An anaemic recovery should be welcomed, not feared.

Bill Mott: 'An anaemic recovery should be welcomed, not feared'

Fundamentalist view: our series in which an expert at making money grow analyses the financial world and gives his advice to savers and investors.

By Bill Mott
Published: 12:05PM GMT 26 Nov 2009


Bill Mott: 'This autumn 2009 rally cannot continue much longer' Any fans of late Fifties and early Sixties American music will know the Drifters song Save the Last Dance for Me. The plaintive boyfriend tells his girlfriend that she can enjoy the party without any cares, but ultimately her price for this enjoyment is to ''save the last dance for him''.

As a fund manager, I am watching the party become increasingly boisterous as market momentum powers ahead. I would like to be well on my way home with my portfolio positioned away from areas of excess optimism before the last dance is played. Looking at the British economy, it seems there are three possible scenarios from here.

Scenario one is a long period of anaemic growth during which the economy gradually rebalances, avoiding "Armageddon'', but does not rally very strongly. I believe this outcome has a 75pc probability.

Scenario two is a ''double dip'' – or W-shaped – recovery in which the market and the economy experience a further downturn as recovery fails to take hold, and has a 15pc chance.

Scenario three is a V-shaped recovery, namely a continuation of the current near-euphoric, liquidity-driven rally and has a 10pc probability of occurring.

As it became clear, at the end of last year and during the first quarter of 2009, that Britain and the global economy were on the brink of meltdown, authorities worldwide began co-ordinated action to stabilise the economy. Generally, a ''kitchen sink'' liquidity policy was introduced. In effect, policy-makers were telling us that long-term economic policy was being suspended to tackle immediate economic dangers.

As a result, the current early signs of economic stability or recovery are dependent on the largesse of governments and central banks. Investors have responded aggressively to these government actions, fuelling a robust asset price reflation in all types of asset across the spectrum from equities to commodities to bonds. This rise in asset prices is itself supporting the economic recovery. The Deputy Governor of the Bank of England recently suggested that one of the expected consequences of quantitative easing – printing money to buy back government gilts – was to raise asset prices.

Clearly a rise in asset prices from March 2009 lows was desirable to improve confidence, but when does a ''helpful rise'' in asset prices evolve to the beginning of a new ''asset bubble'' and where are we in this process?

It is our view that the UK market rally has gone too far, too quickly. Many investors, lamenting that the ''train has left the station'' without them, are playing catch-up. The trouble with this approach, as in all bubble situations, is that continuing to buy overvalued assets now requires you to believe that, although the drivers of the market are not sustainable, you will be able to sell before the inflection point at the peak.

This autumn 2009 rally cannot continue much longer, simply because very low interest rates were not the sole cure that helped us recover from the last bust. So while we have avoided globally a Thirties-style Depression, we need to implement a partial exit strategy to avoid another asset bubble and more financial turbulence. Ideally, we must have an anaemic global recovery (Scenario one) so global imbalances can be slowly corrected without too much dislocation. The dilemma is that tightening policy through tax increases and interest rate rises could result in a double-dip recession, but if loose policy continues, with no action taken, then an asset bubble is more likely.

An anaemic recovery should be welcomed, not feared. Monetary policy must not neglect asset-price movements. If premature tightening of policy causes a mild double-dip recession, this would be better than another asset bubble.

We have avoided the very worst and if the price of us all not dying from pneumonia is a blocked nose for a few years, then it will not have been a bad price to pay.

We have positioned the PSigma Income fund as a hybrid between defensive UK equities with limited economic sensitivity and UK equities that we believe can grow faster than average in a ''bracing but not impossible'' global economy. Putting quantitative easing on hold would be a good first step and would signal that the authorities are determined not to let another asset bubble develop.

As any West Ham United football fan will tell you, liquidity-driven bubbles are not forever…

Bill Mott manages the PSigma Income fund.

http://www.telegraph.co.uk/finance/personalfinance/investing/shares/6636435/Bill-Mott-An-anaemic-recovery-should-be-welcomed-not-feared.html