Sital Ruparelia

Guest article from Mitul Kotecha

The last time I wrote for 6 Figure Career Management in April, the title of my article was Light at the End of the Tunnel.

In it I described how I believed that whilst we should brace for the reality of the tough times that lie ahead, eventually there would be some good news amidst all the doom and gloom.

I concluded with the comment, “Although it may be difficult to see it now there is light at the end of the tunnel and positioning yourself ahead of recovery will be crucial to ensure that you can grasp the opportunities that will likely emerge once you find the light. It is not too late to position for these opportunities especially as now more than at any time since the crisis began there are plenty of signs of recovery or green shoots. The main question is whether these shoots are allowed to blossom or left to wither.”

At the end of last year it looked distinctly like the global financial system was on the verge of meltdown, and that the global economy was about to implode. The change in market sentiment since has been dramatic. Various banking sector bail-outs, massive stimulus packages and the G20 nations agreement pledging $1 trillion for the world economy were major events over the first half of the year which helped to turn sentiment around and stabilize financial and economic conditions. More interest rate cuts by many central banks and expansion of unconventional monetary policy measures provided a further boost to recovery efforts.

These efforts appear to be paying off as confidence has returned to markets and economic data releases, especially in the second quarter of 2009, have revealed a much smaller pace of deterioration. Indeed, economic data has been rather better than many had expected, with those same analysts that had downgraded growth forecasts only a short time ago, now scrambling to revise their expectations upwards.

The good news has also extended to the banking sector, with many banks reporting a stellar performance in the first quarter of 2009. In addition, some US banks have even felt confident enough to pay back government funds, marking a turning point for the US financial sector.

Markets reacted to all of this news positively once it became clear that a systemic crisis had been avoided; most US and European stock indices, with the notable exception of the Dow Jones, ended the first half of 2009 with positive returns. However, their gains were less impressive when compared to the strong performances of some emerging equity markets, with indices in China and India registering gains above 50% this year as recovery efforts in emerging markets echoed those in the developed economies, but with the advantage of far less severe banking sector problems.

The second half of the year will not be so straightforward. Market relief that there will not be a collapse of the global financial system is not sufficient to keep the momentum going into the second half of the year. Until now there has been plenty of less negative news or green shoots but little information to judge the magnitude and speed of recovery going forward.

There are plenty of factors that will dampen recovery in the months ahead. Higher unemployment, massive wealth loss and increased savings will provide a clear downdraft to the global economy. Banks will be increasingly laden with bad loans due to credit card delinquencies, commercial real estate defaults and other sour loans and are unlikely to step up lending in a hurry. In addition, it is still unclear how quickly toxic debt will be removed from banks’ balance sheets, which will act as another impediment to recovery.

The European economy is a particular risk to global recovery, with only a gradual recovery expected. In particular, the biggest Eurozone economy Germany is struggling in the wake of a collapse in exports and a lack of domestic demand. Moreover, banking sector issues remain unresolved especially as there has been little information on European bank stress tests. The relative strength of the Euro and inability of some countries in the Eurozone to devalue their way out of the downturn will also dampen recovery prospects. These factors suggest that Europe will lag behind the recovery in other countries such as the US and UK, where the policy response has arguably been more aggressive.

Unfortunately the jobs market will lag behind the recovery process seen in the wider economy, as is usual in any economic recovery, as employers continue to cut costs and rationalize their labour force. Nonetheless, even here there are signs that things are becoming less severe. The pace of job losses in many countries is lessening. In the US for example, the closely-watched non-farm payrolls report revealed that average monthly job losses in the second quarter of 2009 were much lower than job losses in the first quarter and this trend is likely to continue until into 2010 when hiring becomes positive again.

The bad news however, is that unemployment rates continue to rise. In the US the unemployment rate is likely to head to around 10% from 9.5% currently and this will be echoed in Europe where the unemployment is at a 10-year high of 9.5% currently. In the UK the pattern will be similar and the unemployment rate is set to rise further. Unemployment will likely peak early in 2010, but it’s not all bad news until then. There are already signs that employers are taking advantage of the bigger supply of labour to recruit talent which would otherwise be more difficult to do when the jobs market is frothy.

Overall, recovery will continue but markets will need more than just less negative news to keep them moving upwards. I am cautious about the pace of recovery because I think there are still many roadblocks, but massive government stimulus measures will eventually do the trick even if the pace of economic recovery is a slow one. Now is the time to be well-positioned to take advantage of the upturn in economic conditions as long as your expectations remain realistic.

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Mitul Kotecha is Managing Director and Global Head of FX Strategy for a large European Investment Bank. To follow Mitul’s views on the global economy and financial markets visit his personal blog, “The Econometer” by clicking here.