The mood at the IMF: ‘toxic’ would be too positive

AFR, October 2011

Smart Money was in Washington DC last week for the IMF/World Bank annual meetings. We could describe the mood as toxic, miserable, scared, grim and hopeless. But that would be putting too positive a spin on it.

If the world had been hoping for leadership, and a clear sense of direction out of crisis, then they didn’t get it. There is no shortage of gatherings, groups and institutions in the world today – the G7, the G20, the World Bank, the IMF, the various European bodies, plus of course all of the national sovereigns – but none of them gives any impression of being in charge. Markets, lacking any roadmap they can rely upon to fix the world economy’s many problems, are panicking and falling.

One moment encapsulated the meeting. With the mood at its worst, late on Friday night the G20 – led by France – hosted a press conference. It was packed, as the world’s media waited to hear a message of reassurance and the concrete steps the group would set out for recovery. France’s finance minister and development minister took to the stage and started talking. They talked about a new financial transactions tax; about infrastructure development in the emerging world; about transparency. After half an hour they stopped; they hadn’t mentioned the growing financial crisis once, and became visibly irritated when anybody asked about it. It was like watching an ostrich bury its head in the sand. If the sand was on the Titanic. And the Titanic was on a different planet.

It summed up the sense that the world economy is a car going downhill on a steep mountain road with no driver.

But what does all of this mean for investments? Several themes came out of the meeting, and of market behavior around them:

1. Not only could Greece default, the euro really could collapse. It probably won’t, but the possibility can no longer be ignored. The precise consequences of this are unclear, but anybody thinking of buying into European equities because they look good long-term value might want to wait a little longer for some certainty – and maybe a lot longer.
2. Just because emerging markets have better economic fundamentals than the developed world, it doesn’t mean their markets are invulnerable to global shocks. This perverse logic applied in the 2008 financial crisis and it is happening again: the Singapore dollar, for example, having fallen 8% against the US dollar in about a week having previously soared; and the Indonesian stock market plunging despite the fact that Indonesia has one of the world’s most vibrant economies, built almost entirely on domestic consumption. The US dollar, for all its troubles, remains a safe haven asset and money is returning there during difficult times.
3. Traditional safe havens are not behaving like they used to. Gold fell with all other asset classes, presumably because people have had to liquidate their holdings just to get cash.
4. On its own, the US economy probably wouldn’t go into recession; there’s nothing happening there to suggest the economy would shrink, just grow sluggishly. But the crisis in the eurozone on top of America’s other problems – unemployment, fiscal deficit – may be enough to create the so-called double dip, with the US returning to recession barely two years after coming out of the last one.
5. Remember what happened to the Aussie dollar in 2008? As the world economy floundered, demand for commodities suffered, and assets moved to US dollars for safety, causing the Australian dollar to decline. It’s already starting to do so again, dropping below parity last week, and if we do go back into global recession there will likely be further to go. That said, this time around Australia is a higher rated sovereign credit than the United States, and the case for it as a safe haven is better than ever. If the world investment community does decide the Australian dollar is a safe haven, that should push the currency up, not down.
6. In the medium term, fund managers tend to see good prospects for Asian bonds. Some say Asian equities too, but there’s also a fear that things are going to get worse before they get better.
7. In the meantime, cash is looking rather attractive.
8. And how about Australian equities? Investors will have fresh memories of the market halving over 2007 and 2008. Just like last time, the crisis has very little to do with Australia – arguably even less so. The last crisis was about the banking system, and Australia did have some problems in that area. But the current crisis is about sovereign debt, and Australia has no problem at all in that respect: it is one of the most robust economies in the world. But as we learned last time, when a global stock rout takes place, pretty much everyone suffers, fairly or otherwise. Analysts are already pointing to the good long term value in the Aussie market: Aussie shares now carry a grossed up dividend yield of 7.3%, which looks attractive. But the mood is very much buyer beware.