You might be surprised at my reticence to believe in a sustainable improvement in the economic situation when every day the media seem to be presenting us with encouraging economic statistics. So here is a brief summary of my reasons:

- First of all, in many cases, the signs of recovery that investors seem to be detecting are nothing more than a stabilisation of certain indicators that had previously fallen to their lowest level for several decades. Such a stabilisation is not particularly surprising. The decline in economic activity after the Lehman collapse was so extreme that a slowdown in the deceleration rate was logical.

- Then, following the same line of thinking, the indicators that point to an economic upturn are indicators related to production. The shock caused by the elimination of Lehman Brothers led a whole host of companies to virtually cease production. That led to a situation in which production was unable to satisfy demand, notwithstanding how weak that demand was. In recent months, production has had to play catch-up, which has given rise to the famous 'green shoots' concept. And it is these green shoots of economic recovery that have fuelled the stock market rallies, with the rallies themselves then being seen as proof that the economic and financial crisis was behind us.

- And lastly, the stabilisation of the economic situation has only been achieved on the back of a massive increase in public expenditure. In the United States, the 'cash-for-clunkers' car scrappage scheme has influenced a raft of economic indicators. The improvement in these indicators has subsequently been taken as a sign that recession is over. This programme has been such a success that it has now been extended to domestic appliances. This could well sustain growth in the second half. But the question will still be whether this improvement in economic activity can prove sustainable. I continue to think that given the fundamentals of the US consumer, it will be difficult for the US economy to maintain a growth dynamic when the contribution of the current public stimulus programmes comes to an end. Especially as these programmes have borne the hallmark of a willingness to perpetuate a growth model based on increasing consumer spending. They have thus not only deferred the necessary adjustment of the financial situation of American households, but have, on the contrary, aggravated this situation by inciting the US consumer to take on more debt to buy a new car (or a house now that the Federal Housing Administration is providing new mortgages with a down payment of only 3.5%). At the same time, these programmes have led to a ballooning of the budget deficit and public debt without laying the bases for an increase in the US economy’s medium to long-term growth potential. The United States is therefore increasingly faced with a dilemma: reduce the budget deficit by cutting public expenditure and/or increasing taxes, which would risk plunging the economy back into recession, or not cutting public expenditure which would lead to a debt level that becomes increasingly difficult to finance.

 

It is entirely possible that in the second half of this year, figures will show positive growth (experts in the United States are suggesting growth of nearly 4% in the third quarter). However, the first question will be to see how this recovery could prove sustainable in a context where the traditional components of growth – household consumption and corporate investment – remain weak. In the longer term, a second question will relate to the consequences of the budgetary and monetary policies currently being conducted and the incapacity of governments to attack the real causes of the economic and financial crisis.

With a rise of over 50% in six months, the stock markets have clearly anticipated the economic recovery. To justify a further increase, we will need tangible proof of this recovery before long. As for the "good" company results that the market seems to be so enthusiastic about, they are:

1. relative (in other words they are good compared to expectations that had been lowered considerably), and

2. the fruit of extremely good cost control. But a strategy of cost control has its limits and sooner or later, companies tend to find they have to boost their sales in order to improve their results. This will only happen if the economic context improves. Meanwhile, the US market is trading at 130 times reported earnings and at 25 times operating profits (which exclude exceptional expenses) of the last twelve months.

 

Adopting a defensive strategy does not mean completely abandoning equities, especially since money market investments, with remuneration close to zero, hardly offer an attractive alternative (although low interest rates are not a sufficient reason to invest in equities). But stock selection will become more important than ever. Companies to focus on should meet the following criteria:

1. superior quality – low debt level, high cash flow from operations, low fixed costs;

2. low sensitivity to economic growth;

3. appropriate transparency.

 

Contrary to what one might think, this type of company has considerably under-performed in the rally of recent months, with investors favouring companies of lesser quality that are more leveraged to an economic recovery.

In a deflationary environment, the search for regular income should also constitute a priority for investors with dividends thus remaining a key investment theme.