Pensions Conference 2011. Review of Plenary 1: Our economic future - what next?

We weathered the storm… or did we?

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David Smith began with a review of the financial crisis, and events in global markets since 2008. He reminded us that it had been the worst recession since World War II; that world trade had fallen faster than at the onset of the Great Depression of the 1930s; and was accompanied by unprecedented levels of private sector debt.  The majority of this was inter-bank lending.

One result was a “nasty fiscal hangover” for George Osborne. This point was accompanied by a photo of him with a suitably pained expression.  Projections show that it will take over 20 years for public sector debt to fall back to the “magic” level of 40% of GDP.

The recovery is characterised by a shift in market power from developed to emerging economies.  Before the crisis, China was predicted to overtake Japan’s GDP in 2015, and America’s in the mid-2030s.  By 2010, China’s GDP was already larger than Japan’s, and it is now predicted to overtake America’s in the 2020s.

Although there are signs of “green shoots”, plenty of challenges remain. High rates of inflation are preventing the consumer leading the way to recovery. High commodity prices are causing problems worldwide.  The natural disasters in Japan have had an impact on manufacturing growth, and political and financial crises in Europe and the Middle East are a source of continuing uncertainty.

Dr Wadhwani started his talk by explaining that he is a pension scheme trustee, and by talking about the challenges that his trustee board have been facing, particularly when trying to decide on their optimal investment strategy. He started by picking up on the theme of high inflation, and the uncertainty that this leads to. However, some commentators also see deflation as a risk, and it appears that this is seen as the greater unknown: the Bank of England and the Federal Reserve have brought inflation rates under control in the past – although in the UK it took from 1974 to the mid-1990s for this to be achieved – but no-one really knows how to react in the face of deflation.

The most interesting part of Dr Wadhwani’s talk was when he looked at the relative prices of bonds and equities.  Using a fairly broad-brush model based on long-term averages for indicators such as equity risk premium and dividend growth, he presented a table showing that equities appeared to be significantly undervalued relative to bonds. He broke this down into its various components and presented compelling evidence that the market is out of balance.  Or has the world changed fundamentally?

The part of the talk which impressed me most was Dr Wadhwani’s fears about Europe, and the wide-spread and long-lasting effects should Greece leave the Eurozone. In his view, this would have an enormous impact in global markets, not just the Eurozone, and would seriously impair the ability of markets to continue their bounce back post-recession.

So it was an interesting first plenary – setting the scene for the workshops and discussions which followed, but not in a particularly upbeat way!