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Risk Management: Making Sense of the Surging Markets

by Cesar Bacani, 18 October 2010

topics:
Management Risk Management

tags:
depression domestic consumption double dip recession financial shock quantitative easing stimulus U.S. Federal Reserve

In the book The Great Depression: A Diary, the late American lawyer Benjamin Roth recorded his observations during the 1930s, when the U.S. and much of the world were in the grip of a paralysing economic downturn. One of the most striking passages concerned the period between 1935 and 1937, when businesses turned profitable and the U.S. stock market came back to life.

“It seems to me,” Roth wrote in 1937, “that the time has come where we can formally and officially announce that the depression of 1929 has ended.” He was wrong. In September that year, the stock market crashed and the U.S. returned to recession.

David Cohen, director of Asian economic forecasting for Action Economics, hopes history will not repeat itself, but he fears that a double-dip recession is still possible. The lesson of the 1930s is that the early withdrawal of fiscal stimulus can lead to another downturn. “Also the Federal Reserve [at the time] was not sufficiently expansionary in its policies,” he adds.

Cohen spoke to CFO Innovation’s Cesar Bacani about the risks the world still faces, the expected quantitative easing by the U.S. Federal Reserve, the G-20 summit in Seoul in November and other events that may tip the global economy back into a downturn.

What do you make of the recent bullish tone of global stock markets? Does this indicate that the prospect of a double-dip recession has receded?

This mood can swing from week to week. The stock markets globally had foundered back in mid-August amid the talk of double dip and disappointing data from the United States. But then we saw the global equity markets rebound quite nicely in September, and it seems suddenly people weren’t so concerned about the possibility of a double dip.

In reality the data hasn’t really changed all that much. There’s been deceleration in the pace of global recovery since the middle of the year. This has not been entirely unexpected. Some of the strong bounce we did see in the four quarters through the middle of this year, from the lowest point of the first half of 2009, has been exaggerated by inventory correction.

Remember, the downturn during the height of the crisis in global manufacturing had been [marked] by inventory reductions around the world. Amidst the panic, businesses sharply cut their inventories, so production actually fell even more sharply than the fall in final demand. We enjoyed the flip side of that over the four quarters through the middle of this year, where production rebounded more strongly than the turnaround in final demand around the world because of the boost from the inventory side.

That whole part of the recovery is behind us now. That’s one reason why the growth has decelerated.

And yet the Dow recently passed 11,000 points and the Hong Kong, Shanghai and Shenzhen indexes are remarkably buoyant.

There’s a sense that, although [we face] lingering drags in the United States and Europe from the legacy of the financial crisis, there are factors that tend to re-stream the pace of recovery, and we’re seeing that apparently in the United States. The growth is fairly sluggish, leaving a disappointingly high rate of unemployment, but the consensus is still that growth would continue positive in the United States.

There had been all that nervousness that maybe the restraint measures [on credit growth] by Beijing were dampening economic growth in China, but the most recent purchasing managers indexes, in fact the PMI in the last two months, have shown an encouraging pick-up. That helped contribute to the pick-up in global equities.

Some of the equity bounces have also been supported by the expectations that the Federal Reserve would implement quantitative easing at their next meeting [in November]. But that’s really a big unknown. No one knows how effectively that will boost growth in the United States. As I said, the data, overall, have not changed all that much, so maybe we’ll be due for another correction.

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