The global financial elite don’t want to be fooled again. Scarred by the worst banking crisis since the Great Depression and the hubris that preceded it, bankers, investors and policymakers who gathered in Davos, Switzerland, last week gave a guarded welcome to signs of recovery in the world economy and the endurance of the euro region.
“Optimism, but with a sober tone,” was how Bank of America chief executive Brian Moynihan characterised the mood pervading the World Economic Forum’s annual meeting, even as investors were lifting the Standard & Poor’s 500 index above 1500 for the first time since 2007.
The mood in Davos was “totally different” when stocks last reached that peak, said Harvard University economics professor Kenneth Rogoff.
This year, executives from Deutsche Bank and Goldman Sachs were quick to couple upbeat assessments with warnings that economies remained fragile and prone to policy error. Some bankers fretted that credit bubbles might be forming as central banks pumped out cash.
“The crisis gave them a bit of an inoculation psychologically because they can see what can go wrong,” Rogoff, a former International Monetary Fund (IMF) chief economist, said after a private session at the weekend with IMF managing director Christine Lagarde and Deutsche Bank co-chief executive Anshu Jain.
“They’re not as euphoric as they’d usually be when the stock market went up as much as it has.”
Such humility was rare in Davos on the eve of the credit crisis that engulfed markets in 2008. The year before, John Thain, who was then the chief executive of NYSE Group, said: “The financial markets, the world economies are all actually in quite good shape.”
Josef Ackermann, Deutsche Bank’s chief executive at the time, said investment banks “have a very good future”.
Burnt by the subsequent collapse of Lehman Brothers, more than $1 trillion (R9 trillion) in bank losses, the stigma of bailouts funded by taxpayers and a worldwide recession, leaders of the largest banks displayed little bravado in the Swiss resort this year, even as markets cheered improving economic growth in the US and China and reflected an ebbing risk that a euro-member country might abandon the currency.
The MSCI World index of stocks has climbed 5 percent this year and is up 13 percent from a year ago. During the week of the Davos conference, US stocks capped their longest stretch of daily gains since 2004, as companies delivered better-than-estimated earnings, claims for unemployment benefits fell to a five-year low and the index of leading indicators in the US rose the most in three months.
In China, economic growth accelerated for the first time in two years as government efforts to stoke demand drove a rebound in industrial output, retail sales and the housing market.
And in Europe, investors have become less anxious about the euro region’s most troubled members. The extra yield that investors demand to hold Spanish 10-year bonds over German bunds has narrowed to 354 basis points, from a euro-era record of 638 basis points in July last year. In the same period, Greece’s benchmark ASE stock index has surged 73 percent.
“We’ve chewed through a lot of the problems and… my investing self tells me that the worst is over,” Goldman Sachs chief executive Lloyd Blankfein said. Still, “this wouldn’t be the first time that I’ve suggested the worst was over only to find out that there was a bit of a relapse”.
By January 25, the S&P 500 had climbed 5.4 percent for the year, equalling its increase for the same period in 2012 and exceeding the 2.3 percent advance for the same period in 2011. The benchmark index ended last year with a 13 percent gain and was little changed for 2011.
“Everyone has experienced some positive Januarys that haven’t carried on through the rest of the year,” said Lael Brainard, the US Treasury Department’s undersecretary for international affairs.
UBS chairman Axel Weber said investors needed to prepare for a “bumpy” ride. “Whilst the underlying trend is better, there is still a lot of volatility in the market and it’s not going to be a straight-line recovery,” Weber said. “It’s going to be bumpy, and therefore investors need to be prepared for that push-back, for the mood in the market to turn.
A recurring theme in corridor conversations at the conference was that markets were buoyed by monetary easing, which has pushed down interest rates and spurred investors to take more risk in search of returns. Market gains could prove fleeting once central bank policy reversed, attendees said.
One hedge fund manager, who declined to be identified, said Colombia’s sale on January 22 of 10-year bonds at a yield of 2.72 percent, or 0.88 percentage point above US treasuries, indicated to him that investors might be overlooking risks.
On the same day, yields on dollar-denominated junk bonds dropped to an unprecedented 6.46 percent.
“The world has been over-reliant on central bankers, they are the new superheroes,” Deutsche Bank’s Jain said.
“Governments and business leaders need to pick up the slack” after central banks created an “artificial glut of plenty”.
Bank of Canada governor Mark Carney, who will take over as head of the Bank of England in July, rebutted suggestions that monetary policy was “maxed out”.
There was still room for stimulus in the richest nations, and central bankers should aim to propel their economies into “escape velocity”, he said.
Billionaire Ray Dalio, whose Bridgewater Associates is the world’s largest hedge fund with $130bn under management, said low interest rates would trigger a shift of capital into riskier assets. That would make 2013 a “game changer” for the economy, Dalio said.
Moynihan said any policy reversal by central bankers that caused a rapid rise in interest rates could rattle markets.
“If rates move too fast, it will cause shocks in the system,” the Bank of America chief said. “I’m not sure it’s a high probability, but we worry about it.”
Lauded for a bond-buying plan that has insulated his 17-nation economy, European Central Bank president Mario Draghi said “the jury is still out” on the recession-hit European economy.
Swedish Finance Minister Anders Borg said politicians and the public must now bring crisis-level urgency to long-term challenges such as labour market reform.
Political gridlock in the US was another challenge identified by delegates. A clash over how to tackle the debt ceiling could be enough to hurt the dollar’s safe haven status, said Barry Eichengreen, an economist at the University of California at Berkeley.
Elsewhere, the economies of Japan and the UK are shrinking while last week the IMF cut its estimate for global growth this year to 3.5 percent from 3.6 percent.
“There’s still a lot of muted areas around the world; there’s no one running a victory lap just yet,” Morgan Stanley chief executive James Gorman said.
The euro zone, Japan and the UK were all contracting, Stanley Fischer, the governor of the Bank of Israel, said.
“That means you better not make mistakes,” he said. “Relative to a year ago, we should feel much better. Should we think we are out of the woods? No.” – Bloomberg