Not all swans are black...

David Bowers of Absolute Strategy Research wrote the following sober-minded article, appearing in the Financial Times, in which he reminds investors not to ignore potentially good news amidst all the negativity:

Three years ago we lived in a world that thought it had tamed macroeconomic volatility through independent central banks and inflation targeting. ‘Black Swans’ - low probability but high impact events – were thought to have been eliminated by sophisticated risk management and securitisation. Investors and companies were lulled into thinking that ‘All Swans were White’. With the benefit of hindsight we now know that nothing was further from the truth. In retrospect, the biggest mistake during the Great Moderation was to imagine that the business cycle was dead – rather than simply in suspended animation.

Three years on and we find ourselves in a world where ‘Black Swans’ are everywhere. Investors and corporates alike live in constant fear of low-probability, high-impact events. They have hunkered down in defensive mode and now wait for their competitors to make mistakes. Global multinationals continue to cut costs as though there is no tomorrow.

However, with apologies to the philosopher Karl Popper, the sighting of just one White Swan should disprove the thesis that ALL Swans are now Black. And wouldn’t it be ironic if that ‘White Swan’ turned out to be the rediscovery that the business cycle was not dead? Indeed, the biggest macro shock for many investors may not be another downturn - the ‘double-dip’ that dominates today’s Conventional Wisdom - but rather a strong cyclical recovery spurred on by the massive fiscal and monetary stimulus.

Investors are now convinced that a whole flock of macro “Black Swans” are set to undermine markets in 2010 and beyond. For many, the fears relate to private sector deleveraging, and are focused on anaemic consumer spending, persistent high unemployment and weak housing markets. For some, it is the lack of bank lending to small and medium sized companies that prevents a pick-up in investment and sustained economic recovery. Or that the counterpart to rising private sector surpluses is ballooning public sector deficits that will become increasingly difficult to finance. For others, it is the withdrawal of quantitative easing and the prospect of rising rates that are certain to undermine any recovery.

The reality, however, is that US household consumption is not in freefall. Indeed, personal consumption is currently two per cent above its December 2008 low, and as a share of GDP currently stands close to its all-time high. But what has been unprecedented is the corporate response: massive cutbacks in capital spending, inventories and employment. In short, last year’s US recession was due much more to a rise in the corporate rather than the household saving rate.

The big question now is whether companies have cut back too much. Has corporate spending been pared back too aggressively for the current levels of household spending? Could the corporate sector be more surprised by the resilience of the current level of demand than by a ‘double dip’?

If companies rehire workers that were fired last year, rebuild inventories that had been run down to their lowest operational level, and re-authorise capital spending abandoned at the height of the credit crunch this would come as a shock for the ‘Black Swan’ bevy. It would help lower unemployment and so underpin consumer confidence, bring down loan charge-off rates and help restore the credit multiplier of the banking system, as well as raise nominal GDP growth to a level that would have a major positive impact on the budget deficit.

The emergence of a corporate-led recovery could have some radical implications for investment strategy. For a start, it would shake fixed-income investors out of their complacency, particularly at the front end of the curve. It would also accelerate the transition already underway in equity markets away from last year’s liquidity-driven regime towards a greater focus on equity fundamentals, such as earnings growth, together with the possibility of a major pickup in M&A as corporates restructure their businesses.

If the corporate sector stops running itself for cash and starts investing ‘for tomorrow’, then it is still possible that this ‘Ugly Duckling’ of a recovery could yet turn into a beautiful ‘White Swan’. It is time that we reminded ourselves that not all Swans are Black.