The latest payroll data from the US—jobs have started shrinking for the first time since 2003—and a slide in house prices reinforced fears of a recession and led to a sell-off in the Dow on Friday.
But look on the bright side. The data allows the US Federal Reserve to cut its policy rate at its 18 September meeting. The problem with a cut is that it portrays the Fed as eager to rush in to support the markets, which raises all sorts of issues about moral hazard. Data that show the economy is weakening will therefore provide the US central bank with the fig leaf needed to cut rates.
The concerns that have led to corrections during the current boom can be divided into two types: growth scares and inflation scares.
Of the two, inflation is more daunting, because it forces central banks to tighten, which raises interest rates. Since the entire bull run has been fuelled by cheap money, higher interest rates will lead to an unravelling of leverage and of carry trades, pushing down asset prices. In a growth scare, though, central banks have a weapon that they can wield: lower policy rates. If the US Fed cuts rates, therefore, the bull run is likely to get another lease of life.
Of course, if the US economy goes into a recession, Asian economies, too, will be affected. Brokerage firm CLSA has recently done an analysis on the Asian economies most exposed to the US (CLSA Triple-A, 5 September, “Recycling recycling”) and concludes that “the most likely outcome is that a slowdown in the US will result in a slowdown in total extra-Asian export demand and, faced with this, GDP (gross domestic product) growth will slow across the region.”
The implication is that all the talk of Asian economies decoupling from the US is a trifle exaggerated and “there is no evidence of exogenous Asian domestic demand that might cushion its economies from a slowdown in world trade growth.”
That’s also true because much of the intra-regional exports, such as exports to China, are raw material or component exports that depend for their final demand on the US.
But look at the numbers for India and it’s clear that we’re much less exposed to a US slowdown than the rest of the region. As a matter of fact, if India lowers fuel and commodity prices and allows the Reserve Bank to lower interest rates, the loss in exports could be more than compensated by the rise in domestic demand. Small wonder that the CLSA report concludes: “With the exception of India, we expect all countries to be affected in some measure…” It could be time to start going long on the interest-sensitive sectors.
Is this 1998 or 2001?
Morgan Stanley’s Europe strategist Teun Draaisma is the latest to argue that the credit crunch in the developed markets and its recovery will be very much like 1998, when the Fed was forced to cut rates in the aftermath of the Asian crisis, the Russian loan default and the bailout of hedge fund Long-Term Capital Management.
The Fed funds rate was cut by 25 basis points three times in quick succession that year: on 29 September, 15 October and 17 November. That propelled the Dow Jones Industrial Average, which had fallen to a low of 7,379 points in September 1998, to move up to a high of 11,244 in May, before the Fed started raising interest rates in June that year. (The Dow went on to hit 11,908 in January 2000 and the Nasdaq skyrocketed on the back of retail frenzy, wild theories about a “new paradigm” and a mania in tech stocks, before starting the long trek southward).
Draaisma says this time will be no different: “This final leg of the bull market will be characterized by all the things we have not seen yet this decade, including big retail buying of equities, big strategic M&A, an increase in corporate confidence leading to a capex boom and multiple expansion in equity markets. There would also be a real mania in certain concept stocks, probably mostly in those related to commodities, infrastructure and emerging markets. Remember that it was only after the 1998 correction that the likes of Nokia and Ericsson went to 70 times PE multiples.”
Of course, the tech boom was followed by the tech wreck and there’s bound to be a bust this time also, but the point, Draaisma says, is that the manic phase of the current boom is yet to come.
Sceptics will ask, however, what if the current situation is like 2001 rather than 1998? In 2001, faced with a recession, the US Fed cut its Fed funds rate by 50 basis points on 3 January, followed by 50 basis point cuts on 31 January, 18 March, 20 April, 15 May and further rate cuts almost every month in that year. But it wasn’t till 2003 that the stock markets started to revive.
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