2009 Another Storm?

Hard to say! Well...understandably, many investors are glued to high-frequency indicators such as macro data and corporate announcements as they try to feel for an inflection point in the crisis. Portfolios tend to be positioned with respect to this – either on the defensive side of the line, anticipating a prolonged spell of worsening news, or on the

riskier side, hoping to benefit from the first glimmerings of light at the end of tunnel.

The outlook for the global economy continues to deteriorate. Incoming data have, almost uniformly, surprised on the downside. A combination of declining wealth, notably higher uncertainty, and financial disruptions appears to have led to sharp declines in demand around the world. A significant contraction in international trade is helping to propagate these shocks around the globe. Sharply contracting output is likely to lead to further declines in demand as income falls rapidly. There are scant signs that the momentum of this negative cycle is waning.

Policymakers are trying to contain this process through actions on three broad fronts: monetary, fiscal, and financial. Inflation continues to fall rapidly in most countries in the face of lower commodity prices and rapidly growing output gaps. Central banks are lowering short-term interest rates where they can. However, for an increasing number

of central banks, conventional policy tools are at, or are fast approaching, their limits. They are moving on to other options. Fiscal policy is easing in many countries as well, but not with equal force. China, Russia, and the United States appear set to implement the most aggressive fiscal expansions.

Somehow, the biggest changes have come in those countries that are particularly exposed to international trade. I expect the Japanese economy to contract through the end of this year, with real output GDP falling 3-1/2%. Similarly, I am seeing real output to fall in Hong Kong, Korea, Singapore, and Taiwan this year, and we expect the Russian economy to stagnate (ref from many financial news). I see this all the major industrial economies to contract substantially this year, and only sputtering recoveries until 2010. For emerging economies, 2009 is likely to be the worst year of growth performance since the crisis of 1998. For the global economy as a whole, this is likely to be the worst year for growth in almost 60 years.

Ironically, the long term shape of the world is easier to describe than the short-term transition. How quickly the private sector deleverages and whether it responds to fiscal and monetary stimulus are open questions. But regardless of how the world gets there, we believe that it will have certain characteristics – less leveraged, less imbalanced in trade flows, more regulated and so on.

Next question: Can we change this condition?