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The global economy will power out of this flat spot

06 July 2011 Gareth Stokes
Gareth Stokes, FAnews Online Editor

Gareth Stokes, FAnews Online Editor

What do reggae and economics have in common? The answer, according to Chris Freund, a portfolio manager at Investec Asset Management, can be found in the words of one of Bob Marley’s hit singles. Marley, a Jamaican-born singer, songwriter and musician begins his reggae hit with the lines “Don’t worry about a thing, cause every little thing gonna be all right!” Freund’s economic presentation at the 5 July 2011 Investec Quarterly Media Briefing had a similar ring to it. He kicked off by assuring the gathered audience “Don’t worry, It should all be OK!” He said the consensus among economists and analysts was that the current “soft patch” on global markets would not morph into a dreaded double-dip recession.

Forget the singing – four more reasons to celebrate

It is impossible to predict future economic events with total certainty. However, Freund identifies four economic indicators to support his “it should all be OK” theory. The first of these indicators vests in a graph of the US yield curve going back to 1966. This curve depicts the difference in yield between 30-year and 10-year US Treasuries (or Government Bonds as they’re commonly known in South Africa). It emerges that each US recession going back 50 years started with the yield curve in negative territory. “If we are about to enter a second-round recession,” opines Freund, “this is the first time we will go there from these [yield curve] levels!” The current yield is at 50 year highs, above 1%.

The US real short-term interest rate is the second recession-busting indicator. Each recession, going back to 1975, was preceded by a period of meaningful tightening in short-term real rates. This pattern repeated in the run-up to the latest recession as the Federal Reserve did everything in its power to ‘soften’ the impact of the economic slowdown. At present US short-term real rates – the Federal Funds rate less core CPI – are negative… And the argument is the US cannot go into recession from this position. A third warning sign of recession comes from the banking and financial sector. Prior to recession banks are typically ‘lent to the hilt’ and forced to tighten their lending policies. At present banks are have plenty of capacity to extend credit to both private and corporate borrowers. This, says Freund, further supports the view that we will not see recession.

And finally – busting the second-round recession threat once and for all – companies are spending again. “Companies across the US are cash flush and have just started directing this cash to capital expenditure,” observes Freund. These positive financial indicators coincide with an extremely positive outlook for both US manufacturing and equity markets. Of course dispelling the threat of a return to recession doesn’t guarantee above-average economic growth. Investec believes the US and other developed market investors will have to brace for a long period of slow growth. It will take years for consumers, banks and countries to shake off the debt legacies they created in the run-up to recession...

Risks cannot be ignored...

Although the overall economic prognosis is good there are a number of risks which cannot be ignored. Freund – and many of his peers – have identified three serious threats to the global economy. These include the possibility of a lengthy residential property slump in the United States, a sudden slowdown in Chinese growth and the timing of the resolution to the European sovereign debt crisis.

On the first point Freund observes that distressed sales (foreclosures) continue to drag overall US house prices down. Property experts reckon the lull in US house prices – and any other economy which emerged from housing price booms recently – could continue for another two years. This trend has played out in previous US residential property busts, where peak to trough cycles typically last seven years! The Chinese growth concern is easily dismissed… Growth in that economy is forecast to slow (if only we could have similar) to 8.7% in 2011 and 8.4% next year. But there are early indications inflation will ‘roll over’ in the world’s second largest economy toward the end of 2011, allowing Chinese monetary policy to ease in line with its growth requirements.

The most serious worry centres on how Greece and other struggling European economies deal with their debt issues. As Greek citizens take to the streets to protest their government’s latest austerity measures there is evidence of a run on the country’s banks. Household deposits at Greek banks have been sliding since late 2010 and the value of notes and coins in circulation in that economy is through the roof. The latest thinking is that Greece could default on its debt and that the best solution for a currently weak European banking system would be for this event to be delayed for as long as possible.

Where to invest through 2011

Asset managers will have to stick with disciplined asset allocation strategies if they hope to generate real returns through 2012. Freund reckons equities will be the best place to be in the short-term because they have yet to recover fully from the so-called ‘credit bust’ recession. Bonds should provide reasonable returns… And cash… Well – cash remains trash for now!

Editor’s thoughts: There you have it – the post-recession global economy in a nut shell. We will watch with interest to see how the Greeks (and other European economies) resolve their debt issues. And we’ll warn the South African government that none of these economies reached these debt predicaments overnight! Are you confident the global economy has side-stepped the double-dip recession threat? Please add your comment below, or send it to


Added by Irene, 06 Jul 2011
No ways is the world out of this crisis, and won't be for a very long time. Anybody who says otherwise, is living in a dreamworld or plain lying, as at no time in history has personal, commercial and sovereign debt been so high as at present. This is the usual 'spin' that investment adivsors want the public to believe to continue obtaining more money from the clueless public to help out the financial institutions, who played Casino with other peoples' money in the first instance and brought on the crisis. These financial institutions are all sitting with worthess paper, which they knew borrowers could not afford, and which they pass/ed on to hapless and gullible investors. Does anybody really believe Bank of America, etc are paying back billions of $s, albeit a few cents in the $, to claimant investors out of the goodness of their hearts? Even the billions of taxpayer monies spent by governments all over the world to prop up the sick, 'too big to fail' financial institutions wasn't enough - you cannot resurrect a dead horse, no matter what you try. It is time that elected officials and governments face reality and start planning on how to manage 1. the orderly closure of these sick financial institutions, 2. the global contagion resulting from this and to do as much as possible to protect Joe Public and 3. decide on a new order, better regulation and, more importantly oversight, in the global financial market. The EU taxpayer and protesting Greek has realized that their governments throwing even more good money after bad will not solve anything and are making their voices heard in no uncertain terms. Lucky them, at least, and unlike SA, they have viable opposition parties and are not held ransom by the incumbent government. The best thing to do with your money - pay off any debt, live within your means and be weary of advisors who 'don't put their OWN MONEY where their mouth is'!
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