Sunday, July 18, 2010

The Window Is Closing For A Double Dip Recession In 2010

``The charm of history and its enigmatic lesson consist in the fact that, from age to age, nothing changes and yet everything is completely different.” -Aldous Huxley

Markets make opinion, as a Wall Street axiom goes. This means that people tend to rationalize or provide, rightly or wrongly, oversimplistic explanations for current market actions.

A good example of this is that during the first half of the year, the prevalent opinion was that the Euro was headed for its early demise and that this likewise entailed the political disintegration of the European Union.

Considering that the Euro has massively rallied and had already touched or is within spitting distance of our yearend target (1.30-1.32)[1], the du jour opinion has now shifted to the prospects of a US led global double dip recession following signs of weaknesses in the global equity markets (see figure 3).

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Figure 3: stockcharts.com: Euro and Global Equity Markets

While equity markets in Europe (STOX50) and the US (SPX) seem lethargic, this has had little effect on Asian markets ex-Japan (DJP2) so far.

One important thing that I have learned about dealing with financial markets is not to get emotionally swayed by popular opinions, especially the half-truths espoused and expressed by the highly articulate mainstream experts.

Yet when market opinion seems to grope for explanations to project a deeply-held belief rather than to objectively appraise the current conditions, our inclination is to think in the opposite direction.

While it is true that equity benchmarks in developed markets have been sluggish, they are likely to account for a liquidity driven slowdown more than a double-dip recession.

Yet it would be misguided to look solely at economic variables and assume its independence from political actions because since both politics and economics account for social actions they are all systematically interconnected and interdependent on each other.

As Ludwig von Mises wrote[2], (bold emphasis mine)

``Economics does not allow any breaking up into special branches. It invariably deals with the interconnectedness of all phenomena of acting and economizing. All economic facts mutually condition one another. Each of the various economic problems must be dealt with in the frame of a comprehensive system assigning its due place and weight to every aspect of human wants and desires. All monographs remain fragmentary if not integrated into a systematic treatment of the whole body of social and economic relations.

Hence given the current conditions, combined with the prevailing orientation and dogma espoused by policymakers, we expect any reemergent signs of sustained economic weakness in the US to be met with the reopening and the reactivation of the monetary spigot. This is simply what is known as the “path dependency”.

Working amidst the deepening trends of globalization, the transmission effects of the de facto monetary policies in developed economies will likely impact distinctly emerging economies due to the inherent structural idiosyncrasies.

Thus, as we previously pointed out[3], policy divergences will likely result to diversified market actions, for as long as there won’t be any liquidity seizure similar to 2008 post Lehman syndrome.

More proof of policy divergence?

According to Morgan Stanley’s Manoj Pradhan[4],

``Compared to the early part of 2010 when the roaring recoveries in the AXJ region were accompanied by monetary silence, the normalisation of the monetary policy stance that is well underway now is much more consistent with a sensible exit sequence for monetary policy globally. The beginning of tightening in Latin America initiated by the central bank of Brazil and echoed by the central bank of Peru highlights the game of catch-up that LatAm economies and central banks seem to be playing with their AXJ counterparts. And finally, the G10 economies which house the epicentre of sovereign risks and the CEEMEA economies with their close links to the euro area are at the back of the tightening pack. The AAA liquidity regime in the major economies is thus set to stay in place for longer, with growing risks that an eventual reversal of that regime may need to be stronger.”

In other words, while many in the west are having anxiety over the prospects of double dipping (sounds like ice cream), policymakers in emerging markets and in Asia have already engaged in policy tightening in fear of economic overheating.

Besides, I find it a bizarre reasoning for people to argue for another recession if indeed Asia and emerging markets have been responsible for the recent “cyclical recovery” (see figure 4). My idea is that the flow should depend on the leadership unless any shock would be deep enough to unsettle the current dynamics.

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Figure 4 DBS Bank: Asia Drives Global Demand Growth

As the DBS Economic Research team boldly argues[5],

``So what is driving the global recovery then? Who is putting money on the table? The answer is Asia. Asia is where the world’s new demand is being generated-demand that is the very measure of growth. This is the real bailout of the global economy and it is being financed in Asia.”

While I agree that Asia has been a significant driver of growth, I disagree that the true measure of growth is about demand. Instead real growth is where capital is being accumulated, and where increased demand is merely a symptom of these actions.

Demand growth financed by unproductive debt is no less than a putting lipstick on a pig as evidenced by the recent bubble bust, therefore is not a “genuine measure of growth”.

Nevertheless the DBS Research team lends proof to these demand growth...

``In Asia it is 17% higher. This isn’t government spending on factories and roads. It’s private consumption-household purchases of pots and pans and bread and butter and shoes and rent and gadgets and gas and movies and music and…-and it has grown by 17 percent in Asia since the crisis began. In the G3, on average, consumption hasn’t grown one iota.

``That’s not what people said would happen. Most said that when the US stopped buying, Asia would too. Because Asia didn’t produce any final demand of its own or not “enough” anyway. Asia depended on US demand for its growth. Thankfully-for the US and the EU and Japan as much as for Asia-that turned out not to be true.”

Well the DBS team is correct to say that mainstream expectations have failed to anticipate this rebound since the mainstream’s insights had been weighted towards the sins of aggregatism, which had been mostly deduced from a US centric trade and investment flows to the detrimental exclusion of the other important variables.

While I would also tend to agree that Asia is likely to lead the global economy along with many emerging markets for many reasons such as deepening trend of free trade (or trade integration) in contrast to the west, high savings rate, less systemic leverage, and etc…, I’d say also say that aside from economic matters, my bias tells me that the business cycle could also be shifting from the West to the East.

And that DBS’ optimism could also signify as an endowment effect where “People often demand much more to sell an object than they would be willing to pay to buy it”[6] or what I call as “ownership premium”.

From the above premises I’d suggest that any signs of weakness should be considered as a buying window for Asian stocks particularly the Phisix and her Asean neighbors.

Some of those prominent experts whom has hollered for “deflation” and or “double dip from the start of the year, seem to be seeing the windows have been gradually close as we have entered the second semester. That’s why some of them have now shifted their time frames to 2011.

Having missed one and a half years is bad record enough. Though eventually they’ll be right that would be tantamount to missing the entire upside cycle. In essence, a broken clock can be right twice a day.


[1] See Three More Reasons Why The Euro Rally Should Continue

[2] Mises, Ludwig von Human Action Scholar’s Edition

[3] See Why The Sell-Offs In Global Markets Are Unlikely Signs Of A Double Dip Recession

[4] Pradhan, Manoj Appetite for Restriction, Morgan Stanley, July 16, 2010

[5] DBS Group Research, Economics Markets Strategy

[6] Wikipedia.org Endowment effect

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