There’s been a curious disconnect between the recent rally in the stock markets and the continuing barrage of pessimistic economic forecasts. Equities across the globe have rallied, while the economic data shows that most economies continue to contract. If this is the worst global recession since the Great Depression, then surely the recovery will take longer than it did after the post-dotcom bust? Yet well-known fund managers such as Fidelity International head Anthony Bolton and Templeton Asset Management Ltd’s Mark Mobius have stuck their necks out and said the recent rally is the start of a new bull market.
But consider what the International Monetary Fund’s (IMF) latest World Economic Outlook has to say about the prospects of an economic recovery. It points out that recessions accompanied by financial crises are more severe and last longer than other run-of-the-mill recessions. Similarly, synchronized recessions, which affect most parts of the world at the same time, are also deeper and last longer and recovery too takes a longer time. It observes that during the “Big Five” recessions accompanied by financial crises, output losses have averaged 5% from the peak and the recession lasted for around seven quarters. The recovery from this kind of a recession, or the time taken for output to get back to its peak, has been six quarters. Also, we have to remember these are averages and the current recession is the worst of the lot, which means that this time the recovery could very well take longer.
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So where are we in the current recession? Says the report: “Based on output turning points, Ireland has been in decline for seven quarters; Denmark for five; Finland, New Zealand, and Sweden for four; Austria, Germany, Italy, Japan, the Netherlands, and the United Kingdom for three; and Portugal, Spain, Switzerland, and the United States for two.” In short, even if we take the average of the past “Big Five” slowdowns, the world economy still has a long way to go before the recession ends.
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Yet investors are behaving as if the worst is already over. As fund tracker EPFR.com points out, emerging market equity funds posted their sixth straight week of net inflows for the week to 15 April. As the Asian Development Bank points out, “Emerging Asia’s equity markets have outperformed mature markets since last year’s trough, rising 25.7% through end-March, while the US Dow Jones Industrial Average fell by a further 4.9% during the same period. While mature markets continue to suffer losses arising from weak banking sectors, the region’s stock markets are beginning to benefit from the widening valuation gap on the back of relatively resilient macroeconomic fundamentals.”
The key to the stock market rally may lie in data published by IMF’s World Economic Outlook. The report includes a discussion about the similarity of the current recession with the Great Depression. It points out that there are “worrisome parallels” which include the sharp fall in asset prices, the lack of lending by banks, the questions about the solvency of financial intermediaries and the threat of deflation. At the same time, it also draws attention to the fact that the gold standard prevented countries form starting expansionary monetary policies at the time of the Great Depression, there was no coordination among countries, each of them erecting tariff walls that made the depression worse. This time, though, says the report, “unprecedented policy support, an international monetary system that provides for reflationary adjustment, and more favourable initial macroeconomic conditions are the key features that distinguish the current crisis from the Great Depression.”
The discussion includes a comparison of the financial and economic data at the time of the Great Depression with the current period. And the strange thing is that, if we take the business cycle peak as 100, then, after 15 months from the peak, the S&P 500 was at 62.92 during the Great Depression of 1929-31, while this time, after 15 months, the S&P 500 was at 51.18 from the peak. In other words, pessimism was so rampant that the S&P 500 was already pricing in another Great Depression. (Taking the peak at 100, the bottom of the Great Depression saw the S&P 500 at 48.7, 23 months from the peak). That was a panic over-reaction, since no mainstream economist is making the argument that the current crisis is likely to be as bad as the Great Depression. At the same time, liquidity is more abundant than during the Great Depression, when money supply contracted. Hence the bounceback.
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org
Graphics by Sandeep Bhatnagar / Mint