008 GDP (est): $672 billion

5. Belgium – External debt (as % of GDP): 320.2%
External debt per capita: $119,681
Gross external debt: $1.246 trillion (2009 Q1)
2008 GDP (est): $389 billion 

 I should point out that I’ve taken the above numbers from various sources including of IMF, World Bank and others.

It is a pretty Ugly reading isn’t it? The only good news is that it looks like the policy makers and the central bankers are beginning to take note of the worries and as a result have increasingly started to talk about creating a credible exit strategy as a priority. 

Although one understands that there is need to fix balance sheets (fiscal consolidation) and address the inflationary concerns by having a clearly formulated, defined and coordinated exit strategy in place. But that said Timing will be KEY here as exiting too soon or too late has its own risk. And also it is extremely important that the process should only begin when there is enough hard evidence to see that economy will keep growing on its own after the removal of the stimulus or in other words it is evident that the recovery is solid, financial markets are back to normalcy and credit risk spreads are at an acceptable level and there is a significant risk to inflation over the medium term. We have already seen some of the central banks tighten in the later part of 09 and it is becoming increasingly plausible that others especially in Asia including of countries like India will follow suit as the real inflation starts to pick up.

Going forward the Central banks will need to explain clearly how they intend to use all the tools both conventional and unconventional that are available to them. But having said that, there is also a genuine fear that any preannouncement could possibly push the interest rates up prematurely thus derailing any chance of a ROBUST recovery.  The Q4 of 09 and Q1 of 10 numbers should give us a good estimate of the strength of recovery. The economic improvement has to be across the board and not just in one sector to justify any intervention.  We have seen some encouraging numbers reported from parts of the US economy in later part of 09 including of jobless claims falling to 432,000 – the lowest since September of 09 ,ISM Manufacturing Index rise 55.9 in December which is the highest level since 06, and also an improvement in business and consumer confidence etc but on the other hand the construction spending fell by over 0.6% in November of 08, US business loan defaults rose again in November of 09 and so did the US credit card debts write off. So we are still seeing some very mixed numbers come out which is what I have been expecting and this is why I keep saying to my friends and colleagues always look Beyond the Numbers, and dig deep. 

 I think it is extremely important not to overlook the human cost of this recession. According to the New York Times article dated 28^th December 09, New York’s state courts are closing the year with over 4.7 million cases- the highest ever.  The courtrooms are clearly seeing the aftermath of economic collapse on average folks on the main street and on businesses. I think from a judge’s perspective and also from the folks who are in the midst of all this it will be extremely hard to see signs of an ECONOMIC RECOVERY. But for some of the Wall Street guys it’s back to PARTY again as expected.  I did write a piece titled “Investing in 2009: Back to Basics “ in Feb/March of 09 and I thought I’ll just quote the last paragraph.  “The markets will come back at some point and there will be parties again on the streets, but the question is, will this happen again? I am sure it will. After all, we are human beings! “

Well, moving on even though we are still seeing mixed numbers I think it is probably safe to assume that we could see the US economy grow between 2.5% to 3.5 % in the year 2010.  And the reason for that is the economy has to grow from a very low bottom so even with a very basic and existing demand the economy will grow. And also it is also very plausible that the US may outperform other developed nations including the EU. But the party is going to continue in the Emerging Market. And among the Emerging markets you would see economies with deeper domestic base like Brazil, India, Indonesia and Turkey do better than export driven emerging economies.

While we are busy talking about growth prospect of the global economy and the road ahead one has to also admit that the policy makers have managed to avoid a Great Depression type event by not adopting an extremely tight fiscal and monetary policy. Also there is no doubt that the stimulus packages have delivered as it is becoming increasingly evident from the performance of the economies like China, India, Germany, France and the US among others.  That said there is no doubt that the road ahead is still turbulent and bumpy and a policy mistake here could jeopardize the whole recovery process. Monetary and fiscal policy changes will have to be coordinated. The main aim of any intervention should be to support growth and maintain price stability.

However, one of the safest open market operations could be raising the interest rate on banks’ reserves at the central bank as it will allow the central banks to mop up the excessive liquidity in the banking system by making sure the money is deposited back at the central bank and in so doing prevent excess credit creation and also inflation eventually. This is exactly what the Fed is intending to do through their term deposit program announced on December 28^th 2009.  The clear intention behind the program is to help mop up some of the $1 trillion in excess reserves in the U.S. banking system.  While this should be easily achieved the unwinding of the assets bought by the central banks during the CRISIS will keep them awake.  But that said it will depend on the timing, if they were selling to an extremely confident market they could even make money from the asset sales but let’s see.

And with regards to the performance/returns of various investment classes I think it is probably safe to assume that in 2010 bonds or any other investment class for that matter will not provide or to duplicate the excessive returns as seen in 2009. And going forward we may very well see people chasing the higher yields again and get into more risky asset class. But, however, we may also see people jump back into safer bets like US treasuries if we were to have another Dubai type event so I guess a lot will depend on the market sentiment and confidence. There is still a strong demand for US treasury as evident from the weekly auction in December of 09. If you look at the corporate world you would see that most of them are talking about issuing more public equity to help repay the debt and strengthen their balance sheet. And if the fundamentals keep improving then it will lower the default rate but one shouldn’t underestimate the risk especially if you consider that down the road a rate hike is on the cards so bond holder should position themselves for what is coming. That said I don’t buy the argument that a total meltdown is coming in the bond market and everybody should get out because I believe if the economy grows strongly then it should withstand a hike.  But for now let us hope the policy makers and central bankers get it right ……Fingers Crossed.

UK Economy Contracts for Record Six Straight Quarters – The Questions is does this come as a surprise to anyone?

Apparently not a single analyst out of the 35 polled by Reuters before the data had expected a negative reading in fact they were expecting the economy to grow by 0.2 %. I mean…. what ? The reality is we have been expecting and forecasting a contraction so as far as we are concerned no surprises there. Absolutely NOT! It’s mostly analysis based on common sense really. One doesn’t have to be a ROCKET Scientist to make that Conclusion especially if you were to look at the scale of damage done to the real economy by the CRISIS. You know sometimes I wonder if one should even bother listening to these big guys who get PAID big BUCKS and become a market GURU if they get it right just ONCE. This is why I keep saying to my friends and colleagues “Do it Yourself ” (DIY)…..at least try it. I mean what’s the worst That Could Happen? We all make mistakes but that’s not the POINT. How many of us have LEARN from it? I am beginning to wonder if we have really LEARNT anything from this CRISIS or may be WE don’t want to LEARN or who cares as long as we can keep making MONEY?

Even though things are GETTING and yes looking better. I still have a lot of questions and some of them still worry me.

Here are some of them:

- Banks (some of them ) are now making money but on the other hand they are still loosing money a lot of money each quarter on commercial real estate, credit card loans, consumer loans among other things. Most of the money banks have made is on their Investment Banking business but not on retail or on traditional banking business. And I am glad some of our analyst friends are beginning to notice that. Although things have gotten better but the PROSPECT isn’t that BRIGHT especially if you consider that we are mostly probably heading into a JOBLESS recovery and a recovery that will mostly likely be slow paced.

- The whole SYSTEM has managed to survive because of the LIFE LINE given to it by various Governments from around the World. The markets have gone up and I believe there are two main reasons for it. First- Because they were so badly beaten up that they could only go up; second – Stimulus package(s) have delivered just look at China, India, Korea, France, Germany and others for example.  Although many still doubt that it has but I have no doubt in my mind that it is delivering and this is why we have supported them even though it was not PERFECT. Having said that, we are now seeing a building up of Asset Bubble in the economy (especially evident in China) which needs to be monitored and controlled. My concern is how able and capable the central banks are in making sure the excess don’t build up and CLOG the system again. The other question is do we really know how to price an ASSET correctly or fairly without either over or under PRICING IT? Until and unless we do, we will keep seeing ASSET Bubble Building UP in the SYSTEM. Central banks around the world will have to learn to monitor and supervise asset prices.

- We have still not addressed the SYSTEM RISK ..TOO BIG TO FAIL issue. There has been a lot of TALKS from various corners but no real PLAN.

- The REGULATORS are talking a LOT but DO they really KNOW how to best regulate the MARKET ? They have so far played the BLAME GAME along with Government but do they have what it takes to get things right this time?

- It’s hard to envisage a situation where the WORLD starts growing at the Pre-Crisis levels. So may be the market needs to take a BREATHER?

We have been expecting things to get BETTER in H2 of this 09 so again there are no surprises for us but I believe some of us are getting too or shall I say overly optimistic. Which is not necessarily a bad thing because we do need the AVEARAGE FOLKS on the MAIN STREET to feel confident because CONFIDENCE is KEY to all this. But the PROBLEM with CONFIDENCE is that it can disappear in NO time. So we have to be CAUTIOUS. I must say I am beginning to like TRAFFIC Jams in big cities especially in CITIES like Dubai because it does give me CONFIDENCE that things are looking much better and people are feeling good. And I think it’s important that we look at beyond the numbers and this is why I keep saying to my friends and colleague ALWAYS look at the BIGGER picture and the STORIES behind the numbers. DIG DEEP and not get carried away by listening to the NON STOP sound bites that we get from the MEDIA or the market. I personally get a bit SICK and TIRED of a minute by minute analysis of the MARKET repeated over and over AGAIN on news channels but I do know that I have a CHOICE and I can SWITCH off my TV if I want to. And the reality is we always have a CHOICE (in most cases) so next time when I loose or make MONEY I know it was mostly because of the DECISIONS I made and the options I choose.  As someone said markets are run by human ideas and there is no certainty as to how it will react to an action or in action but you always do  feel PROUD if you get it right and hope that you have learnt something good from your mistakes if you got it wrong.

Coming of Age: Emerging Markets- Next Generation of Growth Engines

Developing countries’ share of global equity market capitalization jumped to a record 24 % in the first half of 09 from the past levels of 15% at the start of 07 as more investors flock attracted by the growth story.

 Investors are now beginning to realize that developed nations are possibly faced with decades of very low growth and may need decades to work off the mountain of debt which is the biggest since World War II.  According to IMF recent forecast the total debt of developed nations used to fund various bank bailouts and stimulus packages could reach above 113% of GDP by 2014. This is more then three times the estimated forecast of 34% for developing nations. Though one could argue that developed countries have had bigger debt burden in the past ( post World War II ) reaching close to 250% of GDP in case of U.K., and over 100% in case of USA but these debts were repaid pretty quickly. On the other hand, we have to take into account that developed nations recorded decades of high growth just after the World War II ended which allowed them to get their fiscal house in order. In the current circumstances it is highly unlikely that the developed economies will see growth levels of post World War II era going forward.

 Developed countries are in a catch-22 situation if they spend more to keep stimulating the economy they risk running into a huge unsustainable fiscal deficit. The combination of low growth and ballooning budget deficit could be very damaging to developed economies. The talk of the town is now increasingly focused on getting the fiscal deficit under control.  It looks like the Governments in the developed world have resigned to the fact that they are entering into a low growth era. World Bank is now forecasting the GDP of high-income countries to shrink by over 4.2% in 09 and the overall global economy to contract by 2.9% in 2009. In terms of regional growth the World Bank is forecasting the growth in the Middle East and North Africa to fall to 3.1 percent, while that of sub-Saharan Africa to drop to 1 percent from an annual average of 5.7% and the LATAM to fall to 2% however, East Asia should post a growth of above 5%. Although the report suggests that economic growth in emerging countries could slow to 1.2% in 09 China and India should achieve a growth of above 6% in 09. We must also add that one of most interesting growth area of the global economy could potentially be rural India with its 700 million plus population. Some companies have already started to focus on rural area of the Indian economy as they see a very bright growth prospect going forward.  The recent Indian budget has rural India at the centre and it looks like the government of India is aiming to UNLOCK the growth potential of rural India which is most certainly a step in the right direction. 

It is becoming more apparent that going forward the growth is going to come mainly from the developing world. The ongoing CRISIS will mostly probably be recorded by historians as the event that triggered a POWER shift. The developing countries are already asking for more influence, oversight and control over how the global economy is managed, supervised and operates. The industrialized world’s clout to impose its policies will only weaken from here on. G-7 countries are beginning to realize that their grip on global affairs is slowly waning and they will have to give away a lot of their influence and control over how the global economy is run but that said it will be unwise to assume that developing economies are ready to lead the world. 

 We are already seeing signs of what could possibly be a shifting world order. We saw Russia host the first BRIC summit albeit a symbolic one. China, the world’s 3^rd largest economy seems to be promoting Yuan as a serious alternative to dollar and it looks like they have a Grand plan for Yuan’s role as a global reserve currency going forward. This is evident from People’s bank of China recent unveiling of rules on Yuan-settlement facility. The rules will apply to companies involved in trade with Hong Kong, Indonesia and Macau. As a trial the central bank is going to allow companies in Shanghai and four cities in the Guangdong province to settle their trades in Yuan with companies in Hong Kong, Macau and Southeast Asia. In a separate announcement on July 6 Bank of China signed clearing agreements for Yuan settlement in Shanghai with over 11 overseas banks, including Standard Chartered, Bank of East Asia and Bank Mandiri of Indonesia. As one of the major trading countries it makes complete sense for China to start reducing its reliance on dollar. Despite of the fact that the stage is being set to promote a real alternative to dollar by major developing economies including China, Russia, Brazil and now India one has to admit that in the short to medium term it is hard to envision dollar loosing its status as a global reserve currency. 

However, more and more investors are getting attracted to the emerging market story and who would blame them. We saw the MSCI Emerging Markets Index rise by over 35 % in June 09, beating a mere 2.9 % rise in the MSCI Index  of developed economies and increasing the value of stocks to $8.6 trillion from $5.1 trillion in 2008. We also saw the market capitalization of Brazilian equities reach close to US 950 billion while that of Indian equities reaching close to US one trillion and Chinese equities surpass the US 3 trillion dollar mark in June. It is becoming more and more evident that developing economies are now moving closer to the centre stage and it looks like the investors have formed an opinion that emerging market is where the PARTY is going to be and this probably explains why the Investors have poured in close to US 26 billion into emerging market equities in the 2^nd quarter of 09.

Although one understands the euphoria but we should not forget the fact that we live in a very interlinked world and any country on a stand alone basis is not capable of growing in isolation forever. It has to be said that not all emerging countries will fair well, Latvia is a prime example, but emerging markets have mostly certainly come of age and going forward without much hesitation one can safely conclude that they are going to be the next generation of growth providers.

Building the foundation for a healthy and sustainable global economy

The message from this global financial crisis is loud and clear; the system that we currently have is flawed, susceptible to produce crises and prone to systemic risk.

As a first step, we will have to fully address the SYSTEMIC RISK and the accumulation of excesses in global the economy that tends to build up during the period of strong growth. The hope is that the market participants, the governments and the regulators around the world have learnt their lessons from the ongoing crisis and will take this as an opportunity to reconstruct the financial system and the way it operates. Although one could argue whether it is safe put your faith in the ability of the market, the governments or the regulators to fix the SYSTEMIC RISK issue.  No doubt, they have bungled up in the past and they would probably do it again. But that is not the point. We all make mistakes and learn from it. So we have to give them the benefit of the doubt. I hope we are all done with the blame game. The regulators and politicians were pretty quick to put all the blame on the banks, the investors, the insurance folks, the rating agencies and everybody else but not themselves. How convenient.

Honestly speaking, we are all to blame for this financial crisis including the folks on the main street who happily leveraged themselves not worrying about the shortcomings.  In fact some folks on the main street got very comfortable with the idea of living on borrowed money without having the ability or resources to meet their obligations. And the reason for that was simple they figured that was the norm.

In the immediate aftermath of the crisis some politicians are proposing the need for creating an early warning system and let the IMF be at the forefront of it. You know, one can’t help but wonder if it’s nothing more then a wishful thinking considering the fact that IMF itself didn’t see this CRISIS coming. Besides that it is no secret that IMF has screwed up in the past and one cannot with certainty say that they won’t slip-up again. And to expect that the ratings agencies or others won’t make mistakes going forward is probably nothing more then a wishful thinking. That’s the reality.

The economy goes through boom and bust cycles one where we see a decade or more of strong growth a.k.a BOOM TIME followed by a flat or negative growth a.k.a. DOOM TIME. Generally during the boom time the global economy tends to get obese without worrying too much about the excesses it has managed to accumulate. The excesses tend to clog the vital arteries connecting the global economy to the engine of growth. It also makes the market participants complacent about the risk and shortcomings hence the boom and bust cycles become a regular event. We have had Tech and Real Estate Bubble Burst. And now the Governments in the developed world as well as the developing world are busy creating a massive debt bubble through heavy government borrowings which has reached a breaking POINT and there are no guarantees that this bubble won’t burst.

What the ongoing CRISIS has taught us is that the current system is flawed and the time has probably come for us to start looking at ways to reconstruct and upgrade the whole financial system incorporating the realities of today’s world.

This CRISIS will probably be a game changer. Going forward the developing countries will ask for more influence, oversight and control over how the global economy is managed, supervised and operates. The developed countries will have to give away a lot of their influence and control over how the global economy is run. And the multilateral agencies including of the World Bank, IMF will have more representation from the developing world reflecting the reality of the changing world.

We live in a very interlinked world and this is why we need to create a system with cushions and additional growth engines that will complement each other and are able to absorb the systemic shock. The economy will work better if it has multiple engines of growth.

One of the ways to create multiple engines of growth could be through a Common market community (CMC) model. The common markets as a platform will drive growth by incentivising trade removing barriers and making inter-trade between the regional economies operating within the common market easier. The Common markets connected to the mainstream global economy would cushion and insulate the individual economies operating within the common market from a disruptive global economic downturn. It could also provide them a safety net to fall back on in a global recessionary environment.

The common markets may also work as a Distribution Network Operator (DNO) that will not only distribute growth to individual economies but also filter the harmful excesses making sure the vital arteries connecting the growth engines do not get clogged and the overall economy remains healthy.

We are already seeing a rapid increase in the number of regional and bilateral free trade agreements (FTAs) or preferential trade agreements (PTAs) being signed. According to the UNCTAD data the Intraregional trade in a number of regional blocs of developing countries has been growing faster than their extraregional trade. The common markets could be the obvious next step.

 There is also ample historical evidence of regional trade. These trades were pretty robust worked well byandlarge resistant to the external disruptive forces without a single common currency or monetary union. So the common markets should work and going forward it will add value.

Besides creating multiple engines of growth through a CMC model, we will also need tools that will allow us to shed the excesses accumulated during the boom time without us having to go through the PAIN of Recession or Depression. The economy needs a growth that is sustainable. A growth that can be managed, supervised and where an excess can easily be removed. 

The recent approval by European Commission of an enhanced European financial supervisory framework based on two new pillars: a European Systemic Risk Council (ESRC) which would  monitor and assess the risks to the stability of the financial system as a whole (“macro-prudential supervision”), and a European System of Financial Supervisors (ESFS) consisting of a robust network of national financial supervisors working in tandem with new European Supervisory Authorities (“micro-prudential supervision”) is probably a step in the right direction. A good oversight and smart regulation should be welcomed. The concern is that going forward the policy makers could burden the system with excessive regulation which could have detrimental effect.

The central banks, the government agencies and the market participants will have to get better at spotting the excesses building up in the economy or particular sector in the economy. The Central Banks will also have to widen their target range and may need to get more proactive.  The idea is to create a framework which could be used to quickly identify the excesses building up in a particular or specific sector of the overall economy and to remove them by following a swift course of action before they start clogging the vital arteries connecting the global economy. This can be achieved if the central banks, the regulators, the ratings agencies and others get more proactive in monitoring, supervising and managing the global economy. All the parties with vested interest will have to work together.

The folks on the main street will also have to realize that if you keep eating without maintaining a strict regular healthy diet and exercise regime you would most probably end up accumulating excessive fat and there is no point blaming other for it. We know all what pain some folks have to go through to shed the excesses. The question is why go through that pain especially when people are able to maintain a good health by following a regular healthy diet and exercise regime. There has to be a realization that the era of excess is gone.

The consumers (especially the American and British consumers) will have to learn to save more and live within their means. We are beginning to see that folks on the main street are starting to save a little bit more. Which is a good news but in the short term it also means that consumers will tend to hold their cash pretty close to their chest and against this back drop it’s hard to envisage a rapid pick up in consumer spending on the level  seen in 06 or 07.  But I’ll happily sacrifice a rapid recovery that could easily falter to a sustainable one.

A healthy and sustainable economy will mean more businesses starting-up or expanding, more hiring, increase in trade and the certainty about the future.

Oh, Recovery, What is thy shape?

Some of my friends and colleagues are busy trying to figure out what could be the shape of the most eagerly awaited recovery. The debate is whether we are going to see a V, W, and U or prolonged I__I shaped recovery. 

 There are some who are suggesting we are probably going to see a V shaped recovery then there are those who are predicting a U or prolonged U shaped recovery and yes there others who believe we might see a W shaped recovery. Boy! Go Figure. Someone has to be right but then I wonder isn’t this all a bit premature? Aren’t we getting ahead of ourselves on making such prognoses or am I simply being Silly?

Let’s find out, shall we?

The shape of the current economy could probably give us some clues as to what the shape of the recovery might be or at the least we could rule out some.  To get a good estimate of the health of the economy let us look at some of headline news during the week ending Friday, the 15^th May 09.

We will start with the numbers out from the European Union. 

According to European Union’s statistic office the GDP in the 16 member Europe region fell by over 2.5% from the fourth quarter, the steepest decline in over 12 years. This was above the market expectation of 2%. German economy shrank by over 3.8% from the fourth quarter of 08; the Italian economy by close to 2.4%; the Spanish economy contracted by around 1.8% in the first quarter of 09; the French economy by around 1.2%. Some pretty grim numbers, no doubt. The Euro zone inflation is at record low of 0.6%. Going forward the rising unemployment will dampen the consumer confidence and there is a strong possibility of inflation remaining lower the ECB’s target of 2%.

 And how are things at the corporate front? 

ING announced higher then expected net loss of Euro 793 million in the first quarter of 09. Allianz reported a fall in profit by over 98%

So how is the UK doing?

According to the Council of Mortgage Lender’s, Home repossession surged by over 51% in the first quarter of 09.  Rents for commercial properties in London fell by over 25% over a period of 12 months. The prognosis is pretty grim especially if we take into account a 56% increase in the number of companies going out of business in England and Wales in the first quarter of 09. With unemployment expected to reach 3 million by 2010 one can safely conclude that we are looking at a slow paced recovery.

Let us look at the US and others.

US retail sales dropped more then expected by 0.4% in April after a 1.3% drop in March. The new mortgage applications dropped to the lowest level since March. Consumers are mostly cash -strapped and to hope that they going to keep spending lavishly is probably a wishful thinking. On the unemployment front the news isn’t good either. The recent announcement by GM to slash its dealership network by around 1,100 and Chrysler by around 789 paints a pretty grim picture.

What about others? 

According to FSS Russia GDP shrank by almost 23% on quarter – on – quarter terms.

China seems to be doing better then the rest. The domestic investment has increased significantly but it will be unwise to assume that China be able to recover in Isolation. The exports and import number out from China are not that encouraging. With the current momentum it is safe to assume that China could grow at 7% or there about in 09 but it won’t be a position to save the world. The data out from China on the 11^tth of May suggests very strongly that China has slipped into a deeper disinflation. Consumer prices fell by over 1.5 percent, factory gate prices fell by over 6.5% so it’s highly unlikely that we are going to see a significant increase in demand for raw materials from China. 

There seems to be a slow paced growth momentum building in Asia but it will be unsafe to assume that the recovery will be rapid and the growth will be on a scale seen before.

Something to think about 

When talking about any recovery I think we should keep in mind that going forward the central banks of the world and the governments will have to raise rates and taxes to fix their balance sheet and to deal with hyper inflation. And on top of that we are going to be overloaded with Heavy Regulation. That’s the aftermath. And these are not the factors that will support speedy recovery on a big scale in fact just the opposite; it will choke off the recovery. It’s pretty much like throwing a spanner into a wheel. There is so much uncertainty ahead. I think we can safely rule out a V shaped recovery. We saw most markets get back in the Red again (at least for now) the week ending Friday, the 15^th May 09 on growth and earning concerns probably the markets were pricing in a pretty rapid V Shaped recovery which they now believe is extremely unlikely hence the retreat. One can’t help but wonder as to whatever happened to all the talk about the negatives being priced-in? Probably the investors are beginning to realize that the prices rose too fast without any solid fundamental support or justification for it and the massive rallies were overdone. I’m not for a moment assuming or suggesting that we are not going to see speculation driven rallies. 

Going forward 

We are not done with volatility yet. We are going to see more mixed data come out in the next quarter which will probably swing the markets both ways. The hope is that the investors will not loose foresight and look at the story behind the numbers and not get carried away by sheer sentiments like seen in the past. 

All the talk about the shape of the recovery is probably premature and a clear sign of the market getting ahead of itself. We should be able to get a good estimate of the health of the economy after the H1 numbers for 2009 are out. It should serve as a good us a pointer for 2009. It should also tell us if the worst is over or there is more to come. Looking at the first quarter numbers we could safely assume with that recovery most likely months away. 

The bottom line is what the markets need is a sustainable recovery that won’t slip out of our hands. And a slow paced recovery will probably be a blessing in disguise for the global economy. It will take time to reconstruct the financial system which we all know now was pretty flawed to begin with and  prone to boom and bust type events.

The shape is secondary honestly speaking I’ll take it in whatever shape it comes.

The route of recovery: Asia to Africa ( A to A )

The steep decline in capital flow including the private capital in addition to the falling commodities prices will severely undermine Africa’s growth going forward. We have to keep in mind that a major portion of Africa’s capital flow in the past came from Asian countries China being at the forefront of it. Asian’s FDI flow to Africa has been a major contributor to the rapid growth and economic expansion of African economies. In trade terms Africa’s exports to Asia which consists of commodities, including oil, non-oil minerals, metals, and agricultural raw materials, now accounts for 86% of its total exports to Asia. Besides China and India Africa’s export to five ASEAN countries (Indonesia, Malaysia, Singapore, Philippines and Thailand) have grown by over 70% and stood at around US$ 44 billion (approx ). Based on the recent data Asia is now Africa’s biggest trading partner.

Africa is now very interlinked with Asian economies so it’s safe to assume that without a recovery in Asia we won’t see a recovery in Africa. Also going forward the ability of African companies and the Governments to attract capital from international markets will be severely undermined for a simple reason that they are now having to compete for the same capital with European and US governments who are also in the market raising capital very aggressively. The expectation is that Asian economies (excluding Japan ) will probably recover faster then US or EU which will obviously benefit Africa.

The African business leaders and politicians should work closely with their Asian counterparts to make sure they are able to quickly tap into the recovery in Asia without any time lag. This is the time for Africa to work on setting a stage for a sustainable future growth.

Something to think about…

The hope is that the anxious investors looking out of their foxhole and roaring to go back on the hunt understand that it will take time to reconstruct the financial system because the one we had was pretty flawed and was always prone to boom and bust type events.

The other important thing that I think we should point out is that when you have too much regulation you don’t have rapid growth or economic expansion and there is no doubt that we are going to be overloaded with new regulations which might even choke the growth before its ready to rock and roll. So we might not get the economic bang we are all awaiting. For any economic expansion you need access to competitive (cheap) capital but the problem is, going forward the central banks will have to raise rates and the governments will have to raise taxes to fix their balance sheet which is pretty much like throwing a spanner into a wheel. Something to think about! 

And what about the financial services sector.  Could this be another options ?

The argument is that the US government will probably not to get into action with a “final” plan for the banking sector because it don’t have a good estimate as yet as to how bad things could get, and coming up with a “final” plan that has to be revised subsequently can’t be good for confidence. So, the idea could be to wait until it is fairly sure that the recession has bottomed out, with the attendant impact on the banks’ balance sheets, and then let the most problematic banks go bust. Jamie Dimon is suggesting that they might be asked to take over some banks. So who knows?   The leaked report is suggesting  that around 10 banks out of 19 might need to raise additional capital including of Citibank, Bank of America, Wells Fargo and Morgan Stanley among others but let’s see what the reality is going be. I suspect that the Govt. will probably strongly urge (meaning force but they won’t admit) the problematic banks to merge with or be acquired by stronger bank. I think this is what Jamie Dimon is suggesting (if one was to read between the lines). The criticism of stress testing is growing from all the corners especially from the ex regulators who were at the forefront during the S&L crisis. I think market has pretty much decided to go positive on bad or good data. It doesn’t matter that’s how it looks like. And the word for that is “everything is priced in” so no worries. A very interesting way of saying ” Guys we couldn’t careless, we just want to make quick money”. Which is ok I guess. Look at Bank of America and AIG stocks for example both these companies are beaten down with losses mounting but their stocks are up. That’s why I am convinced that market has abandon common sense or may be you don’t need common sense?

Mind the Market: Whatever happened to Common Sense ?

I am beginning to think that the lack common sense is what got all us into this Mega Mess. The problem is that common sense is still missing and I wonder why?

The markets are rallying and it’s good but shouldn’t we do a reality check before we get too carried away? I mean the expectations are so LOW that any number above the bottomless floor is sending the markets into rallies. We all want rallies but sustainable rallies please that are supported by solid fundamentals and not driven by speculative play. Folks are talking about recovery against the backdrop of some pretty bad numbers. Yes we are now seeing some mixed numbers (some positives) come out from the 1st quarter but the real economy is still hurting.

To get some perspective let’s just look at the numbers out today from the UK today ( May 01, 2009 ).

According to the Government figures out today ( May 01, 09 ) nearly 5,000 companies in England and Wales went into liquidation in the first three months of 2009 and a record number of people succumbed to insolvency.

The Insolvency Service says that company liquidations rose 56 percent on a year ago to 4,941.

Personal insolvencies rose 19 percent on a year ago to 29,774, the highest since records began in 1960.

The unemployment is now probably close to 8% in the UK. Not to mention the declining house prices

Now let look at US. The unemployment in places like Detroit is over 14%. Average unemployment in the US is close to or above 10% already in at least 4 states. Consumer delinquencies are at historic high levels in the US. And what about EU well the Unemployment in Spain is already around 17% and the growth prospect is pretty BAD.

People on the street are still hurting. But some might argue that the consumer confidence numbers out suggest otherwise well  I wonder if the consumer confidence numbers are the type of real silver lining we should be looking for or a company loosing a little bit less money then expected. I surely think it is unwise for anyone to speculate about the earning prospect of any company in this current environment. Yes some companies will make money no doubt so if their stock goes up there is a justification for that but I don’t see the justification for a massive rally.

Let’s let look at the Banks. Some of them have made money in the 1st quarter of 09 but the devil is in the detail. They are not making money on their Loan book but on trading securities, assets, commodities etc. Are they suggesting that their trading business will keep on generating enough money to cover for all their potential losses on the loan book? I am not buying that argument at all.  They did pass the stress test but it was expected are we suggesting that the government was going to come out say Folks we are screwed our banks have failed. Well I am not suggesting that they have massaged the results of the stress test but what I would say is that the economic criteria set for stress test by the regulators and the government simply can’t incorporate all the uncertainties going forward. Yes the banks had a good strategy that made them money in the first 3-4 months of 09.  And the reason for that is simple the DYSFUNCTIONAL market allowed them to make a huge spread on trading securities but this can’t be a long term strategy. You don’t need leverage these days to book a healthy profit because there are so much of bargains out there but as I said this won’t last for very long.

Yes we are seeing the credit market starting to show some positive movements but by no means it’s back to where it should be to support a speedy or sustainable recovery.

Folks are busy picking the bottom. I wonder why? Shouldn’t we just take a step back and use our common sense. Well the reality is simple. The markets will recover but not today or tomorrow. I just hope that we just don’t run out of Gas before we approach the recovery line. We should prepare ourselves for the road ahead. We are going to face huge tax rises, high interest rate and less government spending as the governments around the world try to fix their balance sheet. So I am quite confident that we are not going back to the growth rate of 05 ,06 or 07 anytime soon. So why all this Euphoria? Yes I want to be happy too but let’s keep it real please. As I said that the expectations are so low that anything above expectation is sending the markets into huge rallies. I never bought the argument about market being efficient and Always Forward Looking.

What I am suggesting is that guys our future is at stake here so let’s not screw it up. We are already paying for the mistakes made by some of our friends. Guys working for a profit making arm of an investment firm lost their jobs because the other guys at the same firm forgot to apply common sense and screwed up. We make a mistake that’s not the point but we shouldn’t keep repeating it. We have already borrowed heavily from our future generation, so let’s apply some common sense.

Getting the Patient Out of Intensive Care – The Economy

To get the “Patient “ i.e. the economy out of intensive care the government in the US has now embarked upon addressing the three BIG issues which it believes are at the forefront of fixing the economy.

So what are these three BIG issues? The downturn in the economy, a very sick financial sector and a paralyzed housing market

Let’s see how the government officials are trying to address or shall I say tackle these issues.

FIXING THE FINANCIAL SECTOR

So what’s the proposal for fixing a very sick financial services sector i.e. the banks?

Under the proposed financial stability plan the first on the list of items deals with a compulsory “stress testing” for banks with over US 100 billion in assets. With this testing the treasury hopes to determine the exact exposure of individual banks to toxic assets. Through the capital assistance program the treasury will provide capital injections where needed with clear lending requirements and limits on dividends, stock repurchase, acquisition and compensation etc. These investments made by the treasury will be kept under a trust called “ Financial Stability Trust”  although the treasury has not shed more light on the  options available to severely undercapitalized financial institutions on prima-facie this is a step in the right direction.

The second on the list is what market is calling a Public-Private Investment Fund (PPIF).Well, we all know the price tag for a probable fix is going to be around US 2 trillion (for now at least). A big part of it is supposed to come from the government and the rest from private investors. The idea is to use this vehicle (whatever you want to call it) to absorb the toxic assets sitting in the balance sheets of the banks at a cost and hope to make some money when the valuation recovers. Under the draft proposed plan it is believed that the government through treasury will provide some sort of guarantee and loans from Federal Reserve will limit the downside risk to private sector investors.  These loans will be on top of the Fed’s existing commitment in the amount of over US 2.4 trillion to support a dysfunctional financial system.  It is assumed that the government will rely heavily on the skills of the private investors to correctly price these toxic assets (and in some cases DEAD assets). It is safe to say that some of these assets will recover from their current valuation over a period time but what we can’t safely say is how much. The fear is that a good chunk of these toxic assets are shall we say DEAD assets with no hope of recovery. So it’s unclear to see how the proposed partnership will make money from this exercise. Similar initiatives taken by the Japanese government over a decade ago (in the 90’s) didn’t deliver the desired result and eventually they had to make the tough call of nationalizing banks with insufficient capital. An average of all projections suggests that the total loss on U.S. securities and loans could reach over US3.3 trillion dollars of this over US 1.6 trillion will have to absorbed the by US based banks. The consensus view is that the banks will require additional capital to keep afloat as the losses mounts. We will have to wait and see. Surely, there is a need to learn the lessons from the past and if past is a guide to the future then it looks like we haven’t learnt MUCH!

The third on the list is a Fed’s initiative called Term Asset Backed Loan Facility a.k.a TALF which is aimed at auto, consumer and student loans. We will have to wait and see how these initiatives play out in the end.

PLAN FOR FIXING THE ECONOMY

The BIG question on everybody’s mind is will the mother of all stimulus packages deliver the BIG BANG the US economy desperately needs?

The recently approved US 787 billion fiscal stimulus package has had a mixed reaction from the market. The question is how will the stimulus package benefit the US economy and the tax payers are probably asking themselves WHAT WILL THIS STIMULUS PACKAGE GET US besides putting an enormous stress on the fiscal deficit of the country. These outflows along with other spending will drive the U.S. fiscal deficit over $ 1.7 trillion (based on estimates) and the government debt/GDP ratio over 85% in the financial year 09. Taking this entire spending spree into account one has to believe that the Government surely thinks that the stimulus package will deliver the goods.

So what’s the aim of the package?

At the forefront of it is creating or saving jobs. The hope is to arrest the mounting job losses by creating over 3 million jobs and get the consumers spending again by providing them with cash tax credit.

Huge chunk of the money will be spent on infrastructure (roads and bridges), school projects, energy efficient buildings, renewable energy and new power lines that would distribute energy from renewable sources, various other projects including of water and public transit and emergency aid to states.

ADDRESSING THE PARALYZED HOUSING MARKET

Some in the US (especially the democrats) have been calling for a housing stimulus bill that will help the struggling home owners stay in their homes and also stop the house prices from falling further. President Obama recently announced an expected plan to fight a deepening housing crisis by committing up to US 275 billion to stop the wave of foreclosures sweeping the US. The plan aims to help around 9 million American families. Under the proposed plan a US 75 billion fund will be formed to reduce the monthly payments for homeowners and provide them a buffer of up to $ 6,000 against any decline in the value of the houses. The treasury will also agree to double its financial aid to Fannie Mae and Freddie Mac enabling them to play a bigger role in supporting the housing sector. The aim is obviously to increase the confidence in Fannie and Freddie ensuring the strength and security of the mortgage market and to help maintain mortgage affordability.

Now the question is what’s the prognosis and will this work?

Well, the short answer will obviously be, it’s too early to tell. We will have to wait and see. Although the package might not be perfect and we could endlessly argue about the pros and cons of the plan, it is probably safe to conclude that these spending should at least arrest the current downward momentum of the economy eventually helping the US economy by putting it on the path to recovery.  Surely the focus should be on getting the SICK PATIENT i.e. the economy out of intensive care before making any prognosis of a full recovery, and recover it will.

Investing in 2009 : Back to Basics

All the talk about Recession and now DEPRESSION can make anyone nervous. Wall Street “ Pros “are making predictions, and in doing so, creating more chaos. Let’s look at the current rallies. One wonders, is this a sustainable rally or a one off, I want to feel good bear market rally. We are seeing markets rally despite of all the negative NEWS. One might argue that the Market is always FORWARD LOOKING. Which begs the question, is it forward looking or just SPECULATING? Let us just look at some of the headline stories of this week to get a perspective. GE downgraded; Germany’s growth collapsing by a record since world war II; UK and France Industrial output at lowest in over four decades; Jobless rate in the US reaching close to 10 %; U.S. household net worth plunging by a record $ 5.1 trillion; Japan’s GDP shrinking by over 12% annually; World Bank is now predicting a negative global growth in 2009. In spite of all these very negative news we saw the markets rallied. One would argue, what’s the basis of this rally? Well may be some “market pros” were expecting the worst and they believe these news are not that BAD after all? The reality is, we have a lot of UNCERTAINTY about the road ahead and it’s unsafe to give any estimate on the growth and earning prospect of a company against this backdrop of negative news. Surely, it will be unwise for someone to assume that the WORST is now behind us. And as to whether we have reached a BOTTOM, well we will have to wait and see.

What should we expect in 2009? How is it going to affect the average JOE on the MAIN STREET

Well, the short answer to that are things LOOK PRETTY BAD but this is not the end of the world as we know it. Yes, there will be changes for sure. Wall Street “Pros” don’t have the answers but best guesses and assumptions.
The turn-around will happen only when the average folks on the main street feel that things are going to get better for them. Unfortunately, the market has not reached the bottom yet, because the bad news keeps coming. So don’t be surprised by the volatility. We should have a good estimate of the health of the economy after the H1 numbers for 2009 are out. It should tell us how bad the economy is and should also give us a pointer for 2009. It should also tell us if the worst is over or there is more to come. We are expecting a pretty UGLY Q1 and Q2 of 2009. Navigating our way through this GLOBAL CRISIS is going to be very challenging to say the least. But rest assured that ” Pros “ will be tempted to make predictions which will probably create more volatility and make the main street more nervous about the future, but this should not worry the folks on the main street. Listen! Pros don’t have a crystal ball so their prediction is mostly a BEST GUESS. They have made wrong calls. We don’t need to be reminded of that. We have seen respected rating agencies fail and market Guru like Mr Buffet getting it WRONG.

So what should we do and who should we trust?

Well, to start with, always look at the bigger picture and the stories behind the numbers, because numbers do not paint the entire picture, so dig deep. We don’t know if the folks on the main street will keep away from Wall Street in 2009, especially after Bernie Madoff debacle. Wall Street of 2009 will definitely be different as the fear of God has been put in most heavy-weight players who once thought they were invincible. We have seen many hedge-funds and banks going BUST and there will be probably more.

What’s the message for an average “JOE”on the main street?

Well, first and foremost, investing should be based on KEEP IT SIMPLE AND BASIC approach. Invest in what you understand and what makes sense to you and not to an EXECUTIVE on Wall Street. Don’t join the rat-race. Ask yourself a simple question – “Can I live with the risk I am taking?” Think long term.

Complicated products are not the answer. In all honesty, no one understands them fully. This does not mean the death of INNOVATION. In fact innovation is good for the market and also for the folks on the Main Street, but innovation should bring simplicity by making things simple to understand, and it does not have to be complicated

Investors have lost faith in money managers. Going forward the money managers will have to be more accountable and disclose their investment strategy fully. Regulators will need to develop a better understanding of products they are regulating. We have witnessed a “ COLLECTIVE “ failure and there is a lot of blame to go around.

2009 will be the year when we will start going BACK TO BASICS. We will see BANKS go back to what they do best ” BANKING “. The markets will come back at some point and there will be parties again on the streets, but the question is, will this happen again? I am sure it will. After all, we are human beings!