Extrapolation Versus Reality


It is that time of year again when managers are called upon to make wise predictions about the outlook for 2012 and a number have been brave enough to say they simply have no idea. After all, the markets are so focused on the eurozone that, until there is some resolution, gauging the outlook for stockmarkets is nothing more than guesswork.

If these fund managers are right and the future is inherently unknown, investors can perhaps appraise the economic situation with a more realistic eye. Not that it makes it substantially more palatable – as the Chancellor outlined in his Autumn Statement last week, the absence of growth – as a result of a combination of inflation, the eurozone crisis and some home-grown problems – has worsened the debt situation in the UK and necessitated the extension of austerity measures.

At the moment, the consensus view points to a mild recession although it is not as bad as 2008, with stronger growth resuming in two years’ time. A number of elements support this view – the services sector is still growing, for example, while consumer spending has held up. It is certainly not the end of capitalism as we know it.

The eurozone is creating its own self-fulfilling prophecy. Until relatively recently, the debt levels of all the major eurozone countries seemed sustainable. However, political intransigence has delayed austerity measures and sent the cost of borrowing soaring, which has – in turn – made the level of borrowing unsustainable.

The worst-case scenario for the eurozone is the single currency needs to be dismantled. This comes with a high price, but there is a tipping point – when the cost of saving the euro becomes more than the cost of dismantling it – and in such an eventuality, even Germany may renege on its commitment to the single currency. The worry is this would pull down with it a bank or two and a number are undoubtedly vulnerable. But at the moment, this is conjecture. No-one knows the real liability lying within the banks.

Elsewhere, debt levels in the US are ugly, but improving growth will help. Unemployment numbers are improving, recent GDP growth has been stronger and there are signs consumer confidence is picking up. Equally, the interest rate cycle in emerging markets is rolling over with many now starting to cut rates again.

While in no way suggesting the environment is not fraught with danger, the disaster scenario – is extrapolation, not reality. This disaster has made a nonsense of forecasting and investors should not get ahead of themselves in predicting the end of the financial world as we know it.


Written by Charles Browning | Associate Director

Charlie joined Mantle Financial Planning in 2000 following a number of years with the Prudential. Read more >>

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