Q1 Economic Review: Elections, Recovery and Underemployment

April 10, 2010 — Mitul Kotecha

I was recently interview by Sital Ruparelia for his website dedicated to “Career & Talent Management Solutions“, on my views on Q1 Economic Review: Elections, Recovery and Underemployment.

Sital is a regular guest on BBC Radio offering career advice and job search tips to listeners. Being a regular contributor and specialist for several leading on line resources including eFinancial Careers and Career Hub (voted number 1 blog by ‘HR World’), Sital’s career advice has also been featured in BusinessWeek online.

As you’ll see from the transcript of the interview below, I’m still cautiously optimistic about the prospects for 2010 and predicts a slow drawn out recovery with plenty of hiccups along the way.

Sital: Mitul, when we spoke in December to look at your predictions for 2010, you were cautiously optimistic about economic recovery in 2010. What’s your take on things after the first quarter?

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Catching up with reality

September 18, 2009 — Mitul Kotecha

Markets have had an exhilarating run up over recent weeks.  Since the start of the month the S&P 500 has risen by close to 7%,gaining around 58% from its March low, as the evidence of global economic turnaround has strengthened and the outlook for earnings improved.

Nonetheless, the rally in equities has meant that valuations are starting to look stretched again. For instance the price / earnings ratio on the S&P 500 has risen to its highest level since January 2004, perhaps hinting at the need for a degree of investor caution in the days and weeks ahead.

Other factors aside from the pace of the move also call for some restraint to market optimism such as the potential for escalation in trade tensions between the US and China, the imposition of regulations on banks and the timing of reversal of extreme stimulus measures. 

As the panic has left markets over recent months volatility has eased as reflected in the VIX index which has dropped to around its lowest level since September 2008, just before it spiked massively higher in a matter of weeks in the wake of the Lehman’s blow up. 

This has been almost perfectly echoed in the move in currency volatility, which has dropped to around the levels last seen a year ago for major currencies.  These levels are not quite pre-crisis levels but for the most part pre-date the collapse of Lehman Brothers, reversing almost all the spike in risk aversion that took place from a year ago. 

It is probably not too much of a stretch to state that having expunged the shock of Lehmans and the worst fears about the global economy from measures of risk and volatility the room for further improvements may be somewhat more limited.  This may be countered by the fact that economic data continues to deliver positive surprises relative to consensus, providing fuel for a further rally in risk appetite. 

However, a lot of good news must surely be in the price by now and it is likely that even the most bearish of forecasters has to acknowledge that an upswing in activity is underway. This ought to ensure that consensus forecasts catch up with reality, leaving less room for positive surprises and perversely less support for equity markets. 

The rally in risk appetite and equity markets has taken its toll on the US dollar which has had a gruelling few weeks during which the US dollar index (a basket of currencies versus USD including EUR, JPY, GBP, CAD, SEK and CHF) has hit new lows almost on daily basis.  Any pause in dollar selling driven by a softer tone to equities is likely to provide better opportunities for investors to take short positions in the currency given that little else has changed in terms of USD sentiment.   How far can the dollar drop?  Well for a start the April 2008 low around 71.329 for the USD index beckons and after that its into uncharted territory.

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Watch out for the pitfalls in H2 2009

July 6, 2009 — Mitul Kotecha

Equity and credit markets have begun the second half of 2009 looking quite fatigued, which is not a good sign ahead of the Q2 earning season.   Perhaps the fact that markets have come so far in such a short period of time has itself prompted a pause. An alternative explanation is that the summer lull is kicking in, with many investors taking the end of H1 2009 as an excuse to book profits and wait until activity picks up again post summer holidays.  A more worrying and more likely explanation is that the massive improvement in market sentiment seen in H1 2009 is  giving way to uncertainty.

Relief that there will be no collapse of the global financial system is not sufficient to keep the momentum in equity and credit markets going into the second half of the year. Until now there has been plenty of less negative news and use of the now worn phrase “green shoots”, but little information to judge the magnitude and speed of recovery going forward.

There are plenty of factors that will dampen recovery in the months ahead. Higher unemployment, massive wealth loss and increased savings will provide a clear downdraft to the global economy. Banks will be increasingly laden with bad loans due to credit card delinquencies, commercial real estate defaults and other sour loans and are unlikely to step up lending in a hurry. In addition, it is still unclear how quickly toxic debt will be removed from banks’ balance sheets, which will act as another impediment to recovery.

Risks outside the US remain significant. Although the outlook for China is improving it is unclear whether the momentum of growth in the country will continue once current stimulus measures are utilised. Much will also depend on whether China and other export economies can shift growth impetus from external demand to domestic demand.

Moreover, concerns about the dollar’s use as a reserve currency continue to intensify as various large reserve holders attempt to diversify away from the dollar.  Although a dollar collapse is unlikely the risk that foreign investors reduce their exposure to US Treasuries remains a threat to the dollar.   This could push up long term interest rates and in turn mortgage rates in the US.  

The European economy is a particular riskto global recovery, with only a gradual recovery expected.  In particular, the biggest Eurozone economy Germany is struggling in the wake of a collapse in exports and a lack of domestic demand. Moreover, banking sector issues remain unresolved especially as there has been little information on European bank stress tests. The relative strength of the euro and inability of some countries in the Eurozone to devalue their way out of the downturn will also dampen recovery prospects.   These factors suggest that Europe will lag the recovery in other countries such as the US and UK where the policy response has arguably been more aggressive.  

The jobs market will lag the recovery process but there are signs that things are becoming less severe.  The pace of job losses in many countries is lessening.   In the US for example, non farm payrolls report revealed that average monthly job losses in the second quarter of 2009 at 436k were much lower than the 691k average monthly job losses in the first quarter.  The bad news however, is that unemployment rates continue to rise.  In the US the unemployment rate is likely to head to around 10% from 9.5% currently and this will be echoed in Europe where the unemployment is at a 10-year high of 9.5% currently. 

The bottom line is that the market rally may have been justified so far but there is little to carry the momentum forward. Equity valuations dropped to low levels in March but can be hardly considered cheap at present. The improvements in indicators of market stress have also reached dramatic levels and going forward there will be plenty of pitfalls in the months ahead.

Posted in bank rescue, central banks, China, Currencies, Economics. Tags: , , , , , , , , , , , , , , , , , , , . 3 Comments »

Recovery efforts pay off in the first half of 2009

July 2, 2009 — Mitul Kotecha

At the end of last year it looked distinctly like the global financial system was on the verge of meltdown and that the global economy was about to implode.  The change in market sentiment since has been dramatic.  Various banking sector bailouts, the pledge of as much as $2 trillion to support the US financial system, passage of the $819 billion stimulus plan by the US administration and G20 agreement pledging $1 trillion for the World Economy, were major events over the first half of the year which helped to turn sentiment around. 

More rate cuts by many central banks and expansion of quantitative easing, with the Fed purchasing $300 billion in Treasuries, and the ECB unveiling a EUR 60 billion covered bond purchase plan, provided a further boost to recovery efforts. This was coupled with the passage of US bank stress tests which at least gave some transparency on the state of US banks’ balance sheets. 

These efforts appear to be paying off as confidence has improved, data releases especially in Q2 09 have revealed a much smaller pace of deterioration, whilst some US banks felt confident enough to pay back TARP funds, marking a turning point for the US financial sector. 

Markets reacted to all of this news positively once it became clear that a systemic crisis had been avoided; most US and European indices, with the notable exception of the Dow ended H1 2009 with positive returns.  However, their gains were less impressive when compared to the strong gains in some emerging equity markets, with indices in China and India registering gains above 50% this year as recovery efforts in emerging markets echoed those in the G10, but with the advantage of far less severe banking sector problems.  

Currency markets have also given up the high volatility seen at the start of the year as many currencies have now settled into well worn ranges.  Measures of equity market volatility have also swung sharply over H1 2009, with the VIX index now less than half of its 20 January peak. Other measures of market stress have undergone significant improvement, with much of this taking place in Q2.   For instance, the Libor-OIS spread dropped to its lowest level since the beginning of 2008 and after peaking at close to 450bps in October 2008, the Ted spread has now dropped to a level last seen in late 2007.  The change in market sentiment over H1 was truly dramatic but there is little or no chance that this will continue in H2 2009 as I will explain in my next post.

Posted in Asia, bank rescue, central banks, China, Currencies, Economics, Economy, equity markets, Europe, Financial crisis, India, US. Tags: , , , , , , , , , , , , , , . 1 Comment »

What the G8 communiqué didn’t say

June 15, 2009 — Mitul Kotecha

There was a stark contrast between the outcome of the weekend’s G8 meeting in Lecce, Italy, and April’s G20 summit in London.  For a start, the tone was far more positive than in London, with Finance Minsters attending the meeting indicating that economic forecasts may need to be revised upwards rather than the steady stream of downward revisions seen over recent months.

The overall tone was one of cautious optimism.  The communiqué noted “there are signs of stabilization in our economies, including a recovery of stock markets, a decline in interest rate spreads, improved business and consumer confidence”.  However, at the behest of the UK the comments “but the situation remains uncertain and significant risks remain to economic and financial stability” was inserted into the final communiqué.   Such an inclusion is logical and at least suggests that officials are not getting to carried away with the improvement in recent data. 

Officials also began discussing “exit strategies” in terms of withdrawing massive global monetary and fiscal stimulus and even requested the IMF look at the issue in more detail.  Whilst it is premature to even discuss exit strategies the comments were clearly aimed at easing bond market concerns about widening fiscal deficits and inflation risks.  As Tim Geithner highlighted, recovery would be stronger if “if we make clear today how we get back to fiscal sustainability when the storm has fully passed”.   Nonetheless, a mere discussion about exit strategy is highly unlikely to remove the current angst that has built up in bond markets globally. 

Additionally, the communiqué included a commitment to develop standards governing the conduct of international business and finance, international regulatory reform, exchange of information for tax purposes and a commitment to refrain from protectionism.   None of these points will move markets this week and all were unsurprising discussion points. 

So what was missing?  The issue of stress tests on European banks was left out of the final communiqué even though it was discussed at the meeting. Reported disagreements with Germany and France over transparency over the publication of stress test results meant that an agreement could not be reached.  This is a big disappointment.  I have written about the issue in two previous posts “European economy in a whole lot of trouble” and “Stress testing European and UK banks” on my blog Econometer.   The fact that more wasn’t done will mean that uncertainty about the health of balance sheets in particular of banks in Germany will remain a constraint to European recovery.  At the least it will make it increasingly likely that in addition to a sharp decline in European growth this year GDP could also drop in 2010.

In addition, economic data continues to lag in the Eurozone compared to the improving signs in the US and elsewhere as highlighted by the huge 21% annual drop in April Eurozone industrial production at the end of last week.  This data even led to another omission with reference to “encouraging figures in the manufacturing sector” previously included in the draft dropped in the final communiqué.   It is clearly too early to talk about manufacturing recovery.

Also missing in the final communiqué was any reference to currencies. Although it was always unlikely that FX would be a major topic at the meeting due to the absence of central bankers attending, the drop in the dollar and concerns from foreign official investors (see a recent post on my blog “Are foreign investors really turning away from US debt”) raised the prospect that there would be some international backing of the US “strong dollar” policy led by the US. 

In the event there wasn’t any comment, but dollar positive comments on the sidelines of the meeting will likely limit any pressure on the dollar this week.  The dollar will be helped by comments on the sidelines of the G8 meeting as well as important comments from Russian Finance Minister Kudrin who stated that he has full confidence in the dollar with no immediate plans to move to a new reserve currency. Ahead of the meeting of BRIC countries this week the comments from Russia add further evidence that there will be no plan to move away from the dollar. Moreover, geopolitical tensions including the protests over the results of Iran’s elections as well as more jawboning from North Korea will work in favour of the dollar this week. 

The euro could look especially vulnerable this week. The lack of attention on European banks stress tests will be a disappointment for those hoping for more transparency and will act as a further drag on the euro.  This is likely to see the euro struggle to make much headway this week, with the recent high above 1.43 likely to provide tough resistance to any move higher in EUR/USD, with a bigger risk of a pull back towards the 1.37-1.38 levels.

Posted in bank rescue, Bond markets, central banks, Currencies, Economics, Economy, Europe, Financial crisis, Germany, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , . 2 Comments »
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