Last night’s ferocious rally shows that the bulls, far from throwing in the towel, are rearing to go and happy to grab any excuse to stage a rally.

The bulls rediscovered their characteristic exuberance, as signs of a surprise pick-up gave them a welcome respite from recent unremittingly bleak figures on the US economy. Once again, there were grounds for hope that the economic future may be less grim than the bears were warning.

Overnight also saw the release of the latest report by Jim O’Neill, the global chief economist for Goldman Sachs, who provides the most convincing argument for the bullish cause.

In his report, entitled ‘The world is down, but far from out’, O’Neill doesn’t even bother to deny the dire state of the US economy.

“The breadth of data disappointments in recent weeks has been striking. It is difficult to avoid concluding that the ending of fiscal stimulus and the period of inventory accumulation has left the economy struggling to grow, faced with the burden of an excessive personal sector and government debt. The sharp rise in weekly jobless claims and the slowdown in the manufacturing sector are perhaps the most worrisome of all the data points.”

What’s more, he concedes, “these are not the only weak areas: the recent data on the housing market was especially disappointing. These developments suggest to us that, as we forecast, the US is set for many quarters of below-trend GDP growth, persistent unemployment and a strangely new disappointing environment for the US.”

So far, O’Neill would have little argument with the bears. Still, he doesn’t believe a double-dip recession is the most likely outcome. “We would estimate the probability of a fresh recession in the US at around 25 per cent-30 per cent”.

This is where O’Neill parts company with the more negative members of the economic fraternity. He argues that just because the US economy is struggling, that doesn’t mean that it will drag the rest of the world down with it.

“Although much of the past 30 years or more has been characterised by US-led global growth, primarily as a result of the strength of the US consumer, the world has to adjust to a new environment.” This, he says, is starting to happen with the growing importance of consumers in the BRICs (Brazil, Russia, India and China) and other emerging countries.

As a result, he says, “investors need to realise that US financial conditions are more important for the rest of the world than the US economy itself.”

O’Neill argues that looking back at what happened in the dark days of 2008/9, particularly after the collapse of the US investment bank Lehman Brothers, it is important to distinguish between the US recession, and US financial conditions.

“It is probably the case that the world economy was unable to insulate itself from the US domestic challenges because of the severe tightening of financial conditions,” he says.

The big difference this time is that US financial conditions have not tightened in recent months, despite growing evidence that the US economy is once again slowing.

“Indeed, as a result of the aggressive policies of the Federal Reserve, conditions have remained very easy. In order for our more positive underlying views of the world to bear fruit, it is important that this situation persists.”

O’Neill says that, historically, a 1 percentage point move in Goldman’s US financial conditions index generally leads to a 0.6 per cent move in the rest of the world’s GDP.

“In this regard, the US policy response to the US economy’s ongoing sub-trend performance is more important than the US economy itself.”

Indeed for this optimist, the flagging US economic activity increases the likelihood that the US central bank will loosen monetary policy even further.

“If the economy performs as we forecast, we would expect fresh steps from the Federal Reserve to ease financial conditions.”

O’Neill is still tipping robust global growth rates, despite the dismal US economic outlook. He expects real GDP growth of 4.8 per cent for the world this year, and 4.6 per cent for 2011. As he notes, this means that his predictions for global growth rates next year are higher than those from most other economists, even though he’s more pessimistic about the US outlook

“We remain in the ‘decoupling’ camp, in so far as we believe that strong growth can persist in other parts of the world despite persistent sluggishness in the US. This is still largely due to our views on China.

He says the Chinese economy lost momentum in recent months, but that this slowdown was the direct result of Beijing’s deliberate moves to tighten financial conditions to cool an overheating economy.

“Now that the economy has slowed and inflation has eased, policy would appear to have achieved its broad aims – for now. As a result, we think policy tightening is behind us and financial conditions should start to improve.” Indeed, he says Chinese financial conditions appear to have eased since early July.

As a result, O’Neill is predicting “renewed strength in Chinese GDP growth in 2011, led by domestic demand. We forecast 10 per cent real GDP growth next year, after 10.1 per cent in 2010.”

But China isn’t the only large emerging economy that’s continuing to perform well. O’Neill, who was responsible for coining the acronym BRIC back in 2001, argues that ballooning consumer spending from other developing economies will buoy global growth rates.

“As can be observed from consumer data in a number of countries – as well as increasingly from the sales and earnings evidence of many multinational companies – consumer demand appears to be quite robust in many of these countries.”

O’Neill disputes the view of most financial analysts who believe that growing demand from the BRICs is not enough to offset US weakness.

“From what we can estimate, the current US dollar value of consumption in the BRIC economies is around $US4 trillion, with China accounting for less than half of that, at approximately $1.8 trillion.

“Sceptical observers are right to point out that this is very modest compared with the $US10.5 trillion size of the US consumer. But what is not appreciated is the pace of growth of the BRIC consumer.

“According to the weighted average of the USD value of their current consumption, these countries are witnessing growth of around $US600 billion in additional purchases. Maintained at the current rate of approximately 15 per cent, this would accelerate to more than $US1 trillion per year by the middle of the decade.” If this pattern continued, by the end of the decade, BRIC consumption would be on a par with US consumption.

O’Neill points out that there could well be further near-term weakness in US share markets due to worries over the US-led slowdown, but he discounts the argument that we’re now heading towards a new bear market.

“If we are right about the likely persistence of the BRIC consumer and that markets do not appreciate their importance, then at some stage a renewed, probably powerful, rally in global equity and risk asset markets will commence,” he predicts.

This story originally appeared in Business Spectator.