Investors upbeat, but this recession is just beginning: Kohler

The gap between the market’s ruddy optimism and the gloom pervading officialdom widened a little more this morning.

The European Commission has revised its estimate of Euro-area GDP in 2009 down to -4% this year, twice the earlier forecast decline, with a second year of (smaller) contraction in 2010.

Germany and Italy are leading the European slump – down 5.4% and 4.4% this year respectively. These countries, and Spain and Britain, are facing unemployment levels reminiscent of the 1930s; it’s a good thing no bright spark has thought of stress-testing their banks.

Meanwhile European stocks rose another 1.6% last night, continuing a rally that has now taken the market about one third higher.

Much the same thing has been happening everywhere – deepening gloom among politicians and finance bureaucrats; euphoria among investors. Will the rising prices of equities eventually change the fiscal and employment outlook, or will the rally just peter out, or will investors soon have another “uh oh” moment and slam into reverse?

As previously noted, the future hasn’t happened yet so it is hard to describe, but perhaps the problem is that the past is being misread. Specifically, the market might think the recession is older than it is.

In fact the “great recession” is only about six months old. The European Central Bank increased interest rates as late as July 2008 because it was worried about the strong economy and high inflation.

The credit crunch – which is something else – began a year earlier, on 9 August 2007 when BNP Paribas suspended three asset-backed securities funds. The French bank was responding to what it then described as the “complete evaporation of liquidity in certain segments of the American securitisation market”, but its actions unwittingly triggered the complete evaporation of liquidity everywhere.

The sharemarket caught up with the credit crunch about 10 weeks later and commenced one of the most brutal bear markets in history in late October.

That bear market is now 18 months old. Investors are sick to death of it. “Are we there yet, dad?” is the plaintive cry from the back seat. Quant analysts have been busily crunching historical data on the average duration of bear markets and come up with a variety of answers depending on the sample. Some are now saying that, yes children, we could be there now.

The global recession is another matter entirely. Recessions usually coincide with the start of bear markets because they are usually caused by official monetary policy, as central banks attempt to control inflation – so we have recessions we had to have.

This time financial markets were crunched by a self-started freeze on bank liquidity. Central bankers didn’t do it, and didn’t really know what to do when it happened.

The great recession really began with the commercial paper meltdown sparked by the collapse of Lehman Brothers in September. Bank lending’s life support machine was turned off and it died.

Governments and central banks had to step in a replace them, which they did to constructive effect.

To justify the massive increase in government debt and central bank balance sheets, the politicians and central bankers have had to tell their citizens that, actually, things are very bad indeed. The economic rhetoric changed completely, and for some reason the words of politicians are far more solemnly reported by the media than expert commentators.

Great recessions do not last six months. Do they last one year, which is the duration that would support a 33% global sharemarket rally in March/April 2009? No.

The European Commission’s new forecast of two years of contraction is more realistic.

This article first appeared on Business Spectator.