Leaders return home from the World Economic Forum’s annual meeting in Davos, Switzerland, having shared views and compared notes, carrying insights from around the world back to their organizations.
One feature of this year’s event was the striking degree of consensus among participants with regard to market and economic outlooks. And the consensus is optimism.
In lunches and panels with CEOs of the world’s leading banks, government finance officials and economists, a recurring theme was that the “nightmare scenarios” have been taken off the table, with European commitment to unity expressed through the LTRO and OMT programs, Chinese growth reestablished and the United States Congress having averting the “fiscal cliff” in an 11th-hour resolution.
Indeed, this optimism seems to be shared by financial markets. For the first time in months, equity mutual funds are seeing net inflows – and at a pace not matched since February 2000. The S&P 500 stock index has seen its biggest January rally since 1997, and stock correlations have broken down dramatically in recent months. (Sovereign-bond spreads have tightened significantly, as have corporate-credit spreads.) But many savvy investors become nervous when they sense growing consensus, and for a relatively silent few, I imagine alarm bells were going off at Davos. One issue is that markets are inherently cyclical and can only accommodate so much of a trend before correcting. But far more dangerous is the prospect of losing sight of the bigger picture.
Indeed, economic news has generally been better in the past months.
There are real signs of a global economic recovery, and one hopes that these trends will gather momentum.
But one must remember the context of continuous and unprecedented monetary and fiscal stimulus. Most of the developed world is still in the throes of a painful deleveraging process. The global economy is far from healthy, and the economic recovery is not guaranteed to be smooth. Interestingly, many participants clearly identified potential land mines that could disrupt the recovery and threaten global asset prices.
Among these were military conflagration in the Persian Gulf and the threat of an energy-supply shock.
Much of the discussion around the Iranian nuclear program in recent years has centered on Israel, but energy markets may actually be the main event here. There is insufficient data to seriously predict price effects from a meaningful supply shock, but the 1973-74 embargo, which sent oil from $3.40 to over $12, a price from which it never returned, should serve as a frightening precedent. It is difficult to imagine current Chinese growth rates holding in the face of an explosive and sustained rise in oil prices.
Another land mine participants discussed is the limits of bond-market patience in the face of near-zero yields and still-deteriorating fiscal conditions across developed economies. A key factor behind the current stimulus has been low interest rates in key economies, enabled by eager bond markets.
As the southern European sovereign crisis of 2011 and 2012 demonstrated, bond markets can riot suddenly, and contagion often follows. The fear of a major economy losing control over short-term interest rates could pose a major threat to economic recovery.
These are just two among many global risks discussed. Of course, the most dangerous land mines are usually the ones you don’t see clearly. This is not an argument for ignoring the case for optimism. It is merely a caution against embracing consensus implicitly. To illustrate the point, many Davos optimists juxtaposed this year’s positive atmosphere with last year’s deeply negative consensus, which also was broadly expressed.
Note that in the 12 months since that foreboding 2012 Davos, equity markets are up over 16 percent.
Tal Keinan, CEO of KCPS and Co., is a Young global Leader of the World Economic forum.