Is the Worst Over?

April 30th 2009

Over the last couple of weeks leading commentators have become increasingly convinced that the worst is now over for the world’s major equity markets. In the last week of March we have seen a rebound in US housing starts, new and existing home sales and durable goods orders, whilst in the Eurozone we have witnessed the fourth successive monthly rise in the expectations component of the IFO business climate survey. Importantly none of these are backward looking indicators, with each having strong track records in “predicting” where the components of aggregate demand are heading.

Meanwhile, in the UK the latest set of Q4 GDP figures confirmed that corporate sector has already taken huge steps in reducing unwanted inventories, which means that it is better placed to enable output to follow demand higher in the year ahead. However, the figures released on net lending were perhaps the most important to date in convincing the market that we are not on a one way trip into depression and that financial markets will be surprised by the swiftness and scale of the rebound later in the year.

Most commentary covering the results of Q1 have seemed to focus on the first decline in outstanding consumer credit since 1993. Given that consumer credit only accounts for about 15% of total household debt, this was merely a sideshow. More important was the near 20% rise in new mortgage approvals in February. True, this was from an extremely low base, but since this followed a 17% rise in December, the increase over the last three months, expressed at annualised rates was a huge 271%! At the same time, the annual rate of growth in M4 money balances held by the non-bank corporate sector, the plunge in which from a cyclical peak of 15.2% in November 2006 to an all time low of -5.9% two years later more than anything explained the economy’s descent into recession, rebounded to -2.1% . Granted this is still extremely low by historical standards, but within this M4 in the non-bank private sector has risen strongly in each of the last three months.

The really fascinating thing about these figures is that that they predate the MPC’s decision to inject up to £75bn of new central bank money into the economy via the purchase of gilts and corporate bonds in the open market. That we should already be seeing a revival in such leading indicators is highly reminiscent of 1992. Then too there were major concerns that the huge increase in the number of “non-performing loans” on banks’ balance sheets would preclude a “normal” recovery, prompting a number of eminent economists to argue that efficacy of interest rate policy had been greatly reduced. But as we now know, with such concerns at their highest, the economy had already embarked upon a normal cyclical recovery. The fact that the authorities have already countenanced the use of quantitative easing can only further enhance the emergent trends in the monetary indicators that we are now witnessing. This is not to say that we won’t see further horrendous economic data releases over the coming few months, but these will tend to things like the labour market which tend to lag rather than lead the economic cycle.

However, more than ever it seems that we will see firm evidence of economic recovery before the end of the year. In such an environment, the biggest risk that we and our clients now face is being out of (as opposed to being in) risk assets.