With the global economy falling into recession over the past few months, the United States government, and governments around the world, have taken unprecedented steps to implement financial stabilization programs designed to reverse the tide. Thomas Dillman, Executive Vice President of Mutual of America Capital Management Corporation, provides his perspective on the scale of the current economic crisis, its likely duration and some possible signs of improvement in the economy.
It is difficult to imagine that market and economic news could get much worse in the future than has been the case over the past few months. That is not to say that we won't continue to receive bad news, but by and large we have been experiencing something akin to our worst fears of just a few months ago.
Economies on Life Support
First, the global financial system is essentially on government life support. In the United States, under the auspices of the U.S. Treasury, the Federal Reserve, and Congress, we've seen interest rate reductions, company bailouts, a tax rebate stimulus package, mortgage foreclosure mitigation programs, capital injections into the banking system, and the creation of a variety of "liquidity programs" to ensure the availability and flow of cheap, short-term credit for banks, brokers, the commercial paper market, money market funds, and even consumer and small business lenders.
The United States, through the Federal Reserve, also has provided a huge currency support program to provide access to U.S. dollars through the central banks of Canada, the United Kingdom, Switzerland, the European Union, Japan, Korea and Singapore. The financial authorities of nations throughout the world have implemented their own financial stabilization programs similar to those adopted in the United States. In addition, the International Monetary Fund ("IMF") has begun lending to the most distressed nations (Iceland, Hungary, and Ukraine) and the World Bank has offered $100 billion in backup funds to the IMF.
Falling into Recession
Second, the global economy is falling into recession at an accelerating rate. In the United States, the flow of economic data is getting worse by the month even though the National Bureau of Economic Research just announced that the domestic economy has been in recession since last December! Job losses for November were reported at 533,000, the worst figure since December 1974, while the prior two months' numbers were revised to show greater losses than originally reported. Consumer spending declined in each of the last five months, and was down 3.1% for the 3rd Quarter. Industrial orders, prices and production all are falling.
Meanwhile, exports, the only component of our economy that had been doing well, are slowing very quickly. Further, the housing recession continues to worsen as foreclosures escalate and housing prices continue to decline. And the crisis in the domestic auto industry—largely a self-inflicted disaster, the seeds of which have been sown over decades—has come to a head due to the deadly combination of frozen credit and recession.
Global Economic Slowdown
While the economies outside the United States appeared to be holding up through mid-year, most have rolled downhill quickly and dramatically in recent months, especially since the financial crisis entered its severe panic stage in mid-September of this year. The United Kingdom, the European Union and Japan have all reported at least one quarter of negative GDP growth.
One of the more dramatic signs that global growth is plummeting is the fact that an index to track prices for shipping goods by sea has declined nearly 95% over the past six months. A large part of the explanation for this decline is that, in many cases, the manufacturers, shippers and ultimate buyers of exported goods cannot get required letters of credit from their local banks. This development highlights the fact that the financial crisis is contributing to the global economic slowdown.
The data coming out of China, however, probably is the most chilling in its implications for the global economy. Merchandise exports fell by 2.2% in November on a year-over-year basis, slowing massively from the 19% growth registered just one month earlier in October. This is the worst export growth rate for China since mid-1999. Chinese imports fell an even more dramatic 18% year-over-year in November versus 15% growth in October, reflecting a weaker Chinese domestic economy as well as a sharp decline in commodities prices.
These numbers demonstrate not only the weakness in China's export markets, but also a serious slowing of spending within the Chinese domestic economy. This latter fact is underscored by the just-released numbers on Fixed Domestic Investment (FDI), registering a 36% year-over-year decline in November, down sharply from the 35% growth achieved in the January to October period of 2008. Chinese FDI growth and export growth were the primary drivers of Chinese economic growth over the past five years, which in turn was one of the principal drivers of global growth over that same time period.
Signs of Improvement
The global financial crisis has yet to be resolved and the global economy's health is rapidly deteriorating. However, as suggested at the beginning of this report, markets have been digesting the flow of very bad information, the massive government response to it, and the future implications of both, for a long time now. And there are some signs that markets may be stabilizing. Interbank lending rates have come down from extremely high levels and have moved closer to average rates over the longer term.
The commercial paper market, with a big assist in the form of government purchases, has begun to expand again, although only modestly. New issuance of long-term corporate debt has picked up somewhat after the implementation of a U.S. Treasury program to guarantee the new debt of commercial banks. Equity markets around the world have staged a recent rally, and here in the United States equity indexes have been up as much as nearly 20% from their late November lows.
Nevertheless, it is our belief that the signs of improvement in credit markets are rather meager and disappointing in relation to the massive monetary stimulus that has been applied. Moreover, as suggested above, these improvements hinge significantly on continued direct government involvement in the financial markets. That is, the markets are not functioning normally. As for the recent equity market rally, such updrafts of 15% to 30% are rather common during bear markets, making predictions of final bear market bottoms a hazardous endeavor.
An Unprecedented Arsenal of Tools
Investors have entered a period of the market and economic cycle during which prospects for the future are at their murkiest. Such times are characterized by deteriorating fundamentals and greater than average price volatility in asset markets. This particular cycle is proving to be an extreme outlier as compared to most other cycles, with some commentators predicting the worst recession since the depression of the 1930's.
The unprecedented arsenal of tools called forth by the U.S. and other nations' governmental agencies in response to a series of economic and market events, that is unprecedented for most of the world's living populations, makes forecasting future prospects an even more highly uncertain venture than usual.
It is our belief that it will take time for the remedies already applied, and those to be implemented going forward, to begin to halt the slide into recession and to stabilize financial markets. We might have seen the absolute bottom in equity markets, unless the global economy continues to decline for a protracted period of time, in which case new lows are conceivable. But even if we've seen stock prices reach their lowest point, we are unlikely to see them experience sustained major advances over at least the next three to six months.
A Changing of the Guard
During the first half of 2009, continued efforts by the Federal Reserve and the U. S. Treasury will be augmented by what are shaping up to be formidable stimulus programs of an energetic new President Obama and his administration. A "changing of the guard," especially when conditions of extreme national stress exist, sometimes inspires optimism and confidence among the populace. America has a long tradition of finding, or creating, the necessary tools to deal with crisis. Ultimately, the odds are that this crisis will be met and dealt with in due time. The key issue for markets is how long that will take.
And, of course, markets look forward and anticipate. Stocks will likely begin to recover well before the "all clear" signal has been sent. Over the next two quarters, investors will be assessing prospects for economic and profit recovery in late 2009 and 2010. This evaluation will incorporate data on the health of the global economy as it is being released, especially the magnitude and direction of change in each data item.
It will also take into account observations of any evidence that monetary and fiscal stimulus programs and other economic stabilization activities are gaining traction (i.e., improvement in the functioning of financial markets), as well as signs that the economy is deteriorating at a less rapid pace. This latter point is important: equity markets construe "less bad" as "good." That's what it means when we say stocks "look through" the present and anticipate the future.
Seeking Clues for Recovery
Sometimes the positive scenarios that markets anticipate are only hopes; these episodes often translate into bear market rallies. But as time passes, new information becomes available, and clarity is heightened, and the probability rises that forecasts of improvement will be confirmed by reality. These are the times when new bull markets begin.
Despite the severity of the problems we currently face, it is important to remain vigilant to signs that conditions are no longer deteriorating because those signs represent clues to the timing of true recovery. We believe that such a pivot point will occur sometime next year, but that the prerequisites for positioning portfolios for such a turn are not yet in place.
The
views expressed in this article are subject to change at
any time based on market and other conditions and should
not be construed as a recommendation. This article contains
forward-looking statements, which speak only as of the date
they were made and involve risks and uncertainties that could
cause actual results to differ materially from those expressed
herein. Readers are cautioned not to rely on our forward-looking
statements.
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