Global GDP this year will probably contract for the first time since the 1930s, with maximum pain expected in the first half of 2009. Moreover, 2010 will probably see only a modest improvement as the deleveraging process continues to play out, with potentially devastating economic and corporate consequences.
The difficult part and one occupying much debate right now is whether policymakers will succeed in preventing the recession turning into a depression and whether they can put in place the foundations for an improvement in 2010.
What we can say for sure is that policy will matter a great deal. Over-indebted households and under-capitalised banks are adjusting their balance sheets, building up savings in the first instance and restricting lending in the latter. There is little chance of a sustained recovery until this process is well on the way to completion and we remain some way from that point.
The good news is we believe that much of the adjustment will have taken place by the early part of 2010 and that a catastrophic deflationary scenario will be avoided. This is principally due to the aggressive and unprecedented policy interventions that have and will be seen over the coming months. We do not under-estimate the volume of the likely stimulus that will be thrown at the problem on a global basis but we also side with respected commentators like Bill Gross at Pimco who believes that the latest Obama stimulus package will not be enough as output will not increase sufficiently to prevent unemployment from continuing to rise significantly over the next year or so.
Governments will ultimately need to resort to quantitative easing, which to the layman means printing money to buy up assets and reliquify the system. The quicker the better, in our view. Printing money like this should be inflationary in normal circumstances and some inflation would be a desirable outcome right now but these are not normal circumstances, with the scale of wealth destruction that has already occurred dwarfing the size of the stimuli. As a consequence, we believe that global deflationary forces will remain with us for some considerable time but eventually we will see some up-tick in pricing power as production capacity is taken out of the economy.
Our strategically cautious stance for 2009 is unaltered and we remain tactically vigilant. We recognise that recessions preceded by banking crises tend to be worse than average both in terms of severity and duration but equally appreciate that within any secular bear market there are usually a number of quite powerful rallies that we need to be on the right side of.
As in 2008, there will be plenty of opportunities to make money as well as lose it.
Gary Potter is co-head of multi-manager at Thames River