Some reasons for optimism

16th January 2012

But when US blogger James Altucher wrote a piece suggesting economic optimism, one response was from a Washington DC reader who threatened to hang him for being upbeat. Stating that house prices had stopped sinking, Americans had cash at the bank, household debt was down, the stock market was not looking too scary, company profits had held up and whatever happened in Greece could be safely ignored in the big scheme of things was enough to provoke plans for his execution.

Why? Maybe the death threat sender was deranged or maybe he (it was a male) had taken a short position on the US economy and wanted undiluted bad news to drive stock and bond prices down.

If it's the second, then he won't be pleased either with Morgan Stanley economist Stephen Roach

Roach is not afraid to say things are bad but he believes it won't be disastrous if investors follow his recipe for ameliorating the debt crisis. It's glass half full stuff. 

He has some mild but cautious optimism on US employment. He says: "I think they [the Federal Reserve] look at it as the glass getting a little more half full – cautiously encouraged but they're not going to celebrate the dawn of a classic economic recovery."

And on China he says: "The banking system in China is the central player in the credit intermediation process and they are obviously responsible for funneling an enormous amount of lending in the aftermath of the financial crisis of '08 to stimulate the economy. Now they are dealing with some of the credit quality issues in the aftermath. But I think these concerns over non-performing bank loans are vastly overblown. The banking system itself is much more liquid given the huge deposit base. Loan to deposit ratios in China are 65% today. Typically pre-crisis loan to deposit ratios for banks that are overextended are in excess of 120 or 130%."

But he's remains bearish on the eurozone until more cash firepower is brought to bear. "Just go back to what the Federal Reserve assembled in the aftermath of the crisis a three years ago. With all the various programs, including QE1 and all of the alphabet soup of special programs, they were able to put together firepower in excess of $12 or $13 trillion U.S. dollars. That clearly put a floor on the crisis and fostered a powerful upturn in risk markets, which is now being drawn into question by a shaky recovery. That's what massive firepower can do and the Europeans don't even have a commitment close to that." 

If you want creative optimism on the European crisis, two academics, Fred Bergsten and Jacob Funk Kirkegaard have written a paper for the Peterson Institute for International Economics.  It's death threat stuff.

Their work, "The Coming Resolution of the European Crisis" questions the view that the euro is doomed.  Accepting the eurozone has multiple and serious financial and economic difficulties, they argue that the fears are "overblown", stating "the crisis is political and even largely presentational."

They believe that the crisis has only two exit routes.  Either Europe jettisons monetary union or it adopts a complementary economic union. If it goes for the latter, "Europe will emerge from the crisis much stronger as a result."

They argue: "The task before euro area leaders ranges far beyond putting together a big enough financial bailout to restore market confidence. They must rewrite the euro area rule book and complete the half-built euro house. This means they must combine creative financial engineering to resolve the immediate crisis, with a wave of new institutions to strengthen the real economy and restore sustained growth."

Meanwhile Schroders analyst Andrew Lyddon says there is hope.

He states: "No matter how bad the outlook seems, it's important not to become blinkered and to adopt the mind-set that the economy, and equity returns, are condemned to be miserable forever. Whilst value investors do tend to be more gloomy than most in the good times, the reverse is often true in bad times. As the world as a whole grows more pessimistic and that sentiment starts to become reflected in the valuations of companies on the stock market, value investors grow more optimistic about the outlook for future returns – not over any single year, of course, but certainly in the longer term. The general retail or house building sectors in the UK are prime examples of this at present, where the market today sees only negatives we see some compelling long term investment opportunities for those willing to be patient.

He concludes: "Being realistic about the outlook is fine, but the inability to have just a little bit of optimism about what the future might hold can be a very costly mistake for investors in the long run."

Lyddon can perhaps expect death threats as well.


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