In praise of patience

Kicking the can down the road might seem cowardly, but it could be just what the global economy needs to get back on its feet, according to Jonathan Wilmot, Credit Suisse’s chief global strategist.

For all the low points of the past few years, the global outlook has rarely been as bleak as it is today. Pessimists see a political crisis in the US, a fiscal crisis in the EU and a simmering social crisis in China, any one of which could destabilise global markets at a time when governments have few tools left to intervene with.

The gloom is already affecting business. European banks are reporting dire second-quarter results and there is not much good news to offset fears, short-term solutions aside. In Europe, Greece remains afloat for now, but nobody expects a quick fix to resolve the underlying problems. In the US, politicians might thrash out an 11th-hour deal to hike the debt ceiling, but their struggle to find common ground raises bigger questions about America’s ability to get its own fiscal house in order.

In China, which remains one of the last bastions of growth, a series of accounting scandals and damning research reports have hurt the reputation of listed companies, though not enough to do much damage to the broader economy. More worrisome are the persistent stories of social disquiet, which could become more frequent if prices keep on rising.

With so much to be alarmed about, global risk appetite has slumped during the past few months. But at least one economist thinks that, beyond all this short-term noise, markets could surprise on the upside, much as they did after last summer’s brief panic.

Jonathan Wilmot, Credit Suisse’s chief global strategist, was in Hong Kong at the end of last week to share his team’s latest views. While agreeing that the crises in Europe and the US pose a serious threat, he compared the economy to a Swiss mountaineer negotiating a steep goat track — the trick is not to look down.

“We're in a very delicate position and it's almost impossible to make sensible forecasts,” he said. “People are very frightened about a lot of things. They're looking into the abyss, not looking ahead.”

Wilmot, however, is always trying to look ahead. He and his team are obsessed with trying to understand economic cycles, crunching numbers to come up with an accurate model of global industrial production, which he says is a much more timely and sensitive indicator than, for example, gross domestic product.

Right now, the numbers give reason for cheer. Growth of industrial production has slumped below trend during 2011, but Wilmot said his models are predicting a recovery through the rest of the year as risk appetite and demand pick up the slack.

Something similar has happened during the past two years, neatly demonstrated by the performance of the S&P 500. The US stock index fell 7% in five days during the summer of 2009 and then rallied 31% in about six months; and last summer it dropped 4.7% in five days, followed by a 28% growth spurt during the following six months. If history repeats after this summer’s 5.7% five-day shock, stocks could spring back again.

According to the research Wilmot has been showing to Credit Suisse clients, trends in world wealth provide another way of understanding the economic cycle, and in the past have shown a relatively close correlation to industrial production. Looking at the last recovery in wealth, from March 2003 onwards, gives reason to hope that the global economy is at least primed to continue strengthening into 2012.

None of this is certain, of course. There are plenty of potential pitfalls, but Wilmot’s analysis suggests the pessimism might be another facet of the economic cycle. “People's expectations are conditioned by the last big experience they have been through — it's natural human psychology.”

This has led to some over-eagerness to spot the early warning signs of the next financial meltdown and has helped to create a ready audience for bearish views and strategies, particularly evident in the recent coverage of China.

“I can't remember seeing so many people being bearish about China,” said Wilmot. “Everyone is looking for the next ‘big short’ and they are looking too hard. People are fascinated by blow-up scenarios, but I don't think that's going to happen in China.”

Wilmot was similarly sceptical of the “hair-shirt brigade” that wanted to force extreme austerity on Greece and is confident that Europe’s rescue package is a decent solution. “It's better to buy time in crises, as long as the debtor is incentivised to behave better, rather than worse — because you need time to find a solution to the failure of the political system, as well as for the economy to grow.”

By Credit Suisse’s own measure of sovereign debt sustainability, Greece is a better credit than its credit default swap implies. Indeed, so is Italy, said Wilmot — as long as there is a bid for its debt at around 6%, its position should be sustainable, he said, adding that the sustainability of the country’s sovereign debt ranks it between Japan and China, according to his team’s analysis.

However, a bigger crisis is inevitable at some point. The eurozone cannot avoid the decision to accept a fiscal union, yet the centre is incapable of convincing its members to vote in favour. It will probably take a crisis to force the issue.

Meanwhile, in the US, politicians are playing a dangerous game of chicken as they try to force an issue of their own — getting America’s debt under control. Here, again, Wilmot’s global growth projections suggest that buying time could be the best approach.

“Even a technical default is a stupid idea,” he said. “The really hard choices on the deficit and debt will be made after the next election, not now.”

Wilmot likes to draw comparisons to historical cycles and has been telling clients that the present recovery is “surprisingly classical” and looks a lot like the US recovery after the panic of 1893, which led to 10 years of growth. Indeed, in some senses we have returned to a classical world characterised by dynamic growth and flourishing trade — unleashed, for the most part, by the end of the Cold War and the return to a multi-polar world of competing interests, growing interdependence and booming production.

Far from worrying about long-term inflation, Wilmot hypothesises that such an environment could eventually produce strong growth at the same time as mild deflation — an environment that has not been seen since the 19th century.

But the abyss is still there. Wilmot sees a binary outcome — a strong recovery is possible, but so is a disastrous slip into the abyss if, for example, the US doesn’t come up with a deal to raise the debt ceiling over the weekend. That would undermine the risk-free status of sovereign debt and play havoc with markets. Those who argue that markets would take such an outcome in their stride, he said, have no basis for such confidence.

Swiss mountaineers and economists alike understand the importance of respecting the dangers they face. Right now, the dangers are very real. Don’t look down.

¬ Haymarket Media Limited. All rights reserved.
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