Morgan Stanley defies the double dip

Senior Morgan Stanley economists and strategists were in Hong Kong last week to preach an optimistic outlook for the world’s economic recovery.

“The global economy is growing moderately – but sustainably,” said Richard Berner, chief US economist and co-head of global economics, in a media briefing on August 19.

He identified “three pillars" to support his positive view.

First, the evidence suggests that there will be no double-dip recession; second, although they will not be a “game changer”, the recent bank stress tests in Europe will instil confidence in financial markets; and third, Morgan Stanley expects a soft-landing in China. As a result, the US bank is “constructive” on risk assets.

Berner and his colleagues, Robert Feldman, head of economic research for Japan, and Jonathan Garner, the bank's chief Asian and emerging market equity strategist, believe their view is more sanguine than markets are currently projecting.

The markets are focused too strongly on so-called secular headwinds, such as sovereign (especially southern European) risk, deleveraging, new and possibly onerous regulation, and high taxes, said Berner.

In contrast, Morgan Stanley gives greater weight to "cyclical strengths”. These include clear signs of “recovery momentum”, strong corporate earnings, a financial system which is increasingly flush with liquidity injected by central banks, and a stabilisation of the US housing market.

However, Berner pointed out that the global economic recovery is at “multi-speeds” and this time around is different from previous occasions. In the past, the US has been the growth engine; now, Asia is the driver, the US is following and Europe and Japan are lagging behind.

And, as Garner noted, emerging market GDP growth “was more resilient in the recession and has recovered fastest. Emerging markets will likely account for 38% of global nominal US-dollar GDP in 2010, compared with 21% in 1999”.

In addition, people in Asian and emerging market countries are “moving centre stage in global consumer markets”, said Garner. He gave the example of Proctor & Gamble, the world’s biggest consumer products company. Developing countries accounted for 32% of its revenues in 2009, compared with 23% in 2005.

But, in another way, the recovery or transition under way is fairly typical. Monetary policy easing and fiscal stimulus are continuing to have an effect, leading to more employment – and, critically, more work hours – and so to higher incomes which could support increased consumption.

On the other hand, Berner believes that the US consumer is likely to be more thrifty than usual. The key motor for the economy will actually be world growth, which might provide a more receptive market for US exports.

Meanwhile, deflationary fears in the US and Europe are “over-blown”, he said. Central banks have “done a good job”, and now dis-inflation is likely to be approaching its low point, allowing prices to start rising.

However, Berner and his colleagues identified three major risks to their rosy outlook: an escalation in mortgage defaults and foreclosures in the US housing market; a continued slow policy response by the Bank of Japan; and that Morgan Stanley is wrong about the resilience of the Chinese property market – that instead, it collapses and has a highly damaging effect on the country’s banks.

Of course, there are vast changes taking place within the make-up and balance of the world economy, so recent history cannot necessarily be a useful guide. Among those historical shifts, Garner highlighted the fact that the third and fastest transition in world manufacturing output since 1750 is now taking place.

“China and other emerging markets’ share of global manufacturing has risen from 14% in 1990 to 37% currently -- a faster percentage share increase than Europe achieved between 1830 and 1860 or the US from 1900 to 1920,” said Garner.

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