Are the noises about the green shoots of a recovery premature wishful thinking or do they have real weight behind them when it comes to anticipating where markets stand right now? Michael Ivanovitch, president, MSI Global, Inc. New York, as the guest of the Cayman Islands chapter of the CFA Society, recently spoke to a packed audience at Harvey’s Grill, giving his assessment for the short and medium term prospects of the global markets. Business Editor Lindsey Turnbull was in attendance and reports. First in a two-part series.
Michael Ivanovitch is president of MSI Global, Inc., a company he founded to conduct research on the world economy, geopolitics and investment strategy. Prior to establishing this analytic and advisory service, Ivanovitch worked as a senior economist in charge of the financial market analysis at the Organisation for Economic Cooperation and Development in Paris. He also served as co-editor of the OECD’s quarterly Financial Market Trends. Before joining the OECD, Dr. Ivanovitch was an international economist at the Federal Reserve Bank of New York, thus he brought to the Cayman Islands a wealth of knowledge which he shared with the capacity audience at Harvey’s Grill in June.
Green shoots of a Bull market?
According to Ivanovitch, the “Doomsday scenario” spouted by some market commentators was nothing more than “nonsense from people with no knowledge of the markets.”
He believed that markets were in the very early stages of a recovery, operating in a post-stimulus world that is stuck with huge fiscal bills. In this context, Ivanovitch thought it was important for the audience to understand the concepts that made up the dynamics of this recovery.
He said that timing was key when it came to stimulating the US economy and went on to describe the types of stimulus that had been injected into the US economy – the fiscal stimulus of large amounts of cash which had an almost immediate effect, and the stimulus created by monetary policy, which would have a slower but more prolonged and more powerful effect on the markets.
“Both are useful in times of crisis such as these, but the impact on the real economy won’t be felt until the third or fourth quarter of this year,” he said. “That was the problem with [former Chairman of the US Federal Reserve] Alan Greenspan – he believed monetary policy stimulus would happen in a matter of months, but this was hogwash!”
Where it all began
Looking specifically to the United States, Ivanovitch said that although some may say that the recession happened overnight, this was in fact untrue and the recession had been “a long time coming”. Looking specifically at the flat GDP growth in 2007 in the US verses the expected growth of around three per cent, he said that governments and central banks should always view this as an economy which needs support.
“The fact that this was not acted upon at that time was due to negligence and incompetence,” Ivanovitch commented. “The output gap was a clear warning that the economy was in dire need of support. And yet we had to face this “sit tight” mentality which believed that free markets would take care of everything.”
The focus of the stimulus package
Ivanovitch explained that a country’s GDP consists of investment, government spending and imports, less exports. “Government has control over its spending,” he confirmed, “yet it has not control over its exports, which are a function of world demand and world prices. Therefore the stimulus package had to focus on domestic demand. Those countries which have based their strategies on exports are heading for trouble.”
In the US Ivanovitch said that domestic demand was still sinking and in need of support but the good news was that net exports were actually doing very well. “Inflationary pressures will subside,” he added.
Indeed, the rising strength of core CPI components indicated deflation fears are greatly exaggerated, according to Ivanovitch. He believed that job losses would continue, however, as firms continued to seek to reduce costs and widen profit margins though increased productivity.
“Firms will not begin to start hiring again right away,” he said. “They will wait for stabilisation. This is why we term unemployment as a lagging indicator and why I believe that the labour market will not improve for some time, even though the green shoots of a recovery will be clearly visible by then.”
Drivers of the recovery
The true turnaround point for unemployment peaking will only happen when GDP and real disposable household income begins to increase, Ivanovitch believed. The steadily rising cheap credit will support a gradual recovery of consumer demand as well.
“Consumption makes up 70 per cent of the US GDP, and this in turn is driven by jobs, income and the cost of credit. There will be no recovery until we get consumption back on track,” he confirmed.
Ivanovitch outlined the US Federal Reserve’s crisis management policy: “The Fed has undertaken a four-pronged attack at stimulating the economy. Firstly, they have provided ample liquidity in the markets. They have extended the range of instruments acceptable as collateral for borrowers and they have increased the number of institutions eligible for Fed loans. Finally, they have created new and more flexible lending facilities for borrowers.”
As the lender of last resort, the Federal Reserve had seen unprecedented borrowing from banks unable to get credit from standard sources, yet the total figure of borrowing was diminishing, according to Ivanovitch: “At the height of the crisis in November 2008 the Fed was lending US$698.8 billion. That figure has come down to US$497.7 billion as of the beginning of June this year. Yet these figures still indicate a huge strain on the financial system.
As a result, Ivanovitch said that banks now had “plenty of money to lend”. In fact, lending by commercial banks in the US was up six per cent on the year previously as at the end of April 2009.
However, lending was not now a priority for banks which were targeting capital gains as their top priority, as well as getting rid of any toxic assets on their books.
Bank lending was a vital component of the recovery process as Ivanovitch explained: “You cannot have a steady and sustained recovery in the US or elsewhere without a strong increase in bank lending.”
Read about Ivanovitch’s views on the monetary base and the state of economies in the rest of the world next month.