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PMR's Editorial philosophy:
"It is only by standing on the shoulders of
giants that I have been able to see further."
Sir Isaac Newton,
1642–1727
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Global View
Market Volatility
Christopher Molumphy, CIO, Franklin Templeton Fixed Income Group/Ed Jamieson, President of Franklin Advisors, CIO, Franklin Equity Group
Whatever the criticisms leveled against the Fed’s unscheduled lowering on interest rates on January 22nd, nobody can now doubt that the Fed will be very proactive in support of the economy. We would fully expect the Fed to continue to be very aggressive. The current market is anticipating further rate reductions in the short term and as far ahead as mid-year.
The US economy has already slowed significantly over the past four months. We probably moved from an annualised growth rate of 4.9% in the third quarter of 2007 to about 1% in the fourth quarter and possibly an even lower rate in the first quarter of 2008. Over the past 60 years, we have experienced 10 recessions; on average they have moved the economy downward by two percentage points and lasted about 10 months. Any recession will probably not be a particularly deep one, thanks to the Fed’s proactive monetary policy, a reasonably strong global economy (particularly developing countries), a fairly healthy corporate sector, consumers who are probably more stable than is characterised and, on the margin, the fiscal stimulus package currently moving through the US Congress.
We do expect gradual, not abrupt, softening in the labour markets, as suggested by weekly initial jobless claims. I n addition, the latest unemployment rate of 5% is still much lower than the long-term average. Consumer spending, which represents roughly 70% of US spending, is key to economic prospects. Since we have not had a retrenchment in consumer spending since 1991, one might be due.
It is quite ironic that the transmission mechanism by which the subprime turmoil spread into the rest of the economy was not the overstretched consumer borrower, but rather the lenders and actual creators of derivatives meant to protect against subprime risk. The resultant credit crunch has caused tighter lending across the board, due in large part to the losses suffered by these lenders. There is a lot of debate about the actual losses that US financial institutions will incur in the subprime sector – somewhere in the neighborhood of US $140 –150bn is probably a pretty good estimate. The end to banks’ problems, at least in the area of subprime-related losses, should be in sight once provisioning efforts approach this level.
The market turmoil seen since mid-2007 means that valuations in fixed-income sectors are very attractive, and in many cases, becoming more so. We may continue to see volatility in the coming months but on a long-term basis, the conditions are ripe for excellent buying opportunities.
One of the benefits of globalisation over the past 10-20 years is that there is a much better balance in the global economy. The US economy, while still the largest, is now not nearly as large relatively speaking as it was thanks to growth in Asia and elsewhere. This increases the ability of the global economy to absorb negative news in one area. Growth in places like China will continue and, at the margin, will have a positive impact on the global economy and financial markets.
Tel: (+27) 11 645-6500
www.franklintempleton.co.za
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