Global markets, depressions and so on...

While global central banks acted relatively quickly to the credit crisis, we are only now getting data on just how badly it is affecting the global economy. The speed and size of falls in production have been surprising and forecasters, such as the IMF, are rapidly downgrading their forecasts for global growth. In October, the IMF thought there was a 60% chance of a recession. After several revisions, the IMF are now forecasting a deep downturn. World growth is expected to fall by 0.5% over 2009, the lowest rate since World War II. For advanced economies the fall is greater, with a 2% contraction expected over 2009.

In our view, one thing the past teaches us is that unless the financial sector is repaired, no amount of monetary or fiscal easing will bring about a lasting recovery. So we think it is encouraging to see further steps by Obama to quarantine toxic assets.

While Australia’s overall financial system is in better shape than many others, collapsing world trade means that both export volumes and prices will fall. The unwinding of the terms of trade boom and difficulty in accessing capital will likely lead to a sharp fall in business investment.

Expressions on Recessions and Depressions

So, what is the difference between a recession and a depression? The old joke states: "A recession is when your neighbour loses their job. A depression is when YOU lose your job". On a more serious note, whilst there is no agreed definition, a depression may be defined as a recession where real GDP falls by more than 10%. The last one in larger developed economies was the Great Depression of the 1930s, where unemployment in Australia got to 20%. Recovery from this was patchy, with another less severe depression during 1937-1938. Normal economic activity did not return until 1940-1941. Since then the US has not had anything close to a depression. The worst recession in the last 60 years was from November 1973 to March 1975, where real GDP fell by 4.9 percent.

Given the sober global outlook for 2009, a reasonable projection is that Australia will have a mild recession with the second half of 2009 starting to see positive growth returning. Year-on-year GDP growth for 2009 should be just positive (could possibly turn out to be slightly negative), with positive growth for 2010. Therefore, we are of the view that this is NOT a depression. Whilst we believe unemployment may hit 7% at its worst, with 93% of Australians still employed, this is not near depression levels.

The Logic of Staying the Course - Interest rates do count

It appears that investor psychology is divided amongst those who are resigned to staying the course, having lived through their portfolio falling, and those who are more prone to panic. Cashing in growth assets at this point in the cycle (arguably close to or at the bottom) is not sensible, if history is anything to go by.

Example: If your equity portfolio has lost 50%, and you decide to move your funds into cash, with interest rates at 3.25%, it would take nearly 30 years for your portfolio to recover and with no tax relief through imputation credits / capital gains tax discounts (of course interest rates are likely to rise at some stage in the future).
On the other hand, over the last nine bear markets in Australia it has taken between 15 months and just under eight years for portfolio values to be restored. On average around three and half years. Part of the reason this is the case is that once the sharemarket reaches a bear market or recession low, it typically bounces back reasonably dramatically in the first year (on average, 32% over the last nine bear markets).

Whilst investors may feel "damned if they do and damned if they don't" in this negative market, the logic is on the side of staying the course; particularly with interest rates so low (even five year Government Bonds offer little relief at around 3.2%).

Stop Reading the Paper! Six Good Reasons to be Cheerful:

• The Australian economy is in better shape than most of the developed world.
• Although it looks like Australia may have a mild recession, the economy should bounce back, as it always has done in the past.
• Recessions represent an opportunity for investors to buy good assets at great prices looking forward to the next boom.
• Sharemarkets typically bounce back well before the recession is over.
• The sharemarket has always bounced back to new highs, although this may take some time.
• Most Australians have long-term superannuation assets that will grow over the long-term and are not forced to sell at rock bottom prices.