Economic update -The Bottom Line
The improving trends in consumer confidence, economic output and credit markets were sustained during August. Whilst this is undoubtedly good news, each advance must be tempered with a realistic assessment of the wider circumstance. The risks to the downside remain considerable. Accordingly, investors should adopt a less aggressive portfolio than their long-run financial benchmark would imply. This has been our position for 34 consecutive months.
UK Consumer confidence, although it remains at historically depressed levels, held steady in August with the GfK NOP survey remaining at -25 (the survey’s record low of -39 was reached in July 2008). Consumer confidence measures in the euro zone, Japan and South Korea follow a similar trend. But with near zero interest rates and a huge fiscal stimulus package (specifically aimed at the consumer) it would be unnerving if consumer confidence measures had not indicated an improvement in ‘expectations’ and a higher propensity for major purchases. Still, a dark cloud persists over the US consumer. The University of Michigan Consumer Sentiment Survey fell in August (as it did in July) and displays no tangible improvement in the year to date.
August also brought an improvement in the GDP figures for the UK economy, and surprised many with the news that the recessions in Germany, France and Japan had been punctured in the second quarter. The strain on the banking system diminished still further with the spread between the gilt repo arrangement and LIBOR falling below 50 basis points for the first time since the banking crisis became apparent in July 2007. Unfortunately bank lending remains muted, indeed in the UK both businesses and home owners are in the unusual circumstance of paying more back to the banks in aggregate than the banks are lending out.
Perhaps, in the light of this evidence, the rapid response from policymakers has averted disaster. But to speak of a V-, U- or W-shaped recovery is to miss the point. A fundamentally different fiscal, legislative and regulatory environment will eventually asset itself. Far from the end of boom and bust, the ‘great moderation’ – the decline in the variability of both output and inflation that persisted for almost two decades and preceded the current economic malaise – is over. Whatever the shape of the recovery, it will emerge only after unprecedented and massive state interventions – interventions that simply could not be sustained and in plain language must be described as a gamble.
In his 25 August speech in Barcelona, Charles Bean, Deputy Governor for Monetary Policy at the Bank of England, called for economists to “take more notice of history and not treat crises as pathologies that happen in other times or other places but as a central feature of free-market economies”. He said little of what the response from politicians should be now that it is almost universally accepted that crises are not exogenous, but are instead integral, to the present model of capitalism. There is a shared appetite among world leaders for greater regulation of hedge funds (and other proprietary speculative investment) and an attack on the tax havens. But these measures are likely to be followed by many more in the coming decade. Capitalism is not threatened by such developments, but a return to rapid economic growth founded on untrammelled high levels of debt coupled with low real wage growth is not a likely outcome. While the recovery will take on the characteristics of the V, U or W at various points in the coming few years, it seems likely that those interventions limit the prospective economic environment to one of volatile but sluggish growth for many years to come.
In spite of a protracted recovery there will be opportunities for investors where there is a will to take careful, informed risks in the framework of a considered investment management programme.