The Recession That Was

Not too long ago Cees Bruggemans was admonished for being an alarmist when an article was published in which he warned that the world was heading into a recession. Following the previous post on this blog, it is somewhat prophetic that he release the following article today.

(Take time to read also at REAP Club – ‘Our next economic upswing another long one‘)

“This Easter the economy was its seventh month of recession proper (counting declining total output from October 2008) and in its tenth month of peripheral recession (counting from July 2008 excluding volatile agriculture).

We are currently probably traversing the worst patch of this cyclical downturn.

Economic data for 3Q2008 and 4Q2008 showed only a marginal recessionary condition compared to the output collapse shaping in many sectors during 1H2009.

In February, manufacturing output was down 15% compared to a year ago. Mining offers a similar story, 12.8% down in February and over 20% down on two years ago.

Ditto the electricity experience, by February 2009 down 11%. Commercial vehicle sales have been 40%-50% down in recent months.

Our exports in Dollar terms were down by half in January and still down by a third in February.

Residential building activity is over 10% down, and next year non-residential building activity may be similarly down (taking longer   to weaken due to longer lead times).

But even construction, for years running at 30% growth during its infrastructure build-up phase, is likely to grow only 5% this year and possibly only 1% next year.

This isn’t due to weakening demand. Instead, there is an enormous base effect. Construction is now running at full tilt henceforth with little growth but with enormous body, year after year as roads, railways, airports and power stations roll off the assembly line.

Agriculture and construction, darling sectors of the high growth phase, only weigh about 6% of GDP. But instead of 30% growth rates   we will probably be going negative shortly in agriculture (some harvests dipping slightly) or record only marginal growth (the construction effort having grown so large).

With the growth champions diminishing their impact, and nearly half of all GDP contributors currently shrinking output by between 10% and 20%, we are knee-deep in recession, with GDP declines reminding of 1985.

Is everything lost then? No ways.

This drop in activity has very specific drivers. Consumer abstinence has been delaying big ticket replacement. Business uncertainty has led to defensive reactions, including huge inventory shedding. It is also driving cutbacks in business fixed investment. These same sentiments overseas are also driving our export collapse.

But each of these output declines is subject to revival, potentially sooner rather than later.

Inventory reductions don’t go on forever. They are only intended to temporarily cut output below sales to work off unwanted inventories. Once done, output can recover.

Local data is extremely poor on this score. Globally there exists a better picture by country and sector.

The worst inventory culling took place during 4Q2008 and 1Q2009. Already 2Q2009 should be better, and by 3Q2009 global growth should be reviving, in the US (consumer-led), China (investment-led) and even Japan. In contrast, Europe, being less policy-proactive and an order taker, may lag, but at most by a few months.

The same will probably happen to South African output, domestic and export assisted. The upturn could be six months away for us.

Though it could already happen in 3Q2009, as expected in the US and China and possibly Japan, for us the first upturn in GDP activity may only come in 4Q2009.

The domestic leg of this upturn will be durable goods based (cars, furniture, appliances, house building) and interest rate driven as replacement caution starts to ease, greatly assisted by high consumer confidence about own finances.

Uniquely to this cycle, its mental component will be driven by global success in arresting the credit and banking crises, with the lead indicator being rising global stock markets.

The SARB leading indicator still fell in January, but only by 0.4%. Passenger car sales were down by 23% in March, less than in preceding months, even when taking account of trading days. Both indicators suggest a slowing descent. Both herald recovery some six to nine months away. This expectation is reinforced by falling interest rates since December.

So will the Great Recession still turn into Depression before it is all over? Judging by the policy action, it won’t. Judging by the processes involved, it can’t.

You can’t indiscriminately keep cutting inventories. Existing car parks get quickly older even as the cost of replacement falls dramatically (not only much lower financing costs but also attractive price offerings). This also applies to ageing business equipment needing replacement.

Governments and central banks are pushing a lot of spending and financial support. That doesn’t remain without effect. Meanwhile   financial markets signal they want to dance again.

The skeptics endlessly question where this will lead. Indeed nowhere for those remaining sidelined.

The recovery’s onset will probably only be fully accepted after the last recessionary hangover has been properly audited and assimilated.

Even now the turn may already nearly be upon us, if not yet properly identified. This would not be unlike the experience with the onset of output collapse last year.

It always takes time recognizing and acknowledging cyclical turns. But one is very much looming straight ahead. So be prepared to dance!”
By Cees Bruggemans, Chief Economist FNB, 14 April 2009