The panel discusses the recession vs recovery debate and how the developed world and emerging markets are affected by the crisis
This week’s Conjecture panel consists of Julian Chillingworth, CIO of Rathbone Unit Trust Management, Robert Quinn, equity strategist at Standard & Poor’s, and James Dowey, chief economist at Neptune.
Where are we in the recession versus recovery debate?
Julian Chillingworth (JC): I think I would say things are getting better slowly around the world. And consequently, I think the depths of gloom and doom we were in, probably in the third quarter of last year, have dissipated quite a lot in terms of investor sentiment and also economists’ comments. But the other general point I would make is I think this recovery is going to be quite slow and lacklustre, and I think particularly in the G7 nations, and so there is quite a lot of hurdles still to jump over.
James Dowey (JD): We see the developed world having been left in a mess by the crisis and we think it is going to splutter and struggle to grow over the next five years. The best opportunities for growth are in emerging markets and the companies to hold are either multi-nationals that have tapped into emerging market growth or companies based in emerging markets. That is our broad overview.
To put a few numbers behind that, we see the emerging markets contributing around 60% of nominal GDP growth over the next five years. Compare that to the 1980s and 1990s when they were contributing around 10%. In the 2000s, they had stepped up to about 40%. We think we will see an acceleration of this slow-burning shift over the next five years.
Robert Quinn (RQ): We are clearly getting divergent speeds here and even within regions, within Europe, you have got some countries are stronger than others. Even in parts of Latin America. And then obviously Asia is very strong entirely. Closer to home, it almost feels like you have survived a really bitter winter, you have gone outside the cabin, collected the firewood and we are inside and we are waiting for that firewood to dry out a little bit because we are all crying out for some warmth – ie growth. And it is taking a while to do that. So Europe I think will definitely lag the US and Asia.
When will the interest-rate tightening start in the major countries? And is there a fear we could end up going back into recession if this is done too quickly?
JC: I think the latter point is preying very much on central bankers’ minds, and consequently our own take on this is that the likelihood if anything is they may prolong the interest rate lower for longer philosophy. We are not in that stage at the moment because the economies are not strong enough, but that may have some inflationary aspects to it further down the line.
But from our perspective, we expect the Fed to gradually tighten from the fourth quarter of this year. The Bank of England may follow suit but I think it is more likely to be in the first quarter, unless Alistair Darling’s comments on 24 March about growth picking up dramatically in 2011 turn out to be the case and the Bank of England takes a more sanguine view. But at the moment, there are so many moving parts with the ECB I suspect they will hold off as well.
JD: We do not think very much at all is going to happen to rates in the developed world any time soon, principally because these countries are not returning to normality on the other side of this crisis. The problems are of a disinflationary nature. If you look at core inflation in the US and in Europe, it is ticking down pretty worryingly.
I think over the next few months within the investor community we are going to see a swing back to deflationary fears. On the other hand, you have high unemployment, which is probably going to be slow to fall over the next couple of years. It is a pretty easy decision for central bankers to make – do not raise rates in that environment.
A third factor is housing markets. It is clear in the US and the UK the falls in the housing market have been stopped by heavy government intervention: the purchase of asset-backed securities by the Fed in the US and the chopping of interest rates in the UK. So if you start to tighten monetary policy, down go those housing markets again and that is a huge hit to confidence.
However, there is a big divergence between the developed world and the emerging markets, which are returning to something like normality already. We are seeing inflationary pressures come through, as mentioned, in India, but equally all over Asia there is inflationary pressure, so they are raising rates.
What is the house view on Russia at the moment?
JD: We are positive on Russia, which right now admittedly has not been the most profitable view to have over the past couple of years. We are positive for the following reasons. First, we think there is a lot of bounceback potential in Russia right now, following the huge fall in GDP last year. We think there is something akin to the bounceback potential following the crisis in the late 1990s. Second, in the past 12 months, we have seen inflation halve from 14% to 7%, which is really helpful for Russian policymakers. Monetary policy has been loosened.
We think we are seeing the beginnings of some foreign investor confidence return to Russia. So we think Russia can manage 4% or 5% growth this year, and stronger next year, of the order of 6%. We think that 6% is about Russia’s trend growth rate in the coming years. Interestingly, the growth rate Russia was managing prior to 2008, 8%-9%, really was not a comfortable rate of growth. I would be much happier as an investor with Russia growing at 6%.
So we are positive on Russia?
RQ: We cover over 100 Nordic companies and a lot of them have greater influence and greater exposure to Russia than, say, more continental European companies. I could give you half a dozen chief execs who have told me personally how in their Russian operations, people come along and turn the lights off over increased whatever brown envelopes, or whatever else. So I think there may be some Western misunderstanding of Russia, but there is no smoke without fire there really.
And also Russian GDP is largely a play on the oil price. If you forecast your oil price for next year, which is not easy to do, you can forecast your Russian GDP growth. And the Russian story in the last cycle was largely driven by consumption. I think consumer spending was round about 10% and above for most of those years. So I think Russia is a high beta player, so if you make a call on the rest of the world, then you can make a call on Russia.
China seems to be taking a robust stance towards the US on its currency relative to the dollar. How do you see this unfolding?
JD: Yes, it is starting to look ugly. We have got Paul Krugman, maybe the most eminent American economist of our time, who has come out and it looks like he wants to start a trade war with China. This is even more interesting when you think that Krugman won his Nobel prize for proving the value of free trade economics. Yes, this is starting to look pretty ugly. It is a concern for China – as much a concern for China as it is for the US.
So we tend to think of this as China holding a sword above the head of the US in the form of all these Treasuries it holds. Therefore, the US is highly compromised. But China is pretty compromised as well. It still relies on exports to the US for growth to a very high level. And we saw how hard the Chinese Government had to work to keep the Chinese economy going in the face of the Western slowdown. That shows you just how important this relationship between the two is.
RQ: I think it will probably start by the end of this year. I think what would delay it is if the Americans get a bit more vociferous and louder. Because the Chinese clearly do not like being told what to do – no national government does. You ask Germany to try and help rebalance Europe, which is a very fair request, and they do not quite like that.
Yes, they did not like being told they should bail out the Greeks on their own did they?
RQ: No, so no one does. And the Chinese culturally do not like that anyway. So if you leave it, it is like I mentioned earlier, at the minute, China is probably overheating. They say they need 8% growth to maintain full employment, and now you are looking at around about 10%. If you strip out the numbers, and it is really hard because they give you a lot of nominal data, but if you strip it out, you can probably get round about third-quarter GDP growth of 10%. And that is q-on-q and that is not annualised. So you are looking at ridiculously strong levels of growth.
And then you see, and I mentioned that, four percentage-point rise in five months in inflation. Inflation is going to get heavier, it is going to get very uncomfortable. You either take the steam out of the domestic economy, which they are not willing to do, you reflate your currency, and take the steam out of the external sector, which they are not willing to do just yet, or inflation gets very high. So the only option you have got really is to ease the currency lever, and I think that will probably happen by the end of this year.
Again, I think it is more political write-ups than anything else. You have got this semi-annual Congress report coming on the currency very soon. So you get these kind of run-ups.
JD: You really do not get a happy outcome from this situation unless China does revalue significantly. There is a very interesting precedent here: in the 1920s, you had a bilateral relationship between the US and Germany. Following the First World War, Germany became hugely indebted to the US on account of the war payments the US demanded. So Germany was trying to pay these debts off to the US but at the same time the US was running a huge trade surplus with Germany. This position for Germany just became untenable.
If you read the dialogue between the two governments at that time, it looks very similar to the dialogue between the US and China now. And we all know how that situation deteriorated eventually. As a comparison, you have even got the 1920s boom in the US that you could compare to the boom in China right now. And that is a pretty bearish comparison but I think it is one worth putting out there.
Which regions look the most attractive on a 12-month view? James, I think I know your answer: you think it is going to be emerging markets.
JD: Yes. In the very short term, though there is still some bullishness to squeeze out of the US.
RQ: I think the US has done quite well recently, because it has a currency effect, looking at the translation impact there. I think Asia, they all move together, really. I imagine emerging markets will probably do better than the others.
JC: America I think will lead the way and this will be helped by a dollar tailwind as well. The trouble I have with the developing world is I do not think it is that cheap. But medium term, yes, you have to have a reasonable position there. But back the States.
RQ: I think it says a lot about your own character really, whether you have been burnt before. Possibly puzzling to me is the [PMI] series are very widely tracked and obviously the manufacturing one went off a lot earlier in this series, we saw a manufacturing rebound. The service indices surveys that are carried out for the US, for Europe and UK are all quite positive and expansionary. And effectively in services, you might as well just scrub that off and say domestic demand. And that is what we are missing in Europe. So the surveys are saying domestic demand will return, all other indicators are saying no. What we have seen actually is we have seen the IP data get revised for the last few months, which will, because it goes directly into the GDP numbers, get an uptick to the Q4 outturn we have already had. But at the minute, we were a bit light on positive catalysts.
JD: What we are experiencing is a typical recovery from a banking crisis, which is not a typical recovery from a recession that has been caused by something else. Typical recovery from a banking crisis tends to be slower, more arduous: unemployment falls more slowly, credit growth is not there. And it is a lot harder work. So no, it is not different this time, but you just have to be looking at the right category of recession.
Actually this might not ring with a lot of what I have been saying – we are pretty bullish right now, and we are pretty long risk. We think that there is an inflexion point ahead where you are going to want to really turn that risk down in the developed markets. The big question, from that point onwards, is do you want to be low-risk broadly, or do you want to be tilting towards where the growth is in the emerging markets? And we think we are investing in the latter camp.
With the launch of the Green Bank announced in the Budget, will this be a decisive fillip for UK environmental funds?
JC: We have had, in the last few years, quite a number of people waxing lyrical about environmental funds of various types. The problem I really have is I think currently it is very difficult for any of these companies to make a reasonable return for investors unless they are subsidised.
Now obviously the green bank fund is indirectly going to be participating in that but I think because of Kyoto, there will be continued subsidies for wind in particular, and that will obviously mean you can make a decent return.
I suspect the fund will lead to quite a lot of new launches of other products, which may have some appeal. But I think investors need to be aware returns from these products have been quite volatile, and I would just emphasise that. But yes, for those people interested in that area, it is an opportunity.
Do you personally feel pessimistic or optimistic going forward for markets?
RQ: It says a lot about your own character and whether you have been burnt before. What is puzzling to me is that the [PMI] series are very widely tracked and obviously the manufacturing one went off a lot earlier in this series, we saw a manufacturing rebound. The service indices surveys that are carried out for the US, for Europe and UK are all quite positive and expansionary.
In services, you might as well just scrub that off and say domestic demand. That is what we are missing in Europe. So the surveys are saying domestic demand will return, all other indicators are saying no. What we have seen actually is the IP data get revised for the last few months, which will, because it goes directly into the GDP numbers, get an uptick to the Q4 outturn. But at the minute, we were a bit light on positive catalysts.
JC: I would slightly turn the question and I say the most dangerous statement is that it is different this time. And I think we are in a normal economic cycle, it is going to be possibly slightly slower than some of the cycles than we have had historically but people should not forget that. And therefore I think we will see economies begin to gradually recover and in the G7 it will be led by the States.
