Adrian Brass Market View
Just six months ago, there was a high probability of another Great Depression. Economic indicators were in freefall and markets were in the throes of what turned out to be the second-worst bear market in a century.
In the face of such a devastating collapse in economic activity, the Obama administration responded with a banking plan, the much- discussed stimulus plan and a housing plan.
The combined spend of almost $1.5tn dwarfed every other government spending programme in history – even more than sending a man to the moon. After that, and with just 20 per cent of the stimulus plan spent, markets now seem comfortable to expect, instead, a Great Recession.
Even before the full impact of the stimulus programme is felt, conditions are improving. The credit system has unfrozen. Corporate loan availability is now back at near-normal levels, as too is the cost of borrowing.
The housing market also shows signs of forming a base for recovery. Affordability is back at 20-year highs, making homes cheap again and bringing buyers back into the market. Home sales are recovering for the first time in two years. That matters because only if the housing market stabilises can we expect to see a sustained economic recovery.
However, before we get too excited and assume that the good times will be rolling again in no time, let’s not forget that someone has to pay for the unprecendented government spending. That invariably means that taxes will have to rise.
As consumers also need to make further efforts to rebuild their personal balance sheets, consumer spending is unlikely to show the same strength that it did in the boom years before the credit crisis.
We should also realise that government is now a bigger part of the economy and, as shareholders, the government agenda may sometimes differ from that of private investors.
As a result, we could see long-term economic growth in western economies somewhat lower than we may have become used to in recent years.
Not to be deterred or outdone by government action, corporate America has responded to the challenge. Management teams have rolled up their sleeves, put on their boxing gloves and fought back like never before. Companies have cut more cost from their businesses than at any time in the past 50 years, increasing productivity in the process.
This helps cashflow and profitability in these lean times but also, importantly, sets them up for a dramatic snap-back in profits when the full recovery arrives.
We may have seen a marked falloff in earnings growth relative to trend but these huge cost-cutting efforts should be instrumental in producing a speedy reversion to trend growth. We are already seeing earnings upgrades come through after several quarters of seemingly never-ending and drastic mark-downs.
Markets may be pricing some of this in but, even after a rebound of 56 per cent by the end of September, we are still more than 30 per cent off the 2007 peak.
The US market is only back at the same level it was at in 1998. That may sound pretty depressing but, if nothing else, it shows that there is a lot of ground still to be made up.
There is no getting away from the fact that the past 10 years have been the worst in the history of the S&P 500. The recovery since March is just a small uptick and hardly worth writing home about yet.
Adrian Brass is portfolio manager of Fidelity American special situations fund