Policy Initiatives Are a Welcome Development Amidst Economic Turbulence
Policy initiatives should help to mitigate the severity of the global economic slowdown, but they don’t represent a panacea that will allow a further slowdown to be avoided altogether.
After the most challenging week in U.S. equity markets in several generations, we’re beginning to see some particularly encouraging developments. While the Federal Reserve has been working aggressively and via increasingly unconventional means since early this year, the policy response to the current global financial crisis outside of the United States had been generally weak. On Wednesday, October 8, the coordinated effort to cut interest rates involving a number of key global central banks was a positive sign that the warnings sounded by U.S. officials were reverberating more loudly around the globe. Over the following weekend and in conjunction with a meeting of representatives from the G-7, additional coordinated measures were announced to bring stabilization to the financial system.
In Europe, policy initiatives estimated to reach a cost of $1.8 trillion permit European governments to invest directly in banks, guarantee loans, and provide additional liquidity to the system. In the UK, the Treasury took controlling stakes in Royal Bank of Scotland and HBOS, two of the country’s largest financial institutions. In doing so, they’ve announced plans to directly intervene to assist homeowners struggling to meet their mortgage obligations. This was followed by plans announced shortly thereafter for the U.S. Treasury to invest $125 billion into nine major U.S. banks with an additional $125 billion targeted to smaller banks as well. We believe that this represents a significant step toward bank recapitalization and thawing credit markets.
As noted earlier, we welcome these developments and believe that they represent a turning point in terms of global acceptance of the situation and commitment to finding solutions. However, we remain cautious about market conditions overall. We believe that this policy response should help to mitigate the severity of the global economic slowdown in perhaps its depth or breadth, but it does not represent a panacea that will allow a further slowdown to be avoided altogether. Moreover, we don’t expect that this coordinated policy response — despite its anticipated effectiveness in addressing many credit market concerns — will be sufficient to immediately navigate the U.S. (or global) economy back into a positive economic trajectory.
As we’ve previously noted, U.S. consumers remain under pressure. Inflation already appears to be receding with commodities prices falling and labor costs well in check, affording producers greater flexibility to avoid raising prices. Retail sales, manufacturing activity, and construction all continue to soften. Employment markets also remain weak, as the U.S. economy continues to shed jobs. Personal income is still faltering, while average household debt levels remain high. Home values nationally continue to decline, erasing paper equity for homeowners and pulling more properties “under water” relative to the associated mortgage debt.
Collectively, these issues point to economic weakness and a struggling consumer. The issue for stock markets in the future will revolve mainly around whether or not the extent to which the economy will slow is already “priced in.” The stock market will move forward if the current economic conditions are reflected in prices, and further deterioration of the economy does not come to pass. As we’ve stated in the past, significant negative expectations have already been priced into this market.
We expect that market conditions will remain very volatile, and additional downside in risk assets continues to be a distinct possibility if future developments are worse than expected. Once the market absorbs the full extent of the policy initiatives that are already underway, we expect that it will turn its attention to other concerns. Capital markets are forward looking, making them particularly susceptible to material surprises — both positive and negative. We anticipate that the first official look at third-quarter GDP growth will indicate that it was very soft and perhaps negative, while corporate earnings will weaken as a result. Further, broad expectations for the fourth quarter suggest continued weakness. The key for the capital markets will be how closely those results align with current expectations; results that are materially worse than anticipated will almost certainly put additional downward pressure on stocks and other risk assets. Conversely, there will likely be considerable upside in the markets if actual conditions turn out to be better than currently anticipated.
As we go to press for this issue, events in the capital markets and a series of interventionary steps by the governments and central banks around the globe have been moving quickly. By the time you read this, there’s reasonable potential that these comments may already be outdated depending upon subsequent events in the market which cannot be foreseen. With this challenge as the backdrop against which we work, we’ve attempted to briefly address the issues that we believe to be among the most significant at press time.
After the most challenging week in U.S. equity markets in several generations, we’re beginning to see some particularly encouraging developments. While the Federal Reserve has been working aggressively and via increasingly unconventional means since early this year, the policy response to the current global financial crisis outside of the United States had been generally weak. On Wednesday, October 8, the coordinated effort to cut interest rates involving a number of key global central banks was a positive sign that the warnings sounded by U.S. officials were reverberating more loudly around the globe. Over the following weekend and in conjunction with a meeting of representatives from the G-7, additional coordinated measures were announced to bring stabilization to the financial system.
Policy Initiatives Are a Step in the Right Direction
In Europe, policy initiatives estimated to reach a cost of $1.8 trillion permit European governments to invest directly in banks, guarantee loans, and provide additional liquidity to the system. In the UK, the Treasury took controlling stakes in Royal Bank of Scotland and HBOS, two of the country’s largest financial institutions. In doing so, they’ve announced plans to directly intervene to assist homeowners struggling to meet their mortgage obligations. This was followed by plans announced shortly thereafter for the U.S. Treasury to invest $125 billion into nine major U.S. banks with an additional $125 billion targeted to smaller banks as well. We believe that this represents a significant step toward bank recapitalization and thawing credit markets.
As noted earlier, we welcome these developments and believe that they represent a turning point in terms of global acceptance of the situation and commitment to finding solutions. However, we remain cautious about market conditions overall. We believe that this policy response should help to mitigate the severity of the global economic slowdown in perhaps its depth or breadth, but it does not represent a panacea that will allow a further slowdown to be avoided altogether. Moreover, we don’t expect that this coordinated policy response — despite its anticipated effectiveness in addressing many credit market concerns — will be sufficient to immediately navigate the U.S. (or global) economy back into a positive economic trajectory.
Economic Challenges Remain
As we’ve previously noted, U.S. consumers remain under pressure. Inflation already appears to be receding with commodities prices falling and labor costs well in check, affording producers greater flexibility to avoid raising prices. Retail sales, manufacturing activity, and construction all continue to soften. Employment markets also remain weak, as the U.S. economy continues to shed jobs. Personal income is still faltering, while average household debt levels remain high. Home values nationally continue to decline, erasing paper equity for homeowners and pulling more properties “under water” relative to the associated mortgage debt.
Collectively, these issues point to economic weakness and a struggling consumer. The issue for stock markets in the future will revolve mainly around whether or not the extent to which the economy will slow is already “priced in.” The stock market will move forward if the current economic conditions are reflected in prices, and further deterioration of the economy does not come to pass. As we’ve stated in the past, significant negative expectations have already been priced into this market.
Looking Forward
We expect that market conditions will remain very volatile, and additional downside in risk assets continues to be a distinct possibility if future developments are worse than expected. Once the market absorbs the full extent of the policy initiatives that are already underway, we expect that it will turn its attention to other concerns. Capital markets are forward looking, making them particularly susceptible to material surprises — both positive and negative. We anticipate that the first official look at third-quarter GDP growth will indicate that it was very soft and perhaps negative, while corporate earnings will weaken as a result. Further, broad expectations for the fourth quarter suggest continued weakness. The key for the capital markets will be how closely those results align with current expectations; results that are materially worse than anticipated will almost certainly put additional downward pressure on stocks and other risk assets. Conversely, there will likely be considerable upside in the markets if actual conditions turn out to be better than currently anticipated.
As we go to press for this issue, events in the capital markets and a series of interventionary steps by the governments and central banks around the globe have been moving quickly. By the time you read this, there’s reasonable potential that these comments may already be outdated depending upon subsequent events in the market which cannot be foreseen. With this challenge as the backdrop against which we work, we’ve attempted to briefly address the issues that we believe to be among the most significant at press time.
