Is the market showing some early signs of recovery?

Ben Bernanke, the chairman of the Federal Reserve, said in an unprecedented interview on the CBS 60 Minutes programme last week that “we’ll see the recession coming to an end probably this year, we’ll see a recovery next year and it’ll pick up steam over time…I do see green shoots.”

Bernanke’s words were followed by a series of rare positive signs. A Monday memo leaked from Citigroup indicated the firm was profitable in January and February after a year in which it required $45 billion (£31 billion) in bail-out money. Bank of America also said it was profitable during the two months, while on March 6 and 7, the FTSE 100 index and Dow Jones industrial average respectively began modest
rallies.

Was the optimism starting to spread? Anthony Bolton, for a long time Fidelity’s star fund manager, was confident enough to call the bottom of the market – enough so to risk repeating a wrong call during the market meltdown of 2008. Fund managers in Merrill Lynch’s monthly survey, questioned between March 6-12 as markets rose were at their most optimistic since December 2005.

Yet the managers appeared reluctant to position their portfolios for recovery: indeed, equity allocations “fell close to an all-time low”, said Merrill Lynch. And according to Adrian Pankiw, an economist at Henderson, the gulf between their words and their fund positioning is “symptomatic” of the current mood − it is not yet time to call off the apocalypse.

Investors would like to persuade themselves that the crisis is on the turn but they are unsure whether markets will continue to grow. Even if they do, they question whether this heralds better news in the wider economy.
Last week the International Monetary Fund (IMF) predicted a shrinking world economy in 2009, and revised several of its forecasts downwards.

Invesco Perpetual’s famed income manager, Neil Woodford, said he anticipated no economic recovery for three or four years.

Of the fund groups, a relatively bullish player is L&G, which at its Fundamentals briefing last week said its indicators showed a recovery would start this year. It added that Britain will escape from recession earlier than other countries, thanks to the weakness of sterling, low interest rates and tracker mortgages. The firm’s lead indicator accurately predicted a recession in Britain in 2008, against consensus forecasts, so its optimism now is striking.

James Carrick, an economist at L&G, points to the upturn in manufacturing – indicated in America by two months of rises in the ISM’s Purchasing Managers Index – as an opportunity for sustained global growth to begin. However, consumers will not necessarily seize the moment, Carrick says.

“I do think we’re due a bounce and in the best case scenario this bounce creates a turn in consumer confidence and people start to spend,” he says. “The downturn in manufacturing is behind us – they’ve cut production enough to offset weaker sales. US car production actually increased in February.”

According to Carrick, trends such as rising unemployment can still be stemmed by a restoration of confidence. “In the UK, 93.5% of people who want a job are in a job. It’s about whether or not they start to think ‘I’m next’.”

Carrick notes the Bank of England’s determination to do “whatever it takes to get us out of this mess. The measures in the UK should be sufficient to stop things getting worse.” He attributes the drying-up of credit mainly to a lack of confidence but admits: “We don’t know whether they [governments] have stopped the death spiral.”

However, Pankiw, Henderson’s economist, says markets are engaged in a “bear market bounce” and there is more bad news ahead.

“Companies have become more comfortable with their inventory situations relative to demand. But that just means they have gone from record low to slightly less record low levels,” he says. “And it still sounds to me like deflationary forces are exerting themselves on the macroeconomy. Surveys say that actually the supply of credit is a bit tight but there’s no demand either.”

In Britain, he says that low interest rates combined with tracker mortgages are a “substantial offset to headwinds from the labour sector,” but then adds: “Is it enough to position us better than some of our peers? I don’t know, but I suspect not substantially.” Henderson’s models see a 3.3% decline in British GDP this year, with Europe and America set to decline by 3%.

Pankiw says there is value in the markets, but although stocks have probably reached their lowest points of the recession, they may revisit those lows.

“Everyone appreciates there is good value in certain asset classes out there. This is a once in a decade or even a lifetime opportunity. But I think there’s still fear of being caught out by a reversal in the fortunes of the economy and the prospects for earnings,” he says.

Echoing Carrick’s praise for government measures, Pankiw says that in Britain and America, they should provide a “substantial boost to real disposable income growth”. However, Keith Wade, the chief economist at Schroders, says fiscal stimulus measures are simply smoothing the pace of the downturn.

“There’s an adjustment that needs to take place: the UK and the US need to move to a higher savings rate,” he says. “The action by authorities is very much trying to smooth that path … if we didn’t have this package then the adjustment would be very violent.”

He adds the deleveraging process is not yet over, and argues there will be more bad news from the banking sector, which requires structural changes.

“We need to really get over this and move the capital into the system or close down a number of banks so that we can move on. The end result will be a smaller banking system that will be able to lend in a more normal way.”

In Wade’s view, small recoveries in the markets and in manufacturing cannot compensate for structural and financial problems yet to be fully addressed.

Judging by Merrill’s findings on managers’ reluctance to commit their portfolios to recovery, Wade expresses a majority view when he says: “We don’t really see why this should be the turning point.”

American Purchasing Managers' Index