Question
Read the following article and answer the questions at the end.
"Predictions of post-GFC gloom were premature" by Don Stammer
WHEN the global financial crisis was at its most intense, banking systems were in meltdown, asset prices plunged and the world economy was on the edge of an abyss. Remarkably, confidence in banks is now largely restored, sharemarkets have rebounded by an average of 60 per cent or so and global growth is back to trend.
In the past 20 months, market sentiment - or the dominant view of investors and commentators - on the lasting effects of the GFC has changed at least three times. It moved from unmitigated gloom to expectations of an unconvincing recovery; to cautious optimism; and, more recently, to counting on the return of better times.
It's useful to look back on these step-by-step changes, if only as a reminder of how profoundly market sentiment can change and of the benefits, where it's possible, of a being a step or two ahead of the crowd.
In late 2008 and early 2009, asset markets were priced for a global depression. Beginning in March last year, investors and commentators began to take a different view, that global depression would be avoided because of the scale of the actions governments and central banks were putting in place: the provision of guarantees on bank deposits, the re-capitalisation of banks, the budget packages, interest rate cuts and liquidity support.
By mid-2009, the dominant view of investors was the expectation that the GFC would be followed by a hesitant recovery and that investment returns would be meagre for a decade or so. This view was given a name, the new normal, and was argued strongly by PIMCO (the large Californian-based bond fund) and McKinsey (the prominent business consultancy).
As PIMCO put it: "The panic engendered by the crisis may be behind us but its longer-term consequences are yet to play out fully . . . Unlike anything the world has experienced in the post-war period, the 2008 crisis struck at the core of the global system and not at the periphery...Our future will likely include a lowered standard of living, high unemployment, stagnant corporate profits, heavy government intervention in the economy and disappointing equity returns."
In McKinsey's words: "It is increasingly clear that the current downturn is fundamentally different from recessions of recent decades. We are experiencing not merely another turn of the business cycle but a restructuring of the economic order."
As the months passed, the new normal view came to be seen as too extreme an assessment of the legacy of the GFC. Non-Japan Asia and economies such as Brazil experienced very minor downturns and soon returned to strong growth.
Even in the US, by March this year the cyclical recovery appeared to be somewhat stronger than suggested in the new normal view -- thanks to growth in exports and business capital spending -- even though unemployment has remained high and the housing market is still distressed.
As the gloom in investment markets lifted further, investors found opportunity to recall the many financial crises or severe recessions that in earlier years had led to predictions that the investment world would never be the same again, only to find that earlier long-term trends subsequently re-established themselves.
My chart shows the long-term performance of Australian shares across 135 years, which include two depressions, two world wars, the advent of railways, cars, planes, globalisation and the internet, and at least a dozen financial crises. Despite many prophecies that the future would be very different, the long-term trend in returns to share investors has been remarkably stable: history hasn't been kind to recurring claims of a new normal.
There's now a growing attitude on the part of investors and commentators that the problems in investment markets and the global economy are cyclical rather than structural. My guess is this view will grow stronger in coming months as new information comes to hand on global growth and corporate earnings. At times the positive market sentiment may ignore problems left behind by the global slump, such as the huge build-up of government bonds on issue in significant countries.
Investors need to allow that, from time to time, the dominant view within investment markets changes at short notice and then can endorse a new theme too enthusiastically. It's better to try to anticipate changes in market sentiment than to run with the herd; or to focus on the long-term returns and allow for big ups and downs through the investment cycle.
Questions
- In what ways can the GFC be seen as being part of the business cycle?
- What are the possible longer term effects of the GFC?