The global financial elite don’t want to be fooled again.
Scarred by the worst banking crisis since the Great Depression (INDU) and the hubris that preceded it, bankers, investors and policy makers who gathered in Davos, Switzerland, last week gave a guarded welcome to signs of recovery in the world economy and the endurance of the euro region.
“Optimism, but with a sober tone,” was how Bank of America Corp. (BAC:US) Chief Executive Officer Brian T. Moynihan characterized the mood pervading the World Economic Forum’s annual meeting, even as investors were lifting the Standard & Poor’s 500 Index above 1,500 for the first time since 2007.
The sentiment in Davos was “totally different” when stocks last reached that peak, said Harvard University economics professor Kenneth Rogoff, 59. This year, executives from Deutsche Bank AG (DBK) and Goldman Sachs Group Inc. were quick to couple upbeat assessments with warnings that economies remain fragile and prone to policy error. Some bankers fretted that credit bubbles may be forming as central banks pump out cash.
“The crisis gave them a bit of an inoculation psychologically because they can see what can go wrong,” Rogoff, a former International Monetary Fund chief economist, said after a Jan. 26 private session with IMF Managing Director Christine Lagarde and Deutsche Bank co-Chief Executive Officer Anshu Jain. “They’re not as euphoric as they’d usually be when the stock market went up as much as it has.”
Such humility was rare in Davos on the eve of the credit crisis that engulfed markets in 2008. The year before, John Thain, then CEO of NYSE Group Inc., said “the financial markets, the world economies are all actually in quite good shape.” Josef Ackermann, Deutsche Bank’s CEO at the time, said investment banks “have a very good future.”
Burnt by the subsequent collapse of Lehman Brothers Holdings Inc., more than $1 trillion in bank losses, the stigma of taxpayer-funded bailouts and a worldwide recession, leaders of the largest banks displayed little bravado in the Swiss resort this year, even as markets cheered improving economic growth in the U.S. and China and reflected an ebbing risk that a euro-member country might abandon the currency.
The MSCI World Index of stocks has climbed 5 percent this year and is up 13 percent from a year ago. During the week of the Davos conference, U.S. stocks capped the longest stretch of daily gains since 2004, as companies delivered better-than-estimated corporate earnings, claims for jobless benefits fell to a five-year low and the index of American leading indicators rose the most in three months.
In China, economic growth accelerated for the first time in two years, the National Bureau of Statistics said in Beijing on Jan. 18. Government efforts to stoke demand drove a rebound in industrial output, retail sales and the housing market.
And in Europe, investors have become less anxious about the euro region’s most-troubled members. The extra yield investors demand to hold Spanish 10-year bonds over German bunds has narrowed to 354 basis points, or 3.54 percentage points, from a euro-era record of 638 basis points in July. Greece’s benchmark ASE stock index has surged 73 percent in the same period.
“We’ve chewed through a lot of the problems and I would say my investing self tells me that the worst is over,” said Goldman Sachs CEO Lloyd C. Blankfein, 58. Still, “this wouldn’t be the first time that I’ve suggested the worst was over only to find out that there was a bit of a relapse.”
The S&P 500 climbed 5.4 percent this year through Jan. 25, after an equal increase for the same period in 2012 and a 2.3 percent advance in 2011. The benchmark ended last year with a 13 percent gain and was little changed for 2011.
“Everyone has experienced some positive Januarys that haven’t carried on through the rest of the year,” said Lael Brainard, the U.S. Treasury Department’s undersecretary for international affairs.
UBS AG (UBSN) Chairman Axel Weber said investors need to be prepared for a “bumpy” ride. “Whilst the underlying trend is better, there is still a lot of volatility in the market and it’s not going to be a straight-line recovery,” Weber, 55, told Bloomberg Television in Davos. “It’s going to be bumpy, and therefore investors need to be prepared for that push-back, for the mood in the market to turn.”
A recurring theme in corridor conversations at the conference was that markets were buoyed by monetary easing, which has pushed down interest rates and spurred investors to take more risk in search of returns. Market gains could prove fleeting once central bank policy reverses, attendees said.
One hedge-fund manager at the conference said Colombia’s Jan. 22 sale of 10-year bonds at a yield of 2.72 percent, or 0.88 percentage point above Treasuries, indicated to him that investors may be overlooking risks. He declined to be identified because he wasn’t authorized to comment publicly.
Yields on dollar-denominated junk bonds dropped to an unprecedented 6.46 percent on Jan. 22, and the Spanish government attracted record demand for a sale of 10-year bonds.
“The world has been over-reliant on central bankers, they are the new superheroes,” said Deutsche Bank’s Jain, 50. “Governments and business leaders need to pick up the slack” after central banks created an “artificial glut of plenty.”
Bank of Canada Governor Mark Carney, who will take over the Bank of England in July, rebutted suggestions that monetary policy is “maxed out.” There’s still room for stimulus in the richest nations, and central bankers should be aiming to propel their economies into “escape velocity,” he said.
Billionaire Ray Dalio, whose Bridgewater Associates LP is the world’s largest hedge fund with $130 billion under management, said low interest rates will trigger a shift of capital into riskier assets. That will make 2013 a “game changer” for the economy, said Dalio, 63.
Bank of America’s Moynihan, 53, said any policy reversal by central bankers that caused a rapid rise in interest rates could rattle markets.
“If rates move too fast, it will cause shocks in the system,” he told Bloomberg Television’s Erik Schatzker in Davos. “I’m not sure it’s a high probability, but we worry about it.”
Lauded for a bond-buying plan that has insulated his 17-nation economy, European Central Bank President Mario Draghi, 65, said “the jury is still out” on the recession-hit European economy. Swedish Finance Minister Anders Borg said politicians and the public must now bring crisis-level urgency to long-term challenges like labor market reform.
Political gridlock in the U.S. was another challenge identified by delegates including Barry Eichengreen, an economist at the University of California at Berkeley. A clash over how to tackle the debt ceiling could be enough to hurt the dollar’s safe-haven status, he said.
Elsewhere, the economies of Japan and the U.K. are shrinking while the IMF last week cut its estimate for global growth this year to 3.5 percent from 3.6 percent.
“There’s still a lot of muted areas around the world, there’s no one running a victory lap just yet,” said Morgan Stanley (MS:US) CEO James Gorman, 54.
The euro area, Japan and the U.K. are all contracting, said Bank of Israel Governor Stanley Fischer.
“That means you better not make mistakes,” said Fischer, 69. “Relative to a year ago, we should feel much better. Should we think we are out of the woods? No.”
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