By ADRIAN LOWCOCK 17/06/2009
The rebound seen since March has been spectacular and indeed many investors have watched it from the sidelines. It would seem that economic leaders; Alistair Darling, US Treasury Secretary Tim Geithner and the IMF’s Dominique Strass-Kahn are all now coming to the same conclusion as we did; the economic data is showing some improvement but the recovery is weak and we have a mountain to climb.
There are several indicators we need to tick off before any sustained recovery can be in place:
The banks need to be solvent and well financed before they can lend again
All the major banks, with the exception of Europe, have had stress tests and raised capital accordingly. Although there may be further collapses in smaller banks, these are unlikely to cause the same problems we saw in 2008. A change in sentiment towards the banks was an essential ingredient in sparking the recent rally as well as economic indicators bottoming. Further recapitalisation maybe required but a corner has been turned. However, stabilising the financial system is not the same as coming out of recession or even seeing the bottom.
A bottoming in the housing market
Data has started to suggest this may be happening, although the information is limited and depends on which report you read. US showed signs of improvement in June but confidence remains weak. The number of mortgage approvals jumped in the UK, but are still much lower year on year. This indicates that any recovery will be slow and drawn out as fragile confidence is rebuilt.
Credit markets need to function
Credit markets have become more liquid in recent months and large issuance has been absorbed by investors. This is a big step forward in putting the economy back on track, however, the credit markets were frozen for a long time and the impact of that has yet to be felt throughout economies.
Unemployment needs to stop rising
The level of unemployment continues to rise in the UK (2.26 million), and rest of the world and we would expect this to continue for some time. However, unemployment lags the economy, when this bottoms out we can have more confidence that the recession is indeed over.
Conclusion
Most of the points above look fairly positive, but they only indicate that the worst of the financial crisis may be behind us. The markets have already priced in a stabilisation in corporate profitability in 2010, so much now depends on sentiment. At this stage of the cycle an uptick in productivity is likely. Many companies simply ‘downed tools’ for the last quarter of 2008, and letting inventory levels run down, are now restocking. As we saw in the latest rally, signs of a recovery have been followed by rising commodities prices which increases production costs. Rising bond issuance has led to higher long term yields on government debt and many borrowing rates are linked to this. The worry is that such issues stifle a promising recovery. It would appear the markets are still trying to price a ’V’ shaped recovery back to the growth levels seen during the recent debt fuelled years. Given the level of deleveraging and substantial debt burden western governments have, we still maintain that any recovery will be slow and protracted.
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