Economy not out of the woods yet: Fidelity

With the markets still in freefall and housing prices continuing to drop, it doesn’t look as though America’s financial future is going to turn around anytime soon. Peter Drake, Fidelity’s vice-president of retirement and economic research, says the bottom might not be far off, though three things have to happen first.

“U.S. housing prices need to stabilize,” he told a large crowd at Monday’s Fidelity road show in Toronto. “Credit markets need to normalize, and the American economy needs to resume growth. The problem started in the U.S., and when that country pulls out of this, it will be a sign that the rest of the world will do the same.”

While we haven’t seen any of Drake’s three indicators fully play out, he does reveal that things are improving. He says the central banks’ coordinated interest rate cuts have helped and adding liquidity into the markets has also been useful. He predicts we’ll see both tactics used again.

Drake also points out that the TED spread, the difference between short-term U.S. government debt and interest rates on interbank loans, has narrowed, which is a sign that markets are moving toward normalization.

“TED spread really matters,” says John Power, a portfolio manager with Fidelity, who also spoke at the road show. “That’s an indicator of whether banks are willing to lend credit to each other. If we don’t fix the TED spread, everything goes down.”

To reach Drake’s three milestones, it’s likely the U.S. government will have to develop at least one more rescue plan. Power, who is not a proponent of the congressional package, says the government has “obliterated” its standing as lender of last resort, but there really is no choice.

“I’m not a great fan of the way the U.S. government has approached all of this, but they’re finally telling us ‘we get it — if this round isn’t enough, we’ll be back,'” says Power. “The chequebook is open and we’ll keep writing cheques until it’s fixed. There is no other option.

“The rules are changing dramatically,” he adds. “They’ve altered the rules in the mortgage market to try and support housing; the treasury is making direct investments amid allegations of socialism; there have been direct investments in banks and many major auto companies.”

Andrew Marchese, a portfolio manager and director of research for Fidelity’s Team Canada, says the market turnaround will come when there is more confidence in the system. “That will come from accurately determining the length and depth of the recession, and then equities as a whole will move upward,” he explains.

He adds that we’ve still got a way to go before the storm clouds part, though, as deleveraging is still occurring and no one knows what else is going to fail.

Still, like Drake, Marchese is more confident now than he was a month ago that things are slowly turning around. He points out that credit markets are “improving slightly,” with the TED spread and the London Interbank Offered Rate (LIBOR) coming down. “But it needs to get better,” he says. “We need short-term financing to firm up and resolve itself, but financial institutions are not willing to lend to each other, so it makes it difficult for businesses out there.”

When the markets do turn around, trouble could still be in store for America. Marchese thinks the current situation most resembles that of the late 1970s. He says the liquidity that’s been injected into the system will find its way out of the financial sector and into the private sector. “When that happens, it will manifest itself in inflation,” he says. “The challenge will be for the global central bank to take back liquidity in a prudent fashion, so it won’t be worse than the last two years of the ’70s.”

While inflation was bad in the late ’70s, at least the present-day crisis won’t devolve into a depression scenario. Bob Haber, CIO and portfolio manager with Fidelity, says the “response has been enormous by the government.” With record levels of monetary stimulus, the world has “seen all the responses by the central government that we did not see or read about occurring during The Great Depression.”

Still, how the world gets out of this global recession depends on how governments react. But, he adds, the “single most important thing to watch is the savings rate.”

He explains it’s likely that consumers will increase their savings and, therefore, reduce consumption. And that is a good thing. “As savings rates go up, you’re going to be spurring investments. In the future, we’ll have a more productive and less consumptive, less leveraged, society, and that’s all positive.”

When people are ready to invest again — and Fidelity’s managers think now is the best time to get back into the market — they should focus on areas that have been unjustly hit by recession fears. “Think about fertilizer companies,” Power told a room of advisors. “Many are trading literally at two or three times earnings. This business isn’t going anywhere but up. Lots of areas and companies have been unfairly punished by credit fears.”

Marchese reveals that he’s favouring Canada, because he’s still bullish on commodities and resource-related stocks. He admits that the downturn has put a number of projects on hold, but he’s confident that once credit starts flowing again, companies will forge ahead with their original plans. “But we have to get through this period,” he says, “and that will take time.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(11/11/08)

Bryan Borzykowski