So we enter 2016 with one of the worst performances ever for financial markets. After I would deliver my gloomy prognosis, many clients in 2015 would say to me “yes, but when will the crisis REALLY start?”
What they really meant was when will it affect them? I would reply that it’s like a house on fire, so I guess it depends on which room you are in. I would argue that the crisis started over a year ago although it intensified in the summer. At one point last year, the downstairs kitchen (commodities), washroom (high yield debt), study (EM currencies) and lounge (BRIC economies) were all on fire. Now it would seem that there is more than smoke in the Master bedroom (the US stock market?) where many were sleeping.
Most stocks were down in the S&P500 last year even though the index held up. A third were down by 20% or more. Finally, those stocks that held the market up, the FANGs (Facebook, Amazon, Netflix and Google), all fell at the start of this year. This raises my confidence that other technical sell signals in place since the early summer were correct. The buy back and M&A mania that held up stocks in the US last year might now quickly fade.
But what actually catalysed the most recent move down?
The latest sell off in Chinese shares has generated fear around the world. I really enjoyed a recent interview on one of the financial channels with one astute strategist. The news anchor, not really acquainted with the nuances of global finance and economics, went back to that old Chestnut (and meaningless distraction) “So are we going to have a China Hard Landing then?”
The strategist replied that – whilst half laughing – we have had a stock market hard landing and a commodity hard landing so we might well have an economic hard landing. I think that the economy is much more important that the stock market. which involves a small percentage of the population and is often a casino unrelated to the economy. Although we suggested selling Chinese shares in May 2015, we were cautious on the economy a lot longer than that.
The economic data that came out at the end of last year and early 2016 all continued to show deceleration. In all likelihood, another wave of deflation being unleashed by more depreciation was also a large factor weighing down on markets. There were rumours last week that Beijing wanted to depreciate another 10-15%. Certainly the Governor of the Bank of India seemed quite concerned yet again about beggar thy neighbour policies: “The current non-system is pushing the world toward competitive monetary easing, to no one’s ultimate benefit.” His article is here:
b). US economic data
Despite the Fed raising rates we think that the leading indicators continue to point down. This has been done to actually attempt to create confidence in a similar policy mistake to the Bank of Japan in the Dotcom bust. This chart from the Atlanta Fed encapsulates what we are seeing across all the high frequency data
c). The FederalReserve
We wrote about this last month and you can see our note on the 19th December. In this last week ex Dallas Fed Chief Fisher wrote a note with which we concur:
I spent 10 years (through last March) as a participant in the deliberations of the Federal Open Market Committee, setting monetary policy for the U.S. The purpose of zero interest rates engineered by the FOMC, together with the massive asset purchases of Treasurys and agency securities known as quantitative easing, was to create a wealth effect for the real economy by jump-starting the bond and equity markets.
The impact we had expected for the economy and for the markets was achieved. By February of 2009, the Fed had purchased over $1 trillion in securities. With interest rates throughout the yield curve moving in the direction of eventually resting at the lowest levels in 239 years of history, the stock market reacted: It bottomed in the first week of March of 2009 and then rose dramatically through 2014. The addition of a third round of QE, which had the Fed buying $85 billion per month of securities to ultimately expand its balance sheet to over $4.5 trillion, juiced the markets.
…..If that is a correct assessment, then there may well be a payback period of lesser movement in stock prices to follow. 2015 might have been the beginning of that balancing out: Minus dividends, the S&P and every other index experienced minor negative returns last year. (If you take out four stocks — Google, Amazon, Facebook and Netflix — the Nasdaq Composite finished down 0.3 percent for the year.) It would not be unreasonable to expect subdued returns this year given that stocks are still richly priced by historic standards.” [emphasis added].
He ominously ended his piece with…
“Now we will see who the truly smart investors are and who merely looked smart by having ridden the rising tide engineered by the Fed. As Warren Buffett has often said: “you only learn who has been swimming naked when the tide goes out.”
My guess is that, going forward, the view will be quite revealing.”
I wouldn’t be surprised to see the Fed reverse course and enter some form of QE4 this year
d). Social and geo-political Disorder
According to Andre Blattman, the head of the Swiss Armed Forces, Europe is on the “edge of civil war.” I don’t know whether the translation is good but the English article is here:
What I do know is that with the attacks on women by refugees in Cologne and elsewhere over New Year, Europe has been thrown in to further divison. This has an impact on financial markets as the Eurozone is a political union, not merely an economic union. And to prevent it from breaking up in the future it seems likely that it needs to mutualise the debts and further integrate the banking system. Markets do not like increasing talk of the Schengen breaking down.
In the Middle East the Sunni-Shiite War that has commenced is also influencing markets. And Saudi cannot be in a good state if they have decided to sell off the crown jewels – Saudi Aramco – as has been rumoured in the last week. Furthermore, will Sovereign Wealth Funds around the world be adding to selling pressure in markets as oil approaches $20?
Now countries across Eurasia from the Atlantic to the Pacific, representing 5 billion people, are destabilising and the financial part of the crisis has just hit American shores.
Soros this week said that its like 2008. I have been referring to an emerging GFC2.0 since last year. But let’s face it, GFC1.0 never really ended. Alchemically the financial crisis transmuted the problem into social, geo-political and economic stresses by our Central Bankers, whilst financial assets blissfully rose for many years. My outlook in 2025 is still optimistic for humanity, culminating in a new Enlightenment, but my prognosis for 2016-20 continues to be for abrupt change. As the final part of my recent series of longer term articles will highlight, I expect most markets around the world to have fallen from peak to trough by over 30-60%, rising civil unrest, and major cyber-terrorist events which will afflict even the US. We continue to push through what I have termed the “Great Paradox”.
“It was the best of times,
it was the worst of times,
it was the age of wisdom,
it was the age of foolishness,
it was the epoch of belief,
it was the epoch of incredulity,
it was the season of Light,
it was the season of Darkness,
it was the spring of hope,
it was the winter of despair,
we had everything before us,
we had nothing before us,
we were all going direct to Heaven,
we were all going direct the other way”
Charles Dickens, “A Tale of Two Cities” published: 1859.
Don’t have an account? Sign up