A theme of this column for almost a year has been the contrast between
apocalyptic views in the financial markets about the earth-shattering
consequences of the credit crunch and the rather more mundane evidence from
the real economy of a mild recession, at worst. My view has been - and
remains - that this episode is likely to be remembered as one of those
extremes of panic or euphoria in financial markets, which tend to reoccur
once or twice every decade, when market prices - of bank shares, of oil, of
the dollar and of several other assets - turn out to be simply wrong.
In making this argument, I have been accused of ignoring market realities and
being blindly contrarian. And I fully agree that contrarian thinking as a
general philosophy is often financially dangerous and intellectually
self-deluding. Oddly enough, though, it seems that at present the analysts
who are doggedly pessimistic are being contrarian and defying economic
evidence. Meanwhile relative optimists, especially about the American
financial system and housing markets, which are generally believed to be the
source of all the world's economy problems, are merely putting forward a
straightforward conventional view.
The consensus view among economists, as opposed to financiers, at present is
that the United States is experiencing, at worst, a mild recession and
perhaps only a typical mid-cycle slowdown. This consensus view is reflected,
for example, in new economic forecasts published by the US Federal Reserve
Board and the IMF in the past two weeks, both of which were revised
significantly higher relative to their expectations of a few months ago.
This relatively benign consensus view is also shared by stock market
analysts outside the financial sector, who generally expect rising profits
in most businesses apart from banking, retailing and real estate.
I would argue, therefore, that the true contrarians at present are the bankers
and headline-writers who keep predicting economic Armageddon. And in the
past two weeks the markets themselves seemed to be coming round to this
viewpoint, taking heart especially from the government guarantees offered to
Fannie Mae and Freddie Mac, the US mortgage giants. Hence the 40 per cent
gain in financial stocks on Wall Street in the week since the US Government
made its mortgage announcements - the biggest weekly gain ever recorded by
any market sector monitored by the Standard & Poor's.
So the financial and economic world appeared to be moving towards a fairly
benign convergence - until the end of last week, when the world economy was
again hit by a flurry of shockingly bad news. Consider some of the
announcements made over a few hours last Thursday and Friday: Britain
revealed the biggest monthly fall in retail sales on record, combined with
an abrupt slowdown in GDP growth. In continental Europe, there were plunging
business confidence and industrial order figures in Germany, France and
Italy. Japan saw its first monthly fall in exports for five years, while
America reported worse than expected figures on home sales and unemployment
claims. Does all this mean that the earlier pessimism in financial markets
is proving to be right, after all?
Let me begin with the bad news. Conditions in Britain and continental Europe
are certainly deteriorating faster than many investors had expected. But the
shock about bad figures from Europe - for example, the biggest monthly fall
in German business confidence since 9/11 - mainly reflects the refusal of
euro-bulls to acknowledge previous evidence of a European slowdown, rather
than any genuinely “new” news. It has been obvious for several months that
British housing and retailing were on the verge of a breakdown and the
continental economy's apparent strength in the first quarter was an
illusion.
In Germany, for example, the swing from boom to bust had long been clearly
visible in the statistics and government spokesmen had already said that the
economy was in a period of negative growth. Retail sales in Germany have
been falling almost continuously since the beginning of 2007, when the
Government imposed a misguided VAT increase, while the growth of German
exports was always dependent mainly on the unsustainable consumption and
housing booms in France, Britain and Spain.
Elsewhere in Europe a similar, but perhaps even more alarming story, has also
been unfolding for months - and all that occurred last week was a
confirmation of evidence that the markets should already have taken on
board. Key measures of business activity and confidence fell much more than
expected this week in France and Italy, as well as in the eurozone as a
whole.
Meanwhile, British retail sales suffered their biggest monthly fall on record,
Spanish unemployment jumped to 10.4 per cent- much more than expected - and
Danish consumer confidence plunged to a 16-year low and Swedish unemployment
suddenly jumped from 5.9 per cent to 8.1 per cent. In Japan, too, the
weakness of exports revealed last week should have come as no surprise. It
has long been obvious that Japan, like the rest of Asia, was in a transition
from export-led to domestic-led growth.
But if Europe or Japan were really the biggest worries for investors, then the
main reaction in the markets would have been to sell the euro and the yen
against the dollar, rather than trashing equities around the world. Instead,
the euro and the yen strengthened, as did the price of oil. Which leaves the
other economic disappointments that supposedly hit financial sentiment last
Thursday - the apparently terrible American housing and employment news. And
here we come to the relatively good news about the state of the world
economy today.
Last week's sudden reversal in asset prices was mainly attributed to
ever-deeper anxieties about the US real estate market, where home sales fell
by more than consensus expectations in June. The impact of these
disappointing figures was then aggravated by a paper by Bill Gross, the
influential chief executive of the world's biggest bond investor, Pimco,
which predicted that US banks would lose at least $1 trillion in the credit
crunch, rather than the $400 million to $500 million already discounted in
the value of bank shares. To explain these alarming figures, Mr Gross
maintained that no end was in sight for the housing slump: US housing, he
insisted, is the world's “one asset class that all observers can agree is
going down”. Except that it isn't.
The median existing-home sale price surveyed by the National Association of
Realtors in June was $215,100. Bloomberg and Reuters reported this as 6.1
per cent lower than a year earlier. But it was 3.5 per cent higher than the
median price in May - and that price, in turn, was 3.3 per cent above the
price in April. In fact, US house prices, which almost everyone believes to
be in freefall, have actually been going up for the past four months, after
reaching a trough of $195,600 in February.
Of course, there are strong seasonal factors in house prices and the NAR
cautions that its house price index should be used primarily for
year-on-year comparisons. But even on this basis, June's 6.1 per cent
year-on-year drop was smaller than the 6.4 per cent drop reported in May and
a marked improvement on the record declines of 8 per cent plus in each of
the previous three months. At the same time, the inventory of homes for sale
was steady at 4.49 million homes, which amounted to 11.1 months of supply,
down slightly from the supply level in April. In Britain and the rest of
Europe, by contrast, house prices have started falling only recently, are
still much higher above historical averages than in America and are
suffering a rapidly accelerating rate of decline. The oversupply of unsold
housing is also growing by the day.
In short, the housing correction - and related credit crunch - appears to be
at or near its low point in America, while in Britain and the rest of Europe
the trouble has only just started. Of course, it is possible to cite
different housing indices, on both sides of the Atlantic, which tell
different stories (although the NAR index is the one with the longest
statistical history and most timely of all the indicators of house prices).
All I want to emphasise at this point is that signs of stabilisation are
starting to appear in US housing statistics, while all the economic figures
from Europe continue to deteriorate fast. This is a contrast the markets do
not seem to have noticed - yet.
anatole.kaletsky@thetimes.co.uk
