FYI | Dec 22 2008
By Chris Shaw
The end of 2008 sees a very weak global economy, one that will certainly dominate the outlook for 2009 given the recession in the US. According to BMO Capital Markets, it will be the longest and among the deepest downturns since World War II.
Standard Chartered notes confidence has also collapsed in-line with the worsening economic data of recent months, a trend it suggests is reasonable given the downside risks still apparent for the global economy. Falling trade reflects the lack of confidence and the group takes the view what is needed is not only a recovery in expectations about growth, but further policy action to free up credit flows.
But the news is not entirely bad, as a view is growing among economists there will be signs of a recovery emerging from about the middle of next year. Economists at BMO Capital Markets have this scenario as their likely time line, the group estimating mid-2009 should be the bottom for the global economy before a sluggish recovery over the rest of the year and moderate growth in 2010.
While Standard Chartered sees the worst of the financial crisis as likely behind us now, it doesn’t expect any quick recovery either, and suspects it could take years for the problems of the various derivative markets around the world to be worked through.
As well, any recovery will be in an environment of a global recession, with the group pointing out an old saying that a recession uncovers what the auditors miss. This is something Australian investors in stocks such as ABC Learning Centres ((ABS)) can well understand. This means there is scope the downturn lasts longer than currently expected, as many assets are being held in the hope of some sort of recovery in value. But if this doesn’t come soon, further falls in asset values could occur.
This leads the group to suggest 2009 will be a tough year, whereas Danske Bank sees the downturn as continuing through the first quarter of next year, but not as deep as recent economic data would suggest. This means despite the fact house prices have yet to stabilise and unemployment in the US is not likely to bottom before sometime in 2010, the middle of 2009 should see the trough of the downturn. Any recovery will be slow though, with growth likely to remain below potential until well into 2010. Risks remain to the downside in the bank’s view.
For the US specifically, BMO Capital Markets expects growth will contract by 2.3% next year, but the latter part of the year will show some improved numbers. Things will be pretty though, as the group expects the unemployment rate to hit 9% next year, its highest since 1983 and more than 5% above the levels of 2007.
As more stimulus measures are applied to counter this, the group expects the focus to turn to quantitative easing given interest rates are already at near zero. While this will help, there remain three keys to a recovery in the group’s view. These are achieving some stability in house prices, the employment market and the restoration of bank balance sheets.
While this implies some downside risks remain, Danske Bank takes the view the US will be the first economy to emerge from the downturn, followed by Asia and with Europe to be the laggard. This is largely because Europe is behind the US in terms of dealing with the downturn and so will need to play catch-up in coming months. BMO Capital Markets also points out this implies some extension of the recent support for the US dollar, as other central banks continue to bring down interest rates.
Danske Bank estimates this catch-up in monetary policy could see the European Central Bank cut rates to as low as 1.5% as it attempts to kick start the European economy. With rates already close to zero in Japan, the downturn there is expected to see the Bank of Japan turn to outright purchases of government bonds and corporate debt as its primary monetary policy mechanisms.
Deleveraging will impact on emerging markets in the early part of 2009 in the bank’s view, while weaker commodity prices will hurt Latin America and weak industrial production in Asia limits growth in that region. Standard Chartered sees the global environment as one of structural problems in the West and a cyclical downturn in the East, but the key for the latter region is to be clear in its policy objectives.
Important in the group’s view will be additional policy responses, with the specifics differing depending on the country in question. With the workout phase of the problems to take some time, the group is firm in its view any recovery will be a gradual one and Asia is the best positioned of the emerging markets. This is because the Asian crisis of a decade ago has left policy makers with more options in terms of possible responses to the crisis. The region is also better placed than Europe given that region has left things late in terms of dealing with the crisis.
The main risk for Asia remains weaker exports, meaning stimulating domestic demand will be important in the group’s view. However, as the group sees the economic fundamentals in Asia as solid, it expects enough success in this regard to retain its positive view on the region.
With risk aversion continuing, there is scope for further gains in the yen in the group’s view, a trend it expects will continue until Japanese begin to invest more overseas. Standard Chartered also points out the Chinese downturn is actually a positive for the country’s long-term economic health, while the region in general should benefit as the stimulus package introduced by the Chinese Government is likely to be successful, as it appears to target the needed areas and is expansive in scope.
For the Australian economy, Standard Chartered sees a prolonged slowdown, as in its view the economic adjustments required to deal with the changed conditions are only just beginning. While monetary policy is already pro-growth, the fiscal policy shift is still to fully flow through and as a result, the group expects the Aussie dollar to remain weak for several more months at least. This is especially so given the bank is forecasting GDP will contract by 1% in 2009.
In terms of commodity prices, BMO Capital Markets sees prices as remaining under pressure in the first part of 2009, in particular given global demand is weak and is likely to stay so for some time. This suggests further falls are possible, but once the global outlook eventually recovers -even modestly- the group sees prices as also likely to begin creeping higher.
Standard Chartered agrees commodity prices will struggle further in coming months, but the plus here is the downside is not limitless and the foundations are being put in place for a recovery from the second half of 2009 as the global economic outlook begins to brighten.
There are also specifics in each market that need to be taken into account. The group gives as one example the expectation there will be a quick re-emergence of supply side issues in the oil market once demand recovers. With respect to the base metals, the group sees copper at risk of further falls in the short-term whereas nickel and zinc should be more resilient given more significant output cuts than for other metals.
Larger stockpiles mean nickel and aluminium prices will take longer to recover than should copper, while both it and tin should continue to show greater price volatility. Nickel and aluminium should be more range traded. The group also expects gold to regain some upward momentum in the second half of 2009, as by then both investor sentiment should have improved and the US dollar gains should be coming to a close.
Best positioned remain the agricultural commodities as the sector continues to experience funding issues and low costs, while fertiliser costs are also currently high and this has the potential to limit output. This is not being adequately factored in the group’s view and adds to its expectation prices should edge higher through 2009.
So what does this mean for equity investors? UBS has attempted to address the issue and suggests returns should not only be positive in the coming year, but should be solidly positive, to the tune of double digit gains as valuation multiples are now supportive and economic conditions should, over the course of the year, show some signs of stabilising.
Danske Bank tends to agree the outlook now favours those investors with a longer-term time frame, as the credit crisis should eventually thaw and this increases the chance corporate earnings return to something closer to trend levels. This means downward revisions to earnings forecasts should slow through 1H09, as forecasts are now much more realistic. Increased levels of disposable income thanks to policy measures and lower oil prices should also help see confidence restored.
While earnings risk remains, UBS sees this as being largely offset by the relative yields available. This means at some point there will be rotation away from risk aversion and towards more cyclical investment options.
But again, the key will be positioning oneself in the correct sectors and economies, with the broker suggesting this means favouring the US against underweight positions in Europe in particular. UBS prefers Consumer Staples, Telcos and Technology stocks and suggests being underweight Materials and Energy in particular. The broker is also modestly underweight Utilities, Industrials and the Consumer Discretionary sectors.
Danske Bank’s overweight sector recommendations are the Retail, Consumer Durables and Apparel, Pharmaceuticals, Biotechs, Transport and Telecoms, while its underweight sectors are Materials, Utilities, Capital Goods, Healthcare Equipment and Services, Real Estate, Food, Beverage and Tobacco sectors. The group is neutral on Financials, Energy and IT stocks.
