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When a Negative IMF Forecast is Still Good

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John Robertson

The profile of the International Monetary Fund has been raised greatly through the current recession especially as its views are being invoked to support domestic policy. We need to be careful interpreting its forecasts.

The IMF has again hit the news in the wake of its regular April forecast revisions. The organisation is now forecasting a global output contraction in 2009 of 1.3% after a 3.2% rise in output in 2008. The average rate of growth over the past 30 years has been 3.3%.

The IMF has access to hundreds of well respected economists with experts covering almost every nook and cranny of the global economy. Even so, there are at least two notes of caution which need to be borne in mind by an equity investor interpreting the IMF forecasts.

The first cautionary note is that the IMF is as fallible as any macroeconomic forecaster. Despite having so much intellectual capital sitting behind its forecasts, the IMF suffers from the same handicap as everyone else doing this job, namely, being influenced too heavily by conditions in the immediate past when it frames its views about the future.

Consequently, it will be prone to come out with its most pessimistic view about the future when economic conditions have been bleakest which is, almost by definition, at a cyclical turning point and at a time equity markets have stopped falling and are about to commence rising.

The IMF has had to revise down its growth forecasts several times in the past year just like everyone else. If it is true to form, it will reach a point at which its latest forecast, driven by the depth of recession, is too pessimistic so that subsequent upward revisions must be made. An investor needs to make a judgment about whether we are at that point now or whether there is still some way to go.

The second cautionary note is that public commentaries about the 2009 anticipated growth outcome risk putting too much emphasis on publication of a single negative number and insufficient emphasis on what that number implies for the underlying pattern of growth.

The latest quarterly GDP estimates from the OECD for its member economies (i.e. all the industrialized countries) show an output contraction in the third and fourth quarters of 2008 of 0.2% and 1.9%, respectively.

Let's say that the advanced economies have continued to contract in the first half of 2009 but at a declining rate. For the sake of argument, assume a 0.4% contraction in OECD area output in the March quarter and a further 0.2% fall in GDP in the June quarter.

If we assume that output then grows by 0.4% in the September quarter, a very modest initial recovery, and by 0.8% in the December quarter, the 2009 growth rate would be minus 1.7%.

This is probably toward the pessimistic end of current forecasts but would still imply an accelerating growth path during the year despite the negative outcome for the year as a whole. From an equity market perspective, the accelerating growth path is likely to be more important than the negative outcome for the year.

The size of the 2009 growth outcome is affected heavily by the contraction which has already occurred.

Assume the same pattern of growth as outlined above for each quarter in 2009 except for the December quarter. For December, let's assume an unambiguous strengthening in activity more consistent with a V-shaped recovery than the relatively flat trajectory implied in most forecasts.

A 5% GDP rise across the industrialized economies in the December quarter would still result in a GDP contraction for the year as a whole of 0.7%.

A negative number could still imply an unambiguous improvement in global economic conditions and, most likely, a strong recovery in equity prices.

So, the lesson here is a simple one but, nonetheless, one well worth keeping in mind: focus on the likely pattern of growth through the year and worry less about the forecasts grabbing the headlines.


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