United Kingdom
The UK has been slower to recover from the steeper than expected fall in output last year and early this. This has prompted the Bank of England to extend its quantitative easing policy, in turn meaning that they take a more cautious view of the recovery than the equity markets. Partly this is due to the equity market expecting recovery in 2010, and pricing that in in advance.
The markets clearly expect that the reflationary policies put in place by the Bank of England will work. A revival in hopes for global growth have been reflected by forecasts for the UK, albeit slightly later for UK plc, which expect a turnaround from this year's fall to a modest, but improving, growth rate in 2010. The spectre at the feast remains the enormous gap in public finances which even politicians have had to acknowledge as they furiously attempt to defer difficult decisions until after the election. The markets must have their confidence maintained in the government's commitment to sustainable fiscal policies or they will stop making money available to fund the recovery. That is forcing all parties to admit that significant cuts in public spending, and tax rises, will be needed to close the fiscal gap in a reasonable timeframe. The ratings agencies have warned that the UK will put its AAA status at risk if it does not announce significant public spending cuts in the pre-Budget report. Economic recovery and the natural ending of fiscal easing measures will not alone be sufficient to stabilise and reduce public debt burdens over the medium-term. Given the inevitability of such fiscal policy tightening at a time when consumers are also trying to reduce personal debt and rebuild savings, the UK seems likely to be less buoyant than the global economy generally. The current competiveness of Sterling should help the usual sectors able to take advantage of this (exporters, tourism etc.).
USA
The US economy is responding to the mind-bogglingly enormous fiscal and monetary stimulus put in place over the past year. This has been helped by the fact that parts of the economy, in particular housing and the motor industry, have effectively been in recession since 2006 and may have reached the absolute low point of the cycle. Like in the UK, the absence of any real controlling process for managing ongoing budgets is likely to cause problems to investors as the economy recovers. The US political system remains open to lobbying and shows little inherent commitment to fiscal restraint, in fairness this is fully representative of US consumers, who seem to believe that the new president is installing a communist state ! The emphasis, and the easier “sell” from the Democrat-dominated Congress, remains focused on increasing spending. The financial system appears to be rapidly weaning itself off the special support measures put in place last year, with the main remaining vulnerability being to real estate lending. This suggests that the special measures and low interest rates will remain in place for some time yet. The signs of the housing market turning up are important and, as in the UK, have the potential to be confidence inducing and self-fulfilling, as those who have waited to buy now see the market near its bottom and banks can afford to be more patient with borrowers in difficulty. Although the remaining consumer debt overhang remains a similar barrier to the UK's problem, recovering house prices would enable savings to be rebuilt and allow a faster rate of economic growth while this was maintained.
Europe
Some European economies including, most importantly, France and Germany emerged from recession in the early summer, while others, in particular Spain and Ireland have remained weak. It is notable that both Spain and Ireland were effectively economic “one-trick ponies”, with both economies built primarily on property development and the finance thereof. There remains some concern that job losses in France and Germany have been delayed by their relatively inflexible labour laws and possibly also by the imminent German election. Rising unemployment could therefore be more of a drag on growth and output in 2010 than in countries where employment responded more rapidly to the downturn and where the worst might soon be over. If recovery arrives more rapidly in the exporting economies, such as Germany, than those that are struggling to remain competitive, such as Italy, or those whose economies grew on a financial bubble, such as Spain and Ireland, there could be renewed significant strains on the Euro. The most likely outcome of such strains is probably even greater fiscal and monetary easing rather than the end of the Euro.
Japan
The Japanese economy has begun to recover from the absolute cliff-fall in output last winter, which wiped out 25 years of output growth. The popular discontent with this crash which, let us not forget, came after nearly 20 years of stagnation, led to a political sea-change, with the opposition DPJ winning by a landslide and ending 51 years of almost exclusively one-party LDP rule. Markets are still unsure what to make of this. The new government's policies are determinedly reflationary and are focused on reviving the domestic economy rather than targeting and relying on export growth. If they can pull this plan off, whilst still addressing the enormous legacy high-debt and high-deficit public finances, the prospects would be bullish for Japanese equities. The key issue is whether their policies can actually revive growth, which in turn would make the fiscal tightening more acceptable and politically feasible or whether they are forced by a lack on international confidence to tighten first, in which case the recovery could fail to start, yet again.
Far East Ex Japan / Emerging Markets
Emerging markets have contributed their positive growth this year, as developed economies have shrunk and, not surprisingly, they seem set to contribute the majority of recovery in 2010. In that respect, decoupling has taken place to some extent, as they have moved on being dependent on the prosperity of western markets to taking on an increasing role in actually driving the global economy. In addition to generally having a younger workforce, confidence has been boosted by general improvements in corporate governance, which has helped to attract inward investment from more conservative investors. The Asian crisis of the 1990’s led to more conservative financial policies, so emerging markets are much less dependent on foreign capital than they were before and in some cases, the dependence has actually reversed. They (in particular China) have the assets and it is the G7 countries that have the debts. The transfer of economic power from the West to the East appears increasingly inevitable.
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