Market Outlook 2011

After falling into the hell of the Great Recession of 2008-2009, the year 2010 offered well-grounded hopes of recovery. Unlike the Florentine poet, the world economy did not descend through Dante’s nine circles of hell but rather decisive action by national authorities managed to brake this fall and reverse the direction to the paths of salvation. The year that is now ending has set a firm course to exit the crisis. But as we already warned a year ago, the extent of the fall and the bold remedies implemented mean that we must be cautious. We have definitely left the crisis behind us but are still facing a complicated road ahead.

First of all, the risk of a double-dip recession has been ruled out and recovery is progressing reasonably well. But some developed economies have lost steam and progress is weaker than in previous exits. An environment of sustained growth in production and world trade is fundamental to tackle the first of the three great challenges facing the world’s economy, namely withdrawing fiscal stimuli and reversing the relaxed monetary policy applied but without harming the recovery inactivity.

The good news is that the emerging world, hardly affected by the recession, has reached a cruising speed that seems consolidated and sustainable, and is pulling along the rest. The Organization for Economic Cooperation and Development forecasts more than 4% growth in global production for 2011 and 2012, thanks largely to the emerging economies. However, major doubts are tormenting the world’s leading economy, the United States, whose recovery has stalled in the second half of the year, and it has still not completely digested the effects of its real estate bubble and can’t create enough jobs to face the immediate future with confidence. In any case, we predict that, in 2011, the US economy will grow somewhat more than 2%, a modest rate compared with other episodes of recovery but reinforcing the progress made in 2010.

Wary of the just how solid the recovery might be, the United States’ central bank, the Fed, has launched another round of quantitative easing whose aim is to lower longterm interest rates, boost the stock market and improve consumer confidence. But this new injection of liquidity has led to a fall in the dollar and the revaluation of certain emerging currencies, further complicating a panorama that was already complex and disrupting the second great challenge for next year: the correction of global imbalances. The «currency war» is threatening to turn into an episode of escalating protectionism, which would invariably put paid to the recovery, as might also happen if the extensive balance of payments imbalances continue.

The third great challenge of 2011 will be to push forward with the structural reforms that underpin these two previous challenges and to correctly apply the lessons learned from the crisis. Particularly in the banking system, with the gradual adoption of Basel III, but also in other areas of the economy in order to boost growth potential, improve public sector productivity, remove obstacles to job creation and redirect the
private sector’s heavy borrowing. These reforms will help to restore macroeconomic stability and confidence, thereby ensuring once and for all that we exit the worst recession in decades.


The sovereign debt crisis worsens once again
After a good start to the year, in which recovery seemed to be on the right track, the world economy is taking its leave of the year with a greater risk of a slowdown in growth, although a doubledip recession has been ruled out.

However, all eyes have once again been on the tensions in the euro area’s sovereign debt markets, reappearing after everyone had believed the situation to be under control after the episode before the summer. How economic policy responds will once again be crucial, both in terms of providing another boost to the economy as well as handling the tensions in the government bond market.

The new chapter in the European sovereign debt crisis is being written by Ireland. Unlike the case of Greece, which was caused by serious problems of competitiveness and a lack of transparency in public sector
management, there are fewer doubts concerning the growth potential of the Celtic tiger. Its problem lies in the huge adjustment in its real estate industry and its overlarge banking sector.When the international financial crisis was at its peak, the Irish government promised to guarantee all bank liabilities in order to avoid financial panic in its economy.

But the hole created in its banks by the real estate sector has been larger than expected. In fact, after the summer, the Irish government once again had to inject large amounts of capital into its banking system which made the deficit expected for this year shoot up to no less than 32% of gross domestic product (GDP).

One of the direct consequences has been the closure of wholesale financing markets for the Irish banking system, forcing it to obtain liquidity via the European Central Bank (ECB). Ireland can meet its public debt payments up to mid-2011, but the situation of the Irish banks and the financial effort required to inject
capital on the part of the central government finally convinced the European Union that it was necessary to draw up a bailout plan.

Ultimately, the financial aid offered to Ireland totals 85 billion euros. This is mostly expected to go towards recapitalizing, restructuring and reducing the size of the banking sector.
In exchange, the Irish government has undertaken to apply a draconian adjustment plan that includes cutting 25,000 civil service jobs, big cuts in social expenditure, a drop in pensions and the minimum wage and a rise in value added tax (VAT) to 23% in 2014.

However, the action taken to stabilize the Irish economy has barely eased the tension in the markets. Interest rate spreads for the debt of some of the most exposed countries compared with German debt have widened, there are still fears that one or more countries will go the same way as Greece and Ireland, and it has even not been entirely ruled out that some economies might have to leave the euro. It is to be hoped, however, that the gradual clarification of the economic and financial prospects, as well as the decisions taken by the Eurogroup, will help get markets back to normal, as happened in the episode in the middle of the year.

Portugal is one of the countries under scrutiny due to its slowness in applying adjustment policies, the persistence of its foreign deficit and especially because of the zero progress made in terms of reducing its public deficit. Neither has its domestic political situation helped the most decisive measures to be adopted that
would relieve the high deficit and growing public debt.

Spain has also been affected by tensions in the current European sovereign debt crisis, although the central government’s deficit is falling as planned (down 47% in the first ten months of 2010) and public debt remains below the European average. The risks perceived by the market now lie in the restructuring of its financial
system, the transparency of public accounts in regional governments and the application of structural reforms. The Bank of Spain has therefore announced new measures to increase the information provided by financial institutions regarding real estate exposure. It has also set a target to finalize the mergers of savings banks by the end of the year. For its part, theMinistry of the Treasury has announced new regulations to improve the budget information provided by autonomous communities.Moreover, the Spanish cabinet has approved a calendar of legislative initiatives that, among others, includes pension and collective bargaining reforms
throughout the first quarter of 2011.

In Europe as a whole, the Union’s Finance ministers have reached a draft agreement establishing the broad lines for the new support facility for countries at risk, which will be implemented 2013 when the current European Financial Stability Facility expires. As from the middle of that year, all debt issues by countries in the euro area will include clauses establishing the conditions under which certain aspects can be modified, such as the repayment period, interest rate or even reducing the principal.

Another element that might help to improve market perspectives are the favourable economic results recorded by the euro area. In the third quarter, the growth rate stood at 0.4%, a good figure after the strong growth posted in the second quarter. The driving force behind activity is Germany, with exceptional dynamism that can be seen when we look at, among other indicators, the trend in the IFO index for business activity, which has risen above the maximum reached in 2006. The situation of the different economies that make up the euro area is uneven, with Denmark and Finland at the head, enjoying annual growth of 3.5%-4%, and Greece
and Ireland bringing up the rear, still in recession.

In Spain, year-on-year growth was positive in the third quarter at 0.2%, the first positive rate after seven quarters of falls. However, the third quarter saw GDP stall after a perceptible recovery in the first half of the year. This slowdown can particularly be explained by the effect of the tax hike in July (VAT), the withdrawal of direct aid for buying vehicles and restrictive budgetary measures, such as the cuts in civil service wages. Growth is expected to reappear in the last part of the year and especially throughout 2011, when the recovery is expected to take hold firmly.

In general, in 2011 advanced economies will continue to record sluggish growth while the emerging economies will only slightly lessen the good pace they’ve enjoyed throughout 2010. These differences can also be seen in inflation.

Industrialized countries are therefore very likely to maintain a lax monetary policy, while less developed countries will continue to restrict theirs. The United States’ economy, which has accumulated low production capacity utilization and a moderate inflation rate, is one of the key figures in this disparity.

The third quarter’s figures continue to point towards a modest recovery, with an economy that grew by 0.5% quarteron-quarter, and the latest actions by the Federal Reserve are framed within this complex context. At its meeting on 3 November, the Fed took a far-reaching decision: to extend its bond purchase programme to support the reactivation in growth and sustain price stability while preventing deflation.

The strategy that the institution presided over by Ben Bernanke has decided to follow has supporters and critics. The latter argue that the meagre economic benefit does not offset the high risk of inflation incurred. In this respect, important members of the Fed have countered these criticisms by stating that the institution has the necessary instruments to toughen up monetary conditions without the need to reduce the size of its balance sheet.


Within a scenario where the ECB does not foresee any substantial changes and most liquidity has already been drained off, Euribor interbank rates are unlikely to see any big variation over the coming months. In the medium term, and as the central bank drains of liquidity or clearly indicates that it will start to raise interest
rates, the European interbank rates are likely to rise gently.

For their part, countries such as China, Brazil, South Korea, India and Chile have recorded strong economic growth and a significant upswing in inflationary risk. The response by national central banks has been to raise official interest rates to keep these pressures under control.

Within this complex situation, the main stock markets have performed in a wide range of ways and erratically. In the medium term, the outlook for international mixed equity is still positive, although fluctuations have not been ruled out by analysts.

The greater fall in European stock markets and especially the Spanish stock market has pushed indicators up to attractive levels. Consequently, and in the medium term, as the euro area’s public debt crisis abates, the gap should close between its equity prices those of the United States and the emerging countries, meaning that confidence has been restored and the recent debt crisis has been successfully handled.
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Full report: Market Outlook 2011