Only a week earlier on July 15, US central bank minutes show that Bernanke expects the US economy to stagger along below its average growth rate for up to six years.

The less-than-glowing assessments from the US central bank chief and disappointing economic indicators on the US and global economies are feeding pessimism among investors and have undermined global stock markets of late.

Investors are concerned that the world’s biggest economies – the US, Japan, the eurozone and China – are slowing. And that even if another global recession is avoided, it might feel like one anyway.

While a return to another recession cannot be ruled out, five factors suggest that investors may be too pessimistic about the outlook.

The first is that the global banking system is more stable now because western banks are in better shape. In the US, loss rates on most types of loans seem to be peaking, while bank capital ratios have risen to new highs. In Europe, while some have questioned the worth of the stress tests on banks, the results showed that only seven out of nearly 100 banks have problems. The improved health of western banks and the higher bank earnings should promote the lending that lubricates the economy. Although evidence on credit conditions is mixed, it seems reasonable to say that conditions are at least not worsening any more.

The second factor is that US companies are cash rich. Past US recessions have been associated with weak corporate cashflows, which has forced companies to lay off workers and reduce spending. Today, however, according to the latest quarterly data from Bloomberg, Russell 3000 companies have around US$2.9 trillion in cash and short-term investments, 19% more than a year earlier. Companies have already made significant cost reductions during the recent recession and are reaping some of the benefits of this in higher cash flows. There should, therefore, be less pressure on them to make further cuts that detract from economic growth.

Market fillip

Thirdly, self-correcting markets are changing relative prices in a way that supports economic growth. Oil prices, for example, are around half their peak reached in mid-2008. That helps keep costs under control for businesses and consumers.

Another factor is that emerging economies are humming. Many emerging markets, especially in Asia, are confident enough of the future to have started winding back stimulus measures to ensure that inflation stays under control. China, a key driver of the global economy, is cooling its property markets and allowing greater flexibility in its exchange rate to moderate its export growth and boost domestic demand. India in July raised interest rates for the fourth time since March. Despite such actions, the IMF expects the economies of China and India to expand 10.5% and 9.4% this year, while fellow BRIC member, Brazil, is forecast to expand 7.1%.

Lastly, more stimulus is possible. While many European countries are installing austerity measures to rein in budget deficits, this is not a universal strategy. Many countries retain significant scope, at least on the monetary side, to prod their economies if conditions turn bleak. In his prepared statement to Congress, Bernanke said central bankers “remain prepared” to act if circumstances required. With the US cash rate near zero, policy options in this regard would include the Fed buying more Treasury, federal agency and mortgage-backed debt securities.

While the pessimists could be proved correct, the greater likelihood remains that the global economy is moving to a new phase of slower growth rather than any kind of renewed downturn.

From a technical perspective, it is worth noting that heightened volatility at this stage of the recovery cycle is not unusual. Past crisis periods have quite often been followed by extended periods of choppy consolidation, such as that which occurred in 2004 when markets, after some bouts of gloom, eventually pulled out of the technology bust. Such thoughts might engender some optimism in Bernanke and others.

China’s, India’s and Brazil’s economic growth since the start of 2007 (quarterly, year on year)

DataStream

Financial information comes from Bloomberg unless stated otherwise.

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