Tuesday, 23 December 2008

Revision momentum still points downwards

It has for many years been a tradition in the stock market to monitor the analysts following a given company. If the company is going through a rough patch, it is taken as a positive indicator once analysts begin to turn their own forecasts more positive. Thus, following the pattern – the momentum in earnings upgrades - in what supposedly more informed folk say about the company, the less informed investor can gauge when it would be time to turn more positive. Admittedly, this observation is rarely taken to be a sufficiently strong indicator about when to buy.

This "methodology" could equally well be applied to the overall economy. Over the past weeks a number of studies and forecasts have been released by various economic research institutions. Approaching the various reports in the way described above does not exactly provide for a lot of optimism leading into the new year.

So far, particularly in the stock markets, one economic statement has gained almost mantra-like status: The economy will improve in Q3 of 2009. Recently it has been updated to: the economy will improve in second half of 2009. When examining the various forecasts, it appears that there is successively less evidence to support this optimism.

In November, IMF reduced the 2009 growth forecasts from 3 percent growth to 2.2 per cent. The industrialised countries are expected to see a negative growth of 0.9 per cent, so the positive economic growth is coming from the developing countries.

In December, the World Bank published a revised estimate of a global economic growth of only 0.9 per cent, but remains optimistic about the outlook for 2009.

In the US, a host of institutions make forecasts and in general they are still revising their forecasts downward. The Energy Information Administration wrote on December 9 that "The current global economic slowdown is now projected to be more severe and longer than in last month's Outlook".

Members of the Securities Industry and Financial Markets Association's Economic Advisory Roundtable – sort of consensus for the financial industry - in December expected the current U.S. recession to continue into mid-2009, with subdued growth thereafter through the end of the year. -1.0% growth in 2009.

In Germany, the Kiel-based institute IfW released a very negative forecast of a negative growth of no less than -2.7 per cent in 2009 and a near-zero growth in 2010. This forecast easily beat the otherwise negative forecasts published by Bundesbank (-0.9%), Institut fur Wirtschaftsforschung (-1.9%), RWI (-2.0%) and ifo (-2.2%).

France's INSEE reported last week that there will be negative growth in the first two quarters of 2009 and that after that, only a very small recovery is likely. Economic periodical The Economist expects France's GDP to contract by 1.3 per cent in 2009.

Italy is the same story: all institutions, Banca d'Italia, OECD, IMF, and a host of private forecasts have since November been moved down from somewhat positive to an expected minus of -1.5%.

Reading through the accompanying notes reveals an interesting fact, namely that the recent downward revisions mainly affect the first half of 2009. Compared to the situation a couple of months ago, it is now expected that the downturn is faster and deeper in the first half of the year and then suddenly things get better in the second half. Personally, I believe it will prove an illusion. I do not understand how it is possible to predict a sharper downturn in the first two quarters of the year without it spilling into the last two quarters.

My guess is therefore that as the next round of revisions comes in February/March of 2009 they will likely postpone the recovery.

All of this looks pretty grim, to say the least. Economic forecasts are always by nature, made under a set of assumptions regarding the future. One typical assumption is the economic policy. Policy makers have the possibility of adding more fiscal stimulus if the economic forecasts look to bad, thereby invalidating the forecasts.

It is typical to use assume that the economic policy (public spending, investment, taxes and the like) will in fact be implemented as they are planned at the moment the forecast is made. At this moment, this is probably the largest source of uncertainty to this very negative outlook.

Across the world, various policy packages have been implemented in order to get the economy going (different from the ongoing initiatives of getting the credit markets going again). Apart from what the Chinese government is doing, so far nothing impressive has been put in place. EU has presented a package of 1.75-2.0 per cent of GDP but a lot of it was already existing policy plans. UK has cut TVA temporarily, which is likely to miss the target as people will not spend the extra cash, but use it to draw down debt. Rumours from the Obama transition team is revised almost weekly in regard to the magnitude of the fiscal stimulus package.

My guess is that as the downwards momentum accelerates in the coming months, more fiscal stimulus may be added as well as a further easing of monetary policy worldwide. If that happens in time, there is still a possibility that the global downturn will bottom out towards the end of 2009. There are, however, far too many ifs and buts behind the various forecasts.

No comments: