“The global economy seems to be recovering,” the chairman of the IMF’s Financial Committee meeting said at press conference over the weekend. "The worst is definitely behind us," advised Youssef Boutros-Ghali, who's also the Egyptian finance minister in his day job.
But most bouts of macro optimism come with caveats these days, and Boutros-Ghali's cheerful commentary was no exception. "We are not out of the woods yet," he added. "We see a strengthening of economic recovery, but we also see an unevenness in this recovery, unevenness within countries, and unevenness between countries."
Earlier in the week, the IMF revised up its global growth forecast to 4.2% for 2010 from January's estimate of 3.9%. Leading the expansion: emerging market economies, Boutros-Ghali emphasized in his Saturday chat with the press. The IMF projects that emerging nations will grow by more than 6% this year and next.
By comparison, economic growth in mature economies is expected to be relatively modest at roughly 2% to 2.5%. Not too shabby on its face. The problem is that the advanced economies need something better than average for an extended period in the wake of the Great Recession. As the IMF's chief economist, Olivier Blanchard, explained on the IMF's blog a few days ago: The 2%-plus outlook for growth in advanced economies
...is just not enough to make up for the ground lost during the recession. Output for these countries is now 7% below its pre-crisis trend, and this “output gap” is expected to remain large for many years to come. Associated with this prolonged output gap is persistent high unemployment. We forecast the unemployment rate in advanced economies to reach 8.4% in 2010, and to only decline to 8.0% in 2011.But while there's a risk of growth that's not quite up to the challenge in the developed world, some analysts think the hazards of a fresh round of economic contraction have diminished. "In the United States, there is a growing consensus that the risk of a double dip recession has abated which is positively impacting markets," the Blackstone Group said in a statement this past week.
The main factor behind this weak performance and this prolonged output gap is weak private demand. In the United States, consumers, who were the drivers of the economy before the crisis, are being more prudent. In Europe, where banks play a central role in financial intermediation, the weak banking sector limits credit supply. In Japan, deflation has reappeared, leading to higher real interest rates, and putting in danger an already weak recovery.
In fact, it's easy to find forecasts of modest growth for U.S. GDP for the year ahead. BMO Capital, for instance, projects the U.S. economy will expand by roughly 2.5% to 3.0% at an annual pace in the coming quarters. MFC Global Investment Management expects even stronger results, albeit with that annoying caveat again:
We forecast a robust economic recovery, as job growth will drive incomes and consumer spending, which in turn fuel a resurgence of business investment. The process of rebuilding inventories, which pushed GDP growth to almost 6% in Q4 2009, is not over yet. In addition, more than half of last year’s stimulus package is still to come, while a synchronized global expansion is boosting exports.Meantime, the always cautious, circumspect and widely followed Jeremy Grantham, chief strategist of GMO, writes in his latest quarterly letter to clients:
But this is not the whole story. Another wave of mortgage defaults and foreclosures threatens renewed declines in home prices, while commercial real estate seems on the verge of a major slump. More losses for banks would only make a constrained lending environment even worse, potentially limiting the normal growth of spending.
The economy is limping back into action, but faces some tough long-term headwinds that I collectively call “seven lean years.” Mortgage defaults in housing, steady repayments of consumer debt, and refinancings in commercial real estate and private equity, are all problems that linger, as do many others, on what is becoming a long, boring list. We may get very lucky and have a strong broad-based economic recovery.Boring but no less relevant. The next several months are sure to be a test of the economy’s capacity from transitioning from crisis mode to something resembling stable-growth mode. The outcome will likely be determined by the prevailing winds in the labor and housing markets, both of which were crushed by the economic turmoil in recent years. In both cases, there are nascent signs of stabilization, which may be a prelude to a bonafide recovery.
One reason for thinking so comes from a new survey of U.S. companies, which are becoming more confident that the economy will grow, which inspires plans for more hiring and less firing. As the National Association for Business Economics reports today:
Job creation increased for the first time in the past two years of this NABE survey. The percentage of firms increasing payrolls rose to 22% from 13% in the January survey. The percentage of firms cutting jobs moved lower—from 28% in January to 13% in April. The share of respondents expecting their firms to add employees over the coming six months rose to 37%, up from 29% in the previous survey.Cautious optimism seems to be the sentiment of the moment. Even assuming that's accurate, what does it mean for the market? Have stocks fully priced in the expected recovery? "If the economic recovery is slow and if unemployment drops slowly," writes Grantham, "then [Fed chairman] Bernanke will certainly keep rates very low, as he has promised in as clear a way as language permits. In that case, stocks and general speculation will very probably rise from levels that are already overpriced."
The margin for error, in other words, is getting uncomfortably thin. That doesn't mean equities won't climb higher. But the potential fallout from any negative surprises isn't getting any smaller.
This post has been republished from James Picerno's blog, The Capital Spectator.