The global economy is in recession, according to a majority of voters in our web poll last week. That might be stating the obvious, but stock markets have not yet priced in an outright recession as investors continue to hang desperately to the thinnest slivers of hope.
Sell-side analysts often support that irrational optimism. Like Dr Pangloss in Voltaire’s Candide, they continue to chant that everything is for the best in the best of all possible worlds. But it is hard to ignore the problems in Europe. Everyone knows that Greece cannot pay back its debts and that Germany will not continue to bankroll it for much longer. And most people also accept that a similar fate awaits Spain and Italy, whose banks are already on ECB life support.
Europeans will need to either take a big haircut on this debt, or else spend the next few decades paying it back. Whatever happens, it seems likely that growth is going to be constrained for many years to come, regardless of whether a short-term crisis is averted.
Many observers are fond of drawing comparisons with Japan’s relatively orderly “lost decade” (actually two decades and counting, so far), but such an outlook seems optimistic. Japan had several huge advantages in addressing its own debt crisis — it started with a very high relative standard of living, huge industrial capacity and growing developed markets to export to.
Most European countries have lower standards of living than Japan did in 1990, as well as much weaker manufacturing capacity and nobody to sell their goods to even if they made any.
China is hardly likely to escape such a catastrophe. Commentators like to argue that China has plenty of savings to fall back on, but most of its reserves are in rapidly depreciating dollars that it has no realistic way of ever converting into hard currency at anywhere near the levels it bought them at. And, if the US continues printing dollars to pay for its huge spending commitments, China's reserves might as well be worthless.
If our readers are right that the world economy is already in recession, stocks still look expensive, regardless of what the cheerleaders are saying.