To say merely that the world economy is much better than it was just 12 months ago would be to greatly understate how far we've come in stabilizing the global financial system.
To say merely that the world economy is much better than it was just 12 months ago would be to greatly understate how far we've come in stabilizing the global financial system. Policymakers constructed aggressive, unconventional and often controversial programs with longer-term implications, but that had palpable near-term results.
Investors, however, remain skeptical, keeping $3.3 trillion in money market funds and purchasing more than $400 billion in domestic-high-grade bond funds last year.
And why not? After all, short-term interest rates can't go lower, and the budget deficit approaches an unsustainable level. Weakness in the U.S. dollar and an extreme rally in the price of gold have only heightened concerns. Naturally, we ask how, when and whether economic-life-support policies should be removed and whether the economy is ready to proceed without them.
For all the upward revisions to growth forecasts, consensus expectations are that the U.S. gross domestic product will grow only 2.71% this year, with even slower growth in Europe and Japan. Given that the U.S. economy shrunk about 3.8% from peak to trough and began recovering only in the third quarter of 2009, we may not return to pre-recession levels until summer.
Fortunately, the business cycle still exists and corporate profits are improving. A profit-led recovery foreshadows renewed business investment and hiring, although both still lag. Companies that slashed employment during the recession probably eliminated even more jobs than the contraction warranted.
Jobless claims in the U.S. have been trending lower since the beginning of March, and leading indicators for full-time employment in the U.S. suggest that positive job growth is likely early this year.
The economic and psychological impact of the improving jobs picture should help drive private consumption while public spending further props up total output.
A return to job creation may be the impetus policymakers need to embark on the long path back to “normal.” Central bankers will surely breathe more easily as interest rates and balance sheets retreat from crisis formations. Statements from the European Central Bank sound increasingly hawkish, and recent minutes from meetings of the Federal Reserve Board suggest a growing desire to end the U.S. zero-interest rate policy. Central banks will likely raise rates in the second half, but with ample warning for the markets. Investors should nonetheless be cautious on interest rate risk.
For the developed world, this will be a “transition” year — the middle of the growth phase between recovery and expansion. The pace of the rally in the broad equity markets is almost certain to moderate, with higher quality and possibly more defensive investments returning to the fore. Investors should recognize that the 60%-plus rally since March 2009 already prices in the stock markets' anticipation of economic growth. A slower, unlevered growth environment rewards investors who compound dependable income streams, including investments in dividend-paying companies, and corporate and municipal bonds.
The renewed growth cycle promises slower growth across most corners of the globe, but with emerging markets generally growing faster than the more advanced economies. Although the recent crisis reminded us that global shocks will still jolt emerging-markets economies, it also demonstrated that those economies, which are increasingly domestic-oriented, are better-positioned than in the recent past to absorb tremors emanating from the developed world.
While concern is already growing about a new bubble in emerging markets, asset prices remain within reason, and inflows into the regions are moderate, compared with past cycles. Moreover, certain emerging markets are running tighter monetary policies than much of the developed world.
The years since 2000 have not been short of surprises, and the new decade is sure to include its fair share of economic, geopolitical and natural challenges. At present, the banking system is better-capitalized and the U.S. housing market has shown signs of stabilization. Global asset markets have rallied, and every major economy in the world is poised to grow. Investors can breathe again.
Jerry Webman is the senior investment officer and chief economist at OppenheimerFunds Inc.
