2008 was the worst year in memory for many investors and one that is likely to change the way the financial sector operates within the economy. Some of the changes will be targeted towards tolerating the current slowdown, others, such as those to investor behaviour and the regulatory environment, are likely to be more permanent.

 

For the first time in most investors’ lives, a deep and coordinated global recession is rapidly developing. Economic growth forecasts are dropping as swiftly as the share prices. Without some substantial global stimuli through both fiscal and monetary policy, we risk falling into a ‘debt-deflation spiral’ that would warrant genuine comparisons with the Great Depression.

 

Monetary authorities have been the first to act. Interest rates are coming down globally and where they are already zero ‘quantative easing’ is either in place or being openly discussed. The credit freeze in the financial markets is finally – and slowly – showing signs of thawing.

 

Nevertheless the shock to the financial system has been so profound it has stifled bank direct debit lending and credit conditions in the real economy remain tight, despite low rates and normalising markets. The reasons banks are not lending stems from a need to address their own losses.

 

What cannot be measured or predicted is the impact the new US president will have on the confidence of the people as economic agents. President Obama ran a campaign based on ‘hope’ and ‘change’ and there seems to be appetite for both. That said, time is of the essence and action needs to be taken quickly or the cost to society will grow.

 

The scale of the economic task ahead for President Obama is daunting.

 

So why haven’t the markets rallied yet?

 

Investor confidence has taken a severe hit, one that is broader than just concerns about a global recession. In addition to the global downturn, the composition of market participants has changed with banks and hedge funds both retreating from the market for their own reasons. This has reduced the amount of leverage in the system and the willingness of investors to step in and take positions.

 

In addition, the regulatory landscape is changing and some investors are happy to sit in cash and wait to see what the new rules of the game are. Both of these conditions are likely to be temporary and greed – however currently unfashionable – in the form of investor risk appetite will return to the perceived pockets of value in the market. Regulators know that clearly and quickly setting the rules of the game is essential to maintaining investors’ interest. There is ample evidence of cash waiting in the wings and when this returns to the market, even if the economy is growing at below-trend rates, markets should still rally. The trigger for this should be a stabilisation of banking sector uncertainty.

 

We are faced with a tough start to 2009 but there are reasons to be hopeful. Despite the turmoil in the banks, the credit markets are thawing, any future bailouts are likely to come with lending conditions attached and fiscal stimuli should avert the worst case outcomes of the downturn. Importantly, the price of risk assets has discounted an even worse environment so, while this will be a difficult chapter, it should ultimately have a happy ending – even if there is a lot of drama in the middle.

 

 

Source: Marketing Hub. Curt Custard.

All data and views are as at 29 January 2009.