Reports Of A Double Dip Are Greatly Exaggerated


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?Double dip?. How many times have we heard this phrase over recent months? As the fall out from the financial crisis continues to be felt, the media and financial commentators have caught onto t

?Double dip?. How many times have we heard this phrase over recent months? As the fall out from the financial crisis continues to be felt, the media and financial commentators have caught onto this catchy warning phrase and repeated it over and over again with increasing frequency. We believe, though, that the risks of a double dip recession have been overplayed.

Why is the term being bandied about so much?

The fact that it suits the media to be sensational is partly responsible. As the term ?double dip? caught on, its usage escalated until it became the phrase of the late summer.

As for the economic concerns themselves, after global economies bottomed out in the middle of last year, many people expected a swift and strong ? a V-shaped – recovery. Historically, the deeper and longer a recession is, the stronger and faster the recovery is.

A year on, however, it became increasingly clear that the recovery was not living up to expectations. It was less impressive than many economists had previously predicted and they found themselves having to revise their forecasts downwards, with some probably overcorrecting on their original optimism.

This may be disappointing, but just because the developed world?s economy is not surging to ?above trend growth? does not mean that it is about to crash again. A protracted but muted recovery may not be headline grabbing but it is hardly the end of the world. It may even be better for the economy in the long run. A sudden bounce, for example, can pose problems for inflation and interest rates.

The fact that the recovery period is panning out differently from previous ones is perhaps not surprising when you consider that the nature of the recession was unusual. Previous post war downturns were either caused by monetary policy tightening or the inventory cycle.

The credit crunch, however, was the result of a culmination of a 20 year build up of leverage or debt in many parts of the private sector. Both financial institutions and households took advantage of low interest rates and the new financial instruments that made the creation of credit much easier. The end result was that too many economic actors leveraged themselves up far in excess of their capacity to finance their borrowings. Much of the leverage was accumulated against what seemed at the time to be ever increasing house prices, leading to the build up of imbalances.

As people borrowed more, savings rates in the West declined, in contrast to developing Asian economies where savings increased excessively. This resulted in a situation where consumers in the West were using their borrowings to buy goods from East.

Undoing this long cycle entails rebalancing global patterns of trade and finance; rebuilding depleted savings at the expense of consumption in the West and creating much less credit. This is a process which takes time and tends to result in reduced consumption, a readjustment of the asset values which were artificially inflated by leverage and lower levels of investment. A good example of this has been house prices which were driven up by easy borrowing, subsequently fell and aren?t currently improving much because of the lack of lending. Growth and employment will remain subdued – we should not really be surprised when economic and employment data only improve slowly.

Then of course this summer the economy and markets suffered several knocks.

In contrast to the West, the Chinese authorities have been using policy tools to try and slow down their economy which they fear could overheat. Here in Europe, the weaknesses in the fiscal and economic foundations of some of the EU smaller members were exposed in the aftermath of the financial crisis.

Markets were faced with the uncertainty of lower-than-expected growth in the West, whilst at the same time facing fears that the Chinese economy would slow by too much and that of enduring further financial chaos in the Eurozone.

However the news is far from all bad. Both the UK and the US are adding new jobs, albeit slowly. Although much economic data is ?less good? than expected, few major indicators are registering a decline. Capital expenditure is again showing signs of life. Many firms have been sitting on piles of cash which they are now beginning to deploy back toward productive activity. Growth in the US and the UK may be mediocre, but the core Eurozone countries are benefiting from the global shift in economic power from the North and West to the South and East.

Of course there are still plenty of risks to navigate. The core European countries may be too dependant on China and the peripheral ones are faced with a long and difficult path to fiscal consolidation and institutional reform, and it could be a bumpy journey.

What does all this mean for investors? We will probably continue to hear the phrase ?double dip? for a while yet, but as we move through autumn these fears should prove unfounded. The realisation that a double dip has been avoided should then be a catalyst to move equity markets higher. While we may not see huge advances on the start of the year, there is still time for the markets to overcome the pessimism and it is worth remembering that the economy and the markets do not follow exactly the same path ? markets are forward looking.

In any case, for long-term investors 2010 is just one year. It is an example of why equity investors should normally invest for the longer-term. At times like these you need to be patient and wait for the pessimism and media sensationalism to blow over. Share prices are not over-valued ? indeed many are undervalued making this potentially a good time to buy ? and there is plenty of room for growth over the coming years. Professional guidance from an experienced wealth manager like Blevins Franks will give you confidence that your portfolio is designed specifically for your personal circumstances, objectives and risk tolerance.

By Bill Blevins, Managing Director, Blevins Franks

17th September 2010

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