Sent: 15-12-2009 16:49:03
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Market Timing: Judgements for 2010
The speed of economic recovery could be one of the critical decisions for investors and their advisers in 2010.
There is accumulating, albeit patchy, evidence of economic recovery. The north American labour market, usually a lagging indicator of economic well being, has offered some upside surprises recently. U.S. employment is declining less quickly and, if the recent rate of improvement prevails, could now be growing. Canada reported an employment increase for November.
In Europe, GDP expanded 0.4% in the September quarter and, in Japan, GDP increased by 1.2% in the third quarter of 2009 after a 0.7% gain in the previous quarter.
It seems increasingly plausible to assume that we are at the beginning of a recovery, a view seemingly endorsed by equity markets. The March 2009 turn in US equity markets is consistent with a fourth quarter end to the U.S. recession, based on the historical connection between the two.
If we can assume for the moment that a recovery is under way, the next questions should be about its speed and durability.
The broad consensus among policymakers and commentators is that the seriousness of the preceding recession will be reflected in the slow speed of the recovery. However, we should bear in mind that the same group had failed to anticipate the speed and severity of the decline or the swiftness of the market recovery once the worst of last year's financial crisis had passed.
In several earlier commentaries, I have drawn attention to the difference between an extrapolation and a forecast. Forecasters are prone to put a heavy emphasis on the most recent set of outcomes when trying to look ahead. In doing so, they tend to extrapolate past conditions rather than forecast future conditions. Strong growth is, therefore, expected to continue. Falling prices will keep falling. Rising currencies will continue indefinitely.
The turning point is a concept which greatly troubles the economic forecaster. Of course, financial analysts suffer from the same affliction. That is why earnings must be downgraded repeatedly as an economic cycle slows and why they must be raised as economic activity accelerates. For the same reasons, the failing company is rarely identified before it finally implodes spectacularly leaving behind ample evidence of the inevitability of the catastrophe for those trading with hindsight.
So, if history repeats, by emphasising the dire condition of the past year, we are likely to be too pessimistic about the state of the global economy at this time next year. Of course, as a matter of sheer logic, we could also be taking too optimistic a view. Extrapolating the current signs of recovery might be failing to recognize how tough it is going to be and the possibility that we will lurch back into a recession during 2010.
But both of these outcomes could be more likely than the consensus view of a gradual build-up in momentum over a prolonged period.
Several reasons to reconsider the likely speed of recovery were highlighted in the article entitled "US Recessions: how quickly can markets recover?" in Edition 56 of the ATC Digest. The tenor of that article was that economic and market transmission mechanisms had begun rendering national boundaries redundant and speeding up the pace of financial market decision making.
The existence of these new forces helped explain the simultaneous collapse of markets around the world in 2008 but also implied, as an extension of the logic, that there was a good chance we would be surprised by the speed of the subsequent market recovery.
As financial advisers begin to contemplate 2010, judgments about these two ideas should be important ingredients in framing their thoughts:
- Am I distinguishing adequately between an extrapolation and a forecast?
Have I considered how the systemic changes to national and global economies are speeding up market response times leaving us with shortened, but more dramatic, up and down cycles than we had previously anticipated?
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