RSSThose Expecting a 2009 Economic Recovery are Too Optimistic
By Jim Welsh | November 20, 2008 | 5:42 PM | 2 Comments
Twenty to thirty years ago, an investor could achieve meaningful diversification by allocating assets to international markets. However, as globalization advanced during the last 10 years, increased trading between countries has led to greater synchronization of the business cycle and financial market trends. In this new environment, most international markets move in the same direction, with
the only differentiating factor being beta levels. While this synchronization seems like a natural progression of increased world trade, most investment professionals have not yet recognized this important change. A year ago, the dominant investment strategy touted on Wall Street was to diversify overseas, by investing in foreign markets, or buying U.S. companies with significant international sales. Since the global economy was forecast to keep on truckin', while the U.S. faltered, this seemed logical.
I didn't share that view. As I noted in my October and November 2007 letters, there were cracks in the global growth story that hadn't been recognized. The European Central Bank reported in October 2007 that their third quarter survey of lending standards showed an increase from 3% to 31% in the number of banks that had increased their lending standards. This meant that banks in the E.U. were reducing the availability of credit, which was going to lead to slower economic growth by mid 2008. In addition, the European Union purchasing managers index had fallen to its lowest level in two years in October, and in Great Britain, service sector growth had dropped to a four year low. And, for the first time in almost a decade, Japan's index of leading indicators pointed to a contraction, as all 10 components worsened. In my March 2008 letter, I noted, "The United States represents more than 27% of global GDP. The combined total of the 16 countries in the European Union comprise just over 28% of global GDP. Throw in Japan and Great Britain, and all these countries represent 71% of world GDP. China and India combined are 7.5%" It seemed fairly straight forward that if 71% of world GDP was slowing and flirting with recession, there was no way India and China would not be impacted. In addition, the central banks in both India and China had been tightening monetary policy throughout 2007, which was going to slow their domestic economies as well.
In recent weeks, it has become painfully obvious that the United States, Great Britain, Japan, and most of the countries in the E.U. are all in recession. The contraction in credit and banking problems are just as serious in Great Britain and within the European Union, as in the U.S. The ECB and the Bank of England have cut interest rates, but they are clearly behind the curve. Excluding Japan, Asia is particularly dependent on exports, with 47% of GDP in 2007 coming from exports. With every developed country in recession, Asian economies are going to feel our pain. In China, the three engines of growth - exports, investment, and domestic consumption - have all slowed down. After five years of growth over 10%, China's growth rate has slowed for five consecutive quarters. In October, power generation declined 4% from the previous year, the most severe falloff in electricity output in a decade.
The synchronized slowdown in global growth will make it difficult for individual economies to recover, especially those dependent on exports. This is another reason why those expecting a mid 2009 recovery are too optimistic. During the last year, U.S. exports were the one area of strength, adding around 1% of growth to each quarter. Even though exports added 1.1% to third quarter GDP, export growth slowed to 5.9% from 12.3% in the second quarter. It will slow more in coming quarters, which will deepen the recession in the U.S.
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Comments (2) | Related Topics » Europe | Asia | Economy
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