FT: From early April to early July you saw the glass half full, and have seen it half empty since against improving economic indicators. Could you explain us why?
M&B: My view was that the sentiment was so negative and central banks providing so much money at near no cost that markets could only improved. Since the bottom of equity markets in March (China and Brazil excluded: they bottomed end October 2008, the MSCI emerging markets index in November) to 27
Th October, the DJ is 50% up, S&P +57%, NASDAQ +70%, FTSE +48%, DAX +53%, NIKKEI +43%, SENSEX + 95%, SHANGHAI +75%, BOVESPA +70% and the MSCI emerging markets +102%. In the meantime,
the economy has not really improved, whilst no longer in a nosedive. The improvement noticed during Q2 and Q3, was mainly due to Government money (car industry and the financial sector in the
US and Europe, tax credit for first-time owners for residential real estate in the
US, etc.) and inventory rebuilding after having been crushed late 2008 and early 2009. However, if unemployment does not improve in the coming months (which I doubt), I believe that
retail sales will be flat or nearly flat towards the end of the year (I do not see how sales could improved when consumers are fearing for their jobs and need to rebuild their balance sheets). In my opinion, this could lead to a second wave of adjustments by companies or at least delay investments and hiring. Interesting enough, last week, Goldman Sachs cut its US GDP prevision from 3% to 2.7%.
I have also been worried about the
commercial real estate situation where
prices dropped 40% between August 2009 (latest data available) and October 2007 (peak of the cycle) – I remember well what happened in the early 1990’s. The outstanding face value of
US commercial real estate loans amounts to
USD 2-3.5 trillion depending on sources, including
USD 270-275 billion due next year and over USD 1 trillion by 2015.
Banks own 45% of commercial real estate loans, compared to only 21% of single-family loans and
U.S. Office Vacancies Reach Five-Year High of 16.5%. In September, the FED noticed that banks were slow to take losses on their commercial real-estate loans.
Undoubtedly, banks will have
additional large losses coming from this sector and the rest of the
economy will be impacted, whilst probably not to the same extent as the residential real estate that had a huge psychological effect in additional to the financial one: this may stall any recovery in 2010-2011. Banks will need either to further reduce their balance sheet to be in adequacy with prudential ratios and/or raise new capital. Just look at all the cash call that banks in Europe and the US have done over the past few months or are attempting to do, besides selling assets.
I will not come back to changes that occurred on rule FSA 115 regarding fair value accounting (and my opposition to it since it increased opacity): whilst giving some breathing space for banks, it did not solve the problem and may compound it in the future.
To summarize: too far too fast. Markets have been sustained by liquidity that has not been channeled to the real economy (i.e. most of it!). I am not however in the camp of the gloom and doom for the world economy, whilst I am rather negative on the Western world economy.
Sources:Bloomberg
U.S. Office Vacancies Reach Five-Year High of 16.5% http://www.bloomberg.com/apps/news?pid=20601206&sid=aEfOnZ74Jis0
Wall Street Journal
Local Banks Face Big Losseshttp://online.wsj.com/article/SB124269114847832587.html
Foresight Analytics
Commercial Mortgage Outlook: Growing Pains in Mortgage Maturitieshttp://www.foresightanalytics.com/stu_mtgmat.php
Congressional Oversight Panel
August oversight report: The continuing risk of troubled assetshttp://cop.senate.gov/documents/cop-081109-report.pdf
MIT
MIT Center for Real Estatehttp://web.mit.edu/cre/research/credl/rca.html
hiller 20 index published by Standard & Poor's today shows that home prices were flat and failed to keep pace with gains so far in 2009. The figures are not seasonally adjusted (+0.4% seasonally adjusted – the fifth straight improvement). In the past year, prices are down 7.3% in the 20 cities.
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