Friday, 23 October 2009

Consumers will not lead this recovery

One of the misperceptions commonly heard in the market these days is that the consumer will lead us out of this recession. It is true that private consumer expenditure is a large part of total GDP and without a rebound in consumer expenditure, there will not be any strong economic growth. However, this downturn did not start with the consumer and the recovery has not started with the consumer.

Rewind to last year in August and September. Bear Stearns had gone, Lehman was going down, the Interbank market was frozen. To most people this would have been distant rumblings had it not been for the carpet bombing with news about the "financial crisis" from every conceivable news outlet. Even the sports pages carried news about the potential impact of the "financial crisis" for the football clubs and the prospective earnings for the highest pays sport stars. Ordinary folk shook their heads and the most rational among them began to cut some of the excess out of their daily consumption.

Corporate executives, however, reacted differently. They heard that their banks would cut dramatically back on credits and that the same would happen to other companies. Faced with an increased uncertainty, CEOs and CFOs across the world reacted swiftly: cancel orders, write down inventories and begin to prepare for further cost reductions (read: layoffs). Given how the corporate world has taken to the "Cisco" model for production and inventories, this effect was rapid and almost coordinated across the world. The effect was a collapse in corporate investments. Together with continued alarming news from virtually all news media, this disturbing news understandably further made consumers nervous and consumption began to give in.

While this is no attempt at underestimating the nefarious effects of a frozen banking sector, there is no doubt that this economic downturn became so rapid and dramatic because modern ERP (enterprise resource planning) systems melded with a 24/7 coverage of the events on virtually every news media. Corporate investments were the leading factor. Everything else followed. Yes, for sure there are subsectors of the US consumer markets also stopped dead in their track as some over-indebted consumers were forced to increase savings. But their effect on the global economy was limited compared to this "CNBC downturn".

It will be the same coming out of the recession. Rapid cost reductions meant that corporate profitability rebounded rather quickly and the stock markets followed. The next thing that will happen is a return to corporate investment and it will be focused on efficiency enhancing investments – i.e. yet another cycle of technology investment. Only then companies will begin to employ. And once the danger of losing one's job in a wave of job reductions, consumers will feel reassured and begin to consume again. The only real exception to this sequence appears to be US consumers, who are currently reducing their savings rates as new consumer credits appear to come on stream.

As many financial market observers use the consumers' sluggish reactions as a "proof" that the stock market rally is overdone, it might be worth noting that when compared to every other post-recession boom this century. There is nothing abnormal about this recovery; it is just a bit above normal, but nothing dramatic. It is quite obvious what is happening at a corporate level. Just check the NAPM or PMI indices: the new order component is increasing strongly. Soon corporate investments will begin to increase strongly as well.

I am usually sceptical of the stock markets' ability to predict anything (it completely "forgot" to predict the current downturn, just to take one example). However, this time it looks as if the market participants are indeed ahead of the economists. Technology and Infrastructure are indeed the winners.

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