A Quick Glance at the Global Economy

Location: Boston
Author: Shigeki Makino
Date: Wednesday, August 29, 2007
 

Not withstanding the current liquidity turbulence that we’re seeing today. The global markets are in good shape with low real rates, very attractive valuations, strong worldwide economic growth and healthy corporate balance sheets.

If you travel around the world, emerging economies themselves remain on fire and they’re clearly more worried about slowing their red hot growth as opposed to avoiding a slow down.

In Europe we still see very solid growth that is really driven by the continent, in particular, Germany which is hitting on all cylinders. The export engine, the domestic consumption as well as domestic capital expenditure are leading to some great benefits for some of the satellite economies that are dependant on Germany such as Switzerland, Austria, the Benelux countries, and the Nordic countries. On top of that we also see a continued improvement in employment along the continent such that things bode well for consumption in the future.

And while Japan’s domestic economy remains somewhat subdued land prices are rising again and you see an incredibly weak yen on top of years of cost cutting that have resulted in an extremely competitive manufacturing/export sector.

So things from an economic standpoint outside the borders of the U.S. actually look pretty robust.

Even within the U.S. I think if you look at what was a very difficult first quarter, sequentially you see improvement as we go along through the calendar year. As far as the markets are concerned around the world, we remain bullish on global markets. Not withstanding the current liquidity turbulence that we’re seeing today, the markets are in good shape with low real rates, very attractive valuations, strong worldwide economic growth and healthy corporate balance sheets. If you look at non financial U.S. corporations alone they have $1.2 trillion of cash on their balance sheet a record and nearly double the amount that they had in 2001. In fact even though people talk about how long in the tooth we are in terms of this economic cycle, internally generated funds are nearly equal to all of their capital spending needs for U.S. corporations.

If you stand back and just look at history as well over the last 25 years or so you see about a dozen major declines in the equity market. And they really break down into three genres in my mind.

• Recessions: There’s been about three recessions. The recessions typically resulted in a 20-30 percent decline in the equity markets over the course of a year.
• Financial institutions collapsing: There has also been about three financial institutions collapses. In those cases it was typically over the course of 1.5 months that you saw a 10-20 percent decline in the market.
• Bull Market Correction: The remaining half dozen or so experiences of major declines have been of the bull market correction type. Here you typically see a 3-8 percent decline.

From peak to trough in terms of the high and the near term low of current market gyrations, we have seen about a seven-to-eight percent drop. So it looks like we’ve already come all the way through a bull market correction. Clearly the market was indicating that there was a chance of a financial institution collapse. But as we stand here today I don’t see a recession. I think the market has started to price in that financial collapse with its decline last week but in fact because of the depth of the markets, the diversification of exposures and the very strongly capitalized situation due to many years of a strong economy and strong capital markets, I don’t foresee a major financial institution collapsing although clearly we’ve seen some significantly sized mortgage originators and some hedge funds collapse.

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