Expect Markets to Have a W-Shaped Recovery

Markets have cheered on “Green Shoots” in last 3 months by climbing 70-100% from the lows; but now is the time for retrospection. Several national and central bank heads remain cautious on outlook and don’t deny uncertainties lying ahead. Low commodity prices and large stimulus plans have helped some sectors and few economies show a “V”-shaped turn. However, the question remains on the shape of global recovery in coming years – most are betting on a “W”.

Public spending as driver

A RMB 4tln stimulus has helped an investment-driven revival in China. Since the stimulus was announced in November 2008, the nation has built 20,000 kilometers (12,430 miles) of rural roads, 445 kilometers of highway and 100,000 square meters (1.08 million square feet) of airport buildings (NDRC May 21, 2009). Public sector banks have been mandated to increase lending; banks had given away Rmb 4,580bn of loans in Q1 2009 against government’s full-year target of Rmb 5,000bn. During Jan-May09 China has imported copper equal to about 70% of last year’s imports.

While the Chinese government has scaled up public investments, the western world has spent USD 3-5 trillion (10-20% of GDP) in recapitalising the financial system through different schemes. In addition, they have helped few sectors, specifically the auto sector, by providing cash incentives to buyers.

Most of the above growth initiatives have been backed by government spending – direct or indirect. Small businesses and big corporate houses both remain cautious on outlook and are wary of committing funds for future expansions, even in BRIC countries. With a seismic collapse in demand and prices fresh in their memories, it is too early to lean on them.

Exit strategy

Faced with large unfunded deficits, central governments (especially in the western world) have limited time and resources for supporting economies. They would seek to gradually pull out emergency measures and have started talking about it already. The G8 discussed this issue recently and the US Fed is also thinking on the same lines so as not to repeat past mistakes. Depending on how correctly the central banks time the market, pulling out of liquidity could have a negative impact specially when recovery on the ground has been modest and hasn’t got the wheel gyrating.

Shape of recovery

The problem of “too much money” (read US dollars) will continue to influence financial markets. Any increase in risk appetite will see dollars leaving the US (thus falling) and flowing back to asset markets, and vice versa. An abundance of money will make markets over-react, resulting in big swings. The recent upsurge in asset prices also seems to be an over-reaction helped by liquidity flowing back rather than by a change in the fundamental picture. Several analysts feel that many asset classes, especially commodities, have run too far ahead.

A sharp run-up in commodity prices and a jump in US bond yields have done some damage to reviving sentiments and business activities; this could show up in coming months. Besides, after having re-stocked at record volumes, Chinese appetite for commodities in H2 may remain low key. A revival in economic activities could take a pause here rather than continuing to improve at the same pace as shown in last few months. The combined effect of these may help markets to slide in next 2 quarters, slowly and quietly.

Similar to IMF, several analysts expect recovery to start in H1 2010. Expecting the next bull market to price these probabilities 3-5 months in advance, the new-year could mark the turn at the earliest.

However, at the moment, the world seems to have entered into a twilight zone where most of us are waiting for the first ray of dawn while being worried about the length of night. The sky is black now, but will be blue quite soon.

Disclosure: No positions

Comments

[William Gamble:]

Nice analysis

Jun 18 09:02 AM

[Snehal Dani:]

Dear Mr. Daga,

Are you suggesting that markets which are at present at V zone of recovery will have another V zone in the pipeline to complete the expected W curve ?

If yes, what is the time horizon for the next adjoining V curve to happen in the market , according to you ?

I must complement you on nice thought process.

Snehal Dani.

Jun 18 09:58 AM

[user396040:]

I think one of the problems here is that our alphabet doesn't really have a letter that accurately describes the situation so we are limited to V, U, W and L shaped theories of "recovery." I think that it will really look more like an L with a base gradually rising to the right but not nearly as sharply as a V or U. The rise will be jagged like a W rather than straight. Unfortunately, we do not have a letter that looks exactly like that and this limits the dialogue

Jun 18 12:02 PM