The much-awaited speech by the chairman of the US Federal Reserve at the Jackson Hole annual conference took place on Friday. Ben Bernanke did not announce any specific measure to shore up the US economy; in fact, he exuded confidence about its prospects in 2011, notwithstanding the acknowledged failure earlier in the year to anticipate the current stagnation. He hoped that US households, having rediscovered the virtues of savings, would finish raising savings rates by the end of this year and return to their spending habits next year.
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The reluctance to link the return to savings with demographics, uncertainty on social security and pensions, as well as the extent of debt reduction that needs to take place, is puzzling. Whether US households feel comfortable opening their wallets would be determined by the above factors, along with the return to hiring at wages that they were used to in the past. In the last economic expansion from 2002 to 2007, while jobs were created, incomes for the vast majority of the population stagnated. That is where low interest rates kicked in, enabling them to borrow against the rising value of their homes and offset declining salary and wage incomes. That is not, and was not, a sustainable model. Hence, a return to spending is unlikely to happen as fast as Bernanke anticipates. Therefore, the Federal Reserve is going to find that it has to downgrade its growth assessment next year, as it has now done for the second half of the year.
In other words, while one understands Bernanke’s reluctance to commit himself at once to additional stimulus measures, Bare Talk reckons that he would be constrained to do so in the not-so-distant future. Of course, to be clear, this is only one point of view. It is possible that American households vindicate Bernanke next year. In Bare Talk’s calculus, an additional monetary stimulus would be needed, especially since there is unlikely to be political consensus behind an additional fiscal stimulus. Quite what it would do to asset prices is guesswork now.
Stocks would rally just as frogs being slowly deep fried initially find the warmth soothing. Such a stock market rally should be sold into, especially in the US, where analysts (based on their company-specific earnings estimates for 2011) seem to be living in la-la land. US stocks could be deemed reasonably valued and worthy of being bought for the long term at current prices only if one attaches reasonable plausibility to analysts’ estimates. A recent McKinsey study showed that analysts have been guilty of systematic overestimation of earnings over several decades. Hence, investors have been warned. In fact, investors wanting to bet on the secular rise of Asia would do well to hedge their bets through short positions on stocks in the so-called mature markets. It is hard to suppress a cynical smile, given the deluded estimates of analysts and the structure of the market—with flash-crashes, programme trades and dark pools now part of “mature” markets.
Europe has been the surprise package so far. After the turmoil in May, things have quietened down considerably, more than even the ardent Europhile would have hoped for. The question remains, however, if the stability would be long-lasting. It is not clear if the budget cuts have begun to bite, and whether social stability and public equanimity would hold up when they do. For now, Europe is proving to be a source of stability.
Asia has surface calm, but political undercurrents are anything but smooth. China recently refused a visa to an Indian military officer, and the revelation that the Indian pavilion was ordered to remove the country’s maps from the Shanghai Expo in July would not have assuaged India, smarting from the visa refusal. China took exception to the US–South Korean military exercise too. South-East Asian markets—mainly Indonesia, Thailand and Malaysia— have been calm and have delivered positive returns to investors this year. Indian stocks are in the black, too, this year. But most Asian markets are not cheap, even with the best growth assumptions. And if political and potential social risks are factored in, they are clearly on the expensive side.
Asset price-driven growth is perceived as elitist and lopsided by the majority that is left behind by the asset price boom. Many Asian nations— big and small—appear to be blissfully unaware of the risks. The real “black swan” risk could well be in the Asian political and social space in the next two years.
Financial markets have been stuck within a range for nearly 12 months, and they are searching for direction. Further gains are hard to come by, given the expectations of a V-shaped recovery in global growth which is priced into most global stocks. A shakeout would be good for markets, for investors and for policymakers who are reluctant to admit the need for hard work to return economies and markets to a more sustainable path.
What does a prudent investor do? She waits. Patience is a virtue in investing, as it is in most situations in life.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org