| | | | | | | | | | | | | | | INTERNATIONAL ECONOMIC BACKGROUND
After a very deep recession, there are now clear signs that the downward momentum in the global economic cycle has been arrested and there are very clear signs of stabilisation and modest signs of a pickup in activity levels. This improvement has come on the back of a very strong official policy response in the shape of aggressive easing of monetary policy through both quantitative easing of money supply and lower official interest rates, and strong fiscal stimulus in a number of countries.
In the US, GDP contracted by just 0.7% in the second quarter of 2009, having contracted by 5.4% in the final quarter of 2008 and 6.4% in the first quarter of 2009. The Institute of Supply Management Index of manufacturing activity moved up to 52.6 in September and the index of service sector activity moved up to 50.9. For both indices, the move up through 50 signifies that expansion is starting. However, the US economic recovery is likely to be a gradual process, particularly as the US consumer is still fragile as evidenced by confidence levels that are still relatively low, albeit up from the lows seen in recent months. The reality for the consumer is that the economy has shed 7.04 million jobs since the beginning of 2008 and the unemployment rate has jumped to 9.8% of the labour force. At the same time house prices have also fallen very sharply, although the Case-Shiller index of house prices shows that the rate of decline slowed to 13.3% in July, down from a peak decline of 19% in January 2009. The personal sector is now in the process of repairing the balance sheet and the savings rate is picking up quite strongly. This process has further to run and will inhibit consumer spending. This all suggests that the US economic recovery will be a gradual rather than a sharp recovery. The IMF is forecasting growth of just 1.5% in 2010, following a projected decline of 2.7% in 2009.
In the UK, the economy contracted by a lower than expected 0.6% in the second quarter of 2009, but was still 5.5% lower than a year earlier. The expectation is that growth expanded in the third quarter. According to the Nationwide House Price Index, house prices have increased by 4.1% since the beginning of the year, and according to the Halifax index, prices increased by 2.8% in the third quarter. The Purchasing Managers Index of manufacturing activity moved up above 50 in July for the first time since April 2008, but moved back under 50 in August and September. While there has been a recovery in manufacturing activity, it is still fragile. The index of service sector activity moved up to 55.3 in September suggesting a decent recovery is underway in the services sector. It all adds to a picture of stabilisation and gradual recovery in the UK economy also. The IMF is forecasting economic growth of 0.9% in 2010, following a decline of 4.4% in 2009.
In the Euro Zone there are also clear signs of economic stabilisation and modest recovery. During the second quarter GDP declined by just 0.1%, and by 4.7% year on year. The likelihood is that GDP expanded in the third quarter and that the economy is now officially out of recession. The Purchasing Managers’ Index of manufacturing activity increased to 49 in September, while the service sector index moved over the crucial 50 level to reach 50.6. Economic sentiment in the Euro Zone is now at the highest level in a year. However, the labour market situation is still difficult, with the Euro Zone rate jumping to 9.6% in August, which is the highest level in 11 years. The rate in Spain stands at 18.9%, in France at 9.9% and 7.7% in Germany. This labour market background will constrain consumer spending across the Euro Zone, but the outlook for exports and manufacturing activity looks somewhat better. The IMF is forecasting growth of 0.3% in the Euro Zone in 2010, following a decline of 4.2% in 2009.
All in all, the global economy does appear to have passed its low point, but recovery is likely to be a gradual process due to the ongoing strong dependence on official support, the damaged global financial system and financial imbalances.
Table 1
International Economic Forecast | | | (Real GDP)
| 2008
| 2009f
| 2010f
| US
| 0.4%
| -2.7%
| 1.5%
| UK
| 0.7%
| -4.4%
| 0.9%
| Germany
| 1.2%
| -5.3%
| 0.3%
| France
| 0.3%
| -2.4%
| 0.9%
| Global Economy
| 3.0%
| -1.1%
| 3.1%
| Euro Zone
| 0.7%
| -4.2%
| 0.3% | Japan
| -0.7%
| -5.4%
| 1.7%
|
| | | | Source: IMF World Economic Outlook, October 2009 |
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| | | | INTEREST RATES
Official rates in the US stand at 0-0.25%, in the UK 0.5% and 1% in the Euro Area. Given the massive spare capacity in the respective economies atv the moment, the lack of any inflationary pressures and the still fragile nature of the economic recovery, there is nop desire to start tightening monetary policy anytime soon. The Chairman of the US Federal Reserve, Ben Bernanke is acutely aware of the mistake made in the late 1920s, when monetary policy was prematurely tightened and the incipient recovery was killed off. There is a strong commitment not to make a similar mistake this time around.
Rates everywhere look set to remain on hold for the foreseeable future. However, once central bankers start to believe that the economic recovery has become sustainable, they are likely to move to take artes back towards more normal levels. At this early stage it appears possible that the ECB could commence a policy of gradual interest rate tightening from the final quarter of 2010 onwards.
EQUITY MARKET UPDATE
Since the lows reached in the early days of March 2009, global equity markets have staged a very strong recovery. At the beginning of March, markets had priced in a very negative economic and corporate earnings scenario. In effect the markets had priced in too much bad news. At that stage investors started to focus on international economic recovery and corporate earnings recovery prospects and markets subsequently rebounded very strongly.
The anticipated recovery in earnings and economic activity proved correct and the equity market recovery was justified. However, considerable progress has now been made in markets, and based on valuation metrics such as Price/Earnings, markets no longer look cheap. This suggests that while markets remain fundamentally supported, it is unlikely that they will be able to sustain the recovery momentum of the past six months. It is likely that progress will be more modest and gradual from here.
Table 2
Equity Market Performance | | | | | JAN 1st-OCTOBER 6th 2009
| From Low-Point
| FTSE 100
| +19.4%
| +45.4%
| S&P 500
| +15.2%
| +53.8%
| | German DAX | +16.5%
| +52.8%
| | French CAC | +15.9%
| +48.1%
| | NIKKEI 225 | +9.4%
| +37.4%
| ISEQ
| +40.9%
| +72.4%
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