The muddy picture presented by the global economy
Like quicksand, whatever developed economies do to try and escape the oppressive burden of excessive debt they cannot avert the sinking feeling that they are heading for at best a decade long period of balance sheet repair.
Economies like the UK, which struggle against the debt by cutting budgets and spending, are experiencing lower economic growth results, that risks bringing them further into the mire. Countries in the Eurozone who have attempted, wilfully or not, to ignore the problem are finding that this too is not an option as the issues simply will not go away. Meanwhile as the US charges across the aforementioned sands, hoping to find firmer ground, observers must now be wondering if the American attempts to spend their way to safety is not just taking them further from what they seek.
It can seem a little odd that the solution to a debt problem may be to spend more money – imagine if that was the advice handed out to individuals with maxed-out credit cards – but this is the path that is loudly advocated by those who say governments do not have the luxury of austerity when the global economy is so fragile.
The summer of stock market volatility is a reminder that the world faces serious economic challenges. We’ve seen a two pronged re-emergence of concerns about the US and Eurozone, with the Greek situation starting it all off (again), followed by fear about Italian banks and finally Standard & Poors, a credit ratings agency, downgrading their rating of the US (from AAA to AA). But these aren’t issues that have appeared overnight. It is as if the markets keep forgetting the problems of the world. Like a hungry addict, markets rise on talk of more liquidity being pumped into the system and suffer a deflation of spirits when it doesn’t materialise.
It is perhaps helpful therefore to think back to the early days in the immediate aftermath of the Lehmans crisis, when policymakers and bankers were scrambling to shore up a crumbling financial system. The consensus at the time was that it was going to be a long haul to get back to above trend economic growth and that a long period of deleveraging (paying back debt) was required. There was also a view that all the extra liquidity that was about to be pumped into the system in the form of quantitative easing (QE) would ultimately be inflationary. The mantra at the time was that economic growth was being taken from the future to shore up the present and prevent the very real possibility of an economic depression.
Indeed in a recent speech, Gordon Brown – the man who boldly declared in the middle of one of the largest credit booms in history to have abolished boom and bust – stated that Europe and the US were due for 10 years of slow economic growth. In short it is an inescapable fact that in the developed economies, it’s going to be a long hard slog and it is emerging economies who are going to have to add a greater share of global growth and that this must come from their own internal domestic demand for goods and services.
Earlier in the year we were optimistic about the outlook for equities based on the fact that many corporate balance sheets were in healthy shape (certainly compared to consumers and governments) and many firms that have weathered the last couple of years are in a position to spend cash to increase market share. We also favoured equities relative to other assets where returns seemed to offer less upside.
The last few months have shown, however, that the defensive attributes of high quality fixed interest assets, such as government bonds and investment grade credit (corporate bonds), should not be overlooked. The logic of buying the debt of a heavily indebted government over the equity of a cash rich multi-national company may seem to favour the corporation, but when fear strikes global markets, it’s to the traditional safe havens of gold, US Treasury’s, gilts and cash that investors flee.
The threat now for equities is whether the next round of earnings announcements will disappoint analysts, leading to a further leg down in equity valuations. It could go either way, but it seems that volatility is almost certain to remain. It will probably take a more robust looking global economy and firmer action from national governments and central banks to provide a believable back-stop to the debt crisis, before a longer term ‘risk-tolerant’ stance can be taken.