Week ahead Sunday January 10th 2016
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Alastair Winter
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Mon, 11 Jan 2016 00:31:15 +0800
Alastair Winter is Daniel Stewart’s Chief Economist. His weekly comprehensive ‘Economic Insights’ publication, uniquely covers global market sentiment, politics and macroeconomics. Unsubscribe from this email
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Week ahead Sunday January 10th 2016 Headlines · First week hangover: don’t blame it all on China · Coming up: more slowdown evidence · L’Europe en danger! Et ses femmes! · Brexit is hard to do · Markets: sauve qui peut! Every stock for itself!
First Week Hangover 2016 has got off to what can only be described as a rather poor start but I am sticking to my headline last week that we may well all be ‘doomed but just not yet’. China is currently getting most of the blame but, in fact, the real causes are problems carried over from last year: · The slowdown in growth is global and not only the fault of China’s manufacturing slump. · The central bank with most clout remains the US Fed even if others are more deluded. · China has almost nothing to do with the Syrian crisis threatening Europe. · All markets have become fragile and exposed to stampedes Alas, the hangover follows what was not even that much of a party. Much of 2015 went by with the Fed’s signalling its desire to remove the proverbial punchbowl and finally doing so just as Santa was expected with his proverbial rally. So, it should really be no surprise that things look grim right now and, unfortunately, there appears to be no equivalent to PG Woodhouse’s ‘Jeeves famous hangover cure’. Hangovers are wretched but they do eventually fade and I remain convinced the major stock markets will end 2016 not so far away from where they started, albeit they are more likely to take a few nasty tumbles on the way and from which not all may recover fully by next December. Having said that, last week’s rout in https://mail.zoho.com/mail/print.do?&m=2843005000007655001&iss=0
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equity markets included the worst ever start to the New Year in the US and has given new material to the soothsayers who routinely come out with such bonmots as ‘Santa Rallies’ and ‘Selling in May’. The latest sooth is ‘as the year starts, so it proceeds’ and this may well prolong the hangover for the more nervous. Why not take a look at Chart 1 and judge for yourself? Chart 1 S & P 500 in 2016?: Pick a number between ‐40% and +30%
Source: Pension Partners via Financial Orbit
Coming up: more slowdown evidence Two charts from last week highlight the current challenges to the global economy and provide a framwork for assessing data to be published in the coming weeks. Chart 2 from Caixin/Markit came out on Wednesday showing China’s Manufacturing, Services and the combined Composite PMIs for December. These surveys are widely regarded to be as close to being independent as any data from China.The shock was that the Services PMI had for the first time ever fallen below the 50 level that delineates expansion and contraction.Taken to extremes, which inevitably it was (especially by the new archetype gung‐ho investor, Mrs Wong), this could mean that the whole Chinese economy was contracting in December. So, forget the official GDP growth rate of 7% and the switch to Consumption! It is going to become increasingly difficult for the authorities to massage the next batches of data and so this week we can expect further softening in both Exports and Imports. Later in the month Retail Sales and Industrial Production in December may also be reported as softer but the authorities will probably try to tough it out with reporting 7% GDP growth in 2015 as a whole. Chart 2 Caixin China Output PMI: Services pooping the Party
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In contrast, at first sight the December US Labor Market numbers seemed very encouraging when they first came out on Friday: 292K new hires in the month, previous months revised higher, another nudge higher in the Participation Rate and also in Average Hourly Earnings. However, the doomsters have since been busy deconstructing the data. Chart 3 tells a similar story to the UK in so far as almost all recent new hires are in the Services sector, where many jobs are lower paid, unskilled and less productive. Indeed, average hourly earnings did not increase month on month from November. Perhaps even more worrying is that of the 292K incease in the December Non‐Farm Payrolls 281K represent an annual adjustment because of the Festive Season that may or may not be accurate. This week Industrial Production is almost certain to be soft again but there may be some cheer in Retail Sales, which are due for a good month after struggling over the last few months. In other words, whether the US is even close to growing at 2% per annum depends almost entirely on shopping. Chart 3 US cumulative new jobs by sector: some better than others?
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Here in the UK, Industrial Production may actually be better as the ONS seems to report good and bad numbers in alternate months but the year on year headline for Manufacturing Output is still set to show a deterioration. Also due for an uplift are British Retail Consortium sales in December (shopping again!). The MPC meets this week but the only question is whether Ian McCafferty will fall back in line with his colleagues and vote to hold Base Rates (probably not). The most interesting announcement will be the NIESR’s rolling 3monthly GDP estimate (not a forecast) which will cover Q4. The previous two rolling estimates came out at +0.6% which suggests an estimate for Q4 of no worse than +0.5%, which sets up a potential clash with the ONS’s first cut when it is published later this month. Chancellor Osborne will have to put up with the latter’s numbers but will not welcome any further downward revisions for previous quarters. His downbeat ‘poisonous cocktail’ speech last week, however, should be seen as a political rather than economic warning. Protocol prevents his giving hints to the MPC but Tory MPs need a wakeup call on Brexit risk and, of course, he must ensure that he gets none of the blame if his upbeat message of only one month ago turns out too optimistic. It should always be remembered that Mr Osborne is usually (but not always!) at least two moves ahead of everyone else.
Meanwhile in the EZ, mixed data suggests that although its economy is no longer getting worse significant recovery remains elusive. This week, with Italy and Spain taking centre stage, should add to this picture following last week’s Unemployment (slightly better), CPI (under pressure again), Industrial Production (stalling) and PMIs (slightly better).
L’Europe en danger! Et ses femmes! One thing that can be said for the EZ elite is that they take holidays very seriously. Sadly, there has been no avoiding the shocking accounts of muggings and sexual assaults in parts of Germany but who would guess that all the major problems are still festering. Greece is not and, to be fair, probably cannot, comply with the bailout conditions, Italy and France are trying to neutralise the Stability and Growth Pact, Germany is still trying to block the Single Bank Resolution, Portugal and Spain are without stable governments, Denmark wants no more integration, there is a NorthSouth dispute over gas pipelines from Russia, the Bundesbank is trying to subvert the ECB’s monetary policies und zo weiter. The Brexit negotiation must be a minor irritant by comparison. However, there is no doubt the Syria crisis represents the greatest threat to Europe and it has already undermined the Schengen agreement on free movement and returned high wire fences to Eastern frontiers. Migration generally brings direct economic benefits to all concerned: more jobs, more public spending but tax receipts taking over from initial social benefit outlays but this time the problem is so many migrants’ arriving at once. This point is made in a most civilised way in the following extract from an article by Klaus https://mail.zoho.com/mail/print.do?&m=2843005000007655001&iss=0
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Brinkbäumer, Editor in Chief of DER SPIEGE: No migrant leaves his or her home casually, frivolously or even with any kind of pleasure at all. It is a farreaching decision and all who pull up roots know it, even those who are still in their formative years. The migrants who come to us merit empathy and what choice do those people have who come from wartorn Syria? What would we do in their situation? There is proof for everything for almost every thesis as well as for its antithesis. Regions that have integrated many migrants in the past are prosperous today, but integration only works if the state doesn't lose control, and Germany at present has lost control. Of course there is a basic human right to asylum, but without an upper limit enforced, if necessary, with border controls it will be almost impossible to find a way out of the crisis. The political and social disruption is only just beginning and it is hard to be optimistic. Much is being made of the rise of extremist political parties but I would suggest that the most sinister longterm threat is to the status of women unless ‘multiculturism’ is made more sympathetic to them. Chart 4 Brexit voting intentions
Source: YouGov via The Times
Brexit is hard to do Full disclosure: both my head and heart are in favour of the UK staying in the EU. Heart is easy to explain as my father was an immigrant, my wife and I between us have family and friends in 8 other EU countries and I spend up to 2 months every year in Italy and France. Head (from an economic stance) is slightly more difficult if the postBrexit outcome is merely a ‘Swiss/Norway plus’ deal in a freetrade zone although I boggle at the logic of still being bound to most European Treaties without being able to participate in future decisions. The extreme solution of joining some sort of ‘AngloSaxon’ Englishspeaking trade group (specifically with multiracial https://mail.zoho.com/mail/print.do?&m=2843005000007655001&iss=0
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US, Canada, Australia and New Zealand) seems even more illogical as well as politically fanciful and economically reckless. At least our European partners value our trade! Nevertheless, it may well be that fear of migrants from Syria, Somalia, Afghanistan and Pakistan rather than Europe itself will tilt the balance in favour of Brexit, which would ironic in a number of ways, not least because we would need to increase trade with many such countries. Chart 4 from pollsters YouGov shows referendum voting intentions to be very finely balanced with a narrow split between both men and women. The party political differences are as one might expect, which means people in London, the North and Scotland want to stay while those in the English shires want to leave. There is a more fundamental polarisation between those educated to ‘A’ Level and above (stay in) and those below (out) and also those aged under 30 (stay in) and over 50 (out). There is less polarisation by social class: AB and CI would prefer to stay while C2 DE want to leave. As with most referenda the onus will be on those who want a change and xenophobia as opposed to lofty superiority traditionally does not go down well in the UK. A subplot may well develop in which it becomes a matter of confidence in David Cameron personally, which should stay the hand of many Tory Eurosceptics. I would like to think the pointlessness of Brexit might swing the balance.
Markets: Sauve qui peut. Every stock for itself OK, let’s get China and last week’s 10% belly flop out the way first. Foreigners are still not allowed to get much involved directly via the domestic stock exchanges and most are too smart to want to. With major shareholders subject to restrictive lockin regulations, the wild swings are all about ‘Mrs Wong’ and the authorities clearly do not know what to do about her, given the absolute priority of keeping the Communist Party in power. The international repercussions are to undermine confidence in global growth and corporate earnings while the clumsy devaluation of the renminbi is more of an issue for China’s trading partners amongst the Developing Economies. It is all very unsettling but investors will just have to get used to it while Mr Xi decides how much he wants to ‘embrace the markets’ as The Economist mischievously put it back in July or, as now seems more likely, prop them up! Chart 5: Xi ha!
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Some Emerging Markets are easier to get into than others but none look attractive right now and this highlights the problem of investing in broad asset classes and geographical markets. Where to get a positive return is proving increasingly hazardous for Japanese investors who are inclined to repatriate when risk is in the air but the resulting boost to the yen is counterproductive, especially for exports to China and other Developing Economies. European equities were fashionable last year but neither exports nor domestic demand are growing fast enough to encourage hopes for much further progress, albeit earnings multiples are still relatively modest compared to the US. In the UK the FTSE 100 looks a rather unhappy cocktail of beatenup overseas resources companies and UK standard bearers in sectors facing margin squeezes and/or enforced structural change. The FTSE 250 has so far proved to be a more solid representative of UK plc and the wider economy but even it failed to escape last week’s selloff. Chart 6: M & A to the rescue?
Source: Bloomberg Inevitably, one has to look to the US for investment ideas but even this is not clearcut. Valuations are historically very high especially when considering the prospects for future growth. After two soild years earnings of S & P 500 companies probably fell by at least 4% in 2015 and the outlook is still not encouraging. Share buybacks no longer look so attractive to corporate executives nor does holding on to their stock options. There may be a silver lining in the form of M & A deals although even these may involve significant equity swap elements. It is only once one starts digging deeper that slightly more hopeful signs appear. If one strips out the energy and materials sectors, average corporate earnings turn positive with Consumer Dicretionary, Healthcare and IT topping the bill. This is yet another reason not to invest only in assetclasses and market indices. Even better is to seek out individual companies that have a new story to tell and/or are temporarily off many investors’ radar screen. These stocks should be able to move independently of the general market or their sector but also be sufficiently liquid to enable short term trades. This approach is applicable elsewhere but the US and the UK offer the most accessible opportunities. This ‘stockpicking plus’ strategy is the principle on which we recently launced our DANTrade equity product. Of course, there will always be great companies to buy and hold for the longterm but that too is becoming increasingly subjectiveand risky! in the current skittish markets. Meanwhile some investors will continue, when all else fails, to rely on the Fed to bail us all out. Plus ça change ……. Chart 7 When you wish upon a star…….
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From jittery 2015 into even more unsettling 2016 Headlines on Sunday January 3rd 2016 · We are all doomed but maybe just not yet · Bear in a China shop · Global growth: shop or drop · Central banks: classic fail · Markets: best not to start from here · Pound pounded
We are all doomed but maybe just not yet One thing that can be said about 2015 is that it was a year of abundant forecasts. Most of them wrong, of course, and often published by people talking their own book. Chart 1 from Dent Research nicely captures the increasing polarisation between the shrill doomsters (bottom right) and the determined optimists, who as the good news runs out, are having to shuffle from top left to top right. For the record, I am wobbling just below top right but still reluctant to go much lower. There certainly are big problems being carried over into 2016 as I highlighted in Economic Insights last month and also at our Private Client Forum on December 1st. My main concern dating back to 2014 and intensifying ever since remains the financial markets themselves. It is really rather scary to realise that most traders and investors have never experienced economic and market conditions such as those currently prevailing. Understanding and managing risk has never seemed https://mail.zoho.com/mail/print.do?&m=2843005000007655001&iss=0
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more important. A cyclical downturn or even secular stagnation ought to be navigable but not if market participants panic. So, while there is as ever a need to ‘keep calm’ it would be wise not to ‘carry on’ as usual! Chart 1 The Human Model of Forecasting
Source: Dent Research
Bear in a China shop While the arguments rage about the truthfulness of official China data it is worth remembering that the country has been fuelling global growth for much of the last 25 years, especially in the last seven when it ‘heroically’ sought to make up for recession in the decadent West. China has become the largest or second largest trading partner for most of Asia, North and South America and Africa but now both imports and exports are falling. As one might expect from a centralised one‐party state, fear of losing power takes precedence over not just publishing inaccurate data but also prudently managing the economy itself. It could, of course, be argued that the task is almot impossible anyway with a population of almost 1.4bn spread unevenly over 3.7m square miles. For the last two years the government has been trumpeting a switch in emphasis from manufacturing, infrastructure investment and exports to consumption but more recently seems to have lost its nerve and reverted to type.The trouble is that so much of the new investment may well be unproductive as well as funded by debt and a rigged stock market. No doubt loss‐making debt‐laden state‐owned enterprises will be propped up but the government is going to have choose soon between continuing to open up the economy to market forces or battening down the hatches. Either choice will slow growth further for China and the rest of the world. Given the shamelessness of China’s leaders, we can expect throught 2016 a lot of pious waffle for international consumption and increased domestic control freakery (e.g. prominent financiers and business leaders ‘helping the authorities with their enquiries’). Chart 2 China matters
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Source: Boston Consultancy Group via visualcapital.com
Shop or drop So, while China is sorting itself out, where will global growth come from and in what form? A sudden revival in trade can be ruled out just because of China while government spending remains constrained indefinitely almost everywhere. More Business Investment would be most welcome but it depends on growth in profits and confidence and both seem at best flat in most major economies. The spotlight has, therefore, to fall on consumption. We are doing our bit in the UK but apart from Spain retail sales in Europe are somewhat patchy and dire again in Japan. This means that US consumers have to step up and at first sight Chart 3 suggests they are. However, the headline numbers have been made ‘real’ by being adjusted for inflation (not much of that recently!) and further analysis suggests that 18% over ten years is not very exciting , even allowing for a 3% drop after the Great Financial Crisis. Over the last five years it works out at only about 2% per annum allowing for compounding and it has been wobbling a bit of late. No surprise, therefore that US GDP has been struggling to get much above 2% over the same period, including 2015. Chart 3: can consumers continue to save the day?
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Source: St Louis Fed The trouble is that if consumers are to spend more they will have to borrow more too, which they may well not feel either inclined (because of low inflation on the prices of stuff) to do or, indeed sufficiently confident of their future financial position. Moreover, the banks may spoil the party through reluctance to lend because of past excesses (notably in Europe) or lending too much imprudently (in China and the US) and then repenting suddenly (as Hyman Minsky warned in the 1970’s and 1980’s). I have mentioned before the work of Professor Steve Keen on the correlation between debt and economic growth and what consumers do next is the key economic question for 2016. There may be a big boost from lower oil prices but consumers in the richer economies are increasingly worrying over healthcare and age care, which are two of the areas where inflation is picking up. Investors should worry too!
Central Banks: Classic fail Monetary policy is not really supposed to be understood by the likes of you dear readers, and me. It requires mysterious constructs such as Dynamic Stochastic General Equilibrium and mathematical models which are so logical that economic data often requires adjusting to make the models ‘work’. The great spanner in the works is something called the ‘Liquidity Trap’, which is when businesses become reluctant to invest and consumers to spend. The ‘classical’ avoidance solution is to make everyone feel good by slashing interest rates and printing money via Quantitative easing, which also should entice investors into taking bigger risks through switching out of cash, government bonds and mortgage‐backed securities. All this extra money being splashed about is supposed to reduce its value vs. goods and services: i.e. it generates inflation, which in moderation, helps to stimulate growth. Less publicised motives for QE are to bail‐out improvident banks and to devalue the national currency. True‐believers amongst central bankers argue that the lower official interest rates and the larger the QE programme the better. It is just a case of doing it for long enough and all will be well. Unfortunately, the models appear not be working any more, even if they may have at first: · Many companies have taken advantage of lower interest rates not to borrow for investment but to fund share buy‐ backs. · Most consumers, especially those with middle and lower incomes, have yet to be convinced that they should stop worrying about their jobs and their old age (see above) · Investors have been as likely to invest in foreign equities and bonds, commodities and currencies as backing domestic companies, creating large hot money flows. https://mail.zoho.com/mail/print.do?&m=2843005000007655001&iss=0
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· Competitive currency devaluations have become more common. It is proving very difficult to start tightening again either through ending new QE asset purchases or raising interest rates as financial markets have reacted unfavourably in each of 2013, 2014 and 2015. Traders and investors have become addicted to a powerful cocktail of low rates and large QE programmes. Somewhat theoretical studies at the Atlanta Fed have calculated ‘shadow’ Fed Funds rates to be as low as the equivalent of ‐3% (vs. the official target range of 0.00‐0.25%) in May 2014 by which time the FOMC had taken fright and started the taper that it had delayed in the previous year. Chart 4: Economic model not working, so change the facts?
Chart 4 (blue line) shows that after 7 years of zero interest rates and QE programmes totalling $4.5tn that the FOMC’s preferred measure of inflation remains close to zero after falling below the target 2% level in 2012. A quick tour of other major economies reveals headline CPI levels at similar levels, except (sigh) in China where it is currently at 1.5%, despite several years of Producer Price deflation. In my house this record wold be greeted with the lugubrious cry of ‘classic fail’. Two points need to be made here. First, the headline PCE and CPI numbers include energy and food prices, which when stripped out leave so‐called ‘core’ numbers that are considerably higher (green line on Chart 4). Naturally, the central banks now place greater emphasis on the latter even though the politicians have yet to take the hint and change the inflation mandates. Second, even the headline numbers are likely to increase sharply over the next few months as the first major slump in oil prices drop out of the calculation, which the central bankers are likely to gloss over while patting themselves on the bank. At this stage it seems almost churlish to mention Minsky’s theory that economies are inherently unstable and periods of apparent equilibrium are always temporary. So, I won’t! What next from central bankers? The FOMC continues to have a credibility problem despite, or because of, months of hand‐wringing over the first rate hike. Having at last proclaimed the return of economic normality, Dr Yellen et al would be damned if they faltered on the gradual tightening that they have themselves predicted. On the other hand, they will be damned if they do carry on hiking when there is no fundamental economic justification and markets are sending out alarm signals. There seems to be an unofficial truce that the FOMC will solemnly forecast three or four rate hikes in 2016 while markets will price in only one or two. Chart 5 from Bloomberg highlights how the damage inflicted by a 1% increase in interest rates has risen throughout the great bond bull market to $3tn on some $45tn investment grade issues (tracked by the BofA Merrill Global Broad Market Index). The doomsters are convinced that, faced with the threat of a market rout and a new recession. the FOMC will reverse last month’s hike and even launch QE4 this year. For now,however, it does https://mail.zoho.com/mail/print.do?&m=2843005000007655001&iss=0
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appear that the market’s expectation of one or two hikes is about right. Speculation will resume as soon as this week in the build up to Friday’s release of the December Labor Market numbers but these are unlikely to be conclusive. Chart 5 Don’t do it, Janet!
Here in the UK, the MPC is subject to gentle ridicule because despite its protests to the contrary its decisions on interest rates seem beholden to the FOMC’s. If there is any substance to this it is because the UK and US economies are experiencing similar rates of growth and inflation. It should be noted that the MPC stopped its QE programme as long ago as 2012 and has since been much more willing to debate its efficacy. Moreover, apart from some curious recent kite‐flying by Chief Economist Andy Haldane, the Bank has resisted any moves towards zero or negative official rates. Having said that, the MPC will not not want to tighten faster than the FOMC and may not raise rates at all in 2016 or merely stop at one symbolic hike. In Asia, the PBoC will have to do as it is told by the party leadership and further loosening can be expected. The bond market is growing rapidly but is not yet large enough to justify a QE programme similar to those elsewhere. There should, however, be large‐scale direct bail‐outs of state‐owned banks and other enterprises and the private sector, especially in the shadow banking sector where retail savings are at risk, is also likely to benefit from PBoC largesse. The policy of a weaker exchange rate will continue but not so aggressively as to jeopardise its growing international status. Government pressure on the Bank of Japan is much subtler than in China but it seems its QE programme will carry on indefinitely while inflation remains minimal and the yen does not weaken. The hunt for assets that the BoJ can buy has been quaintly extended to include ETFs that do not yet exist. All in all, more classic fails ahead! The Super Mario image took a major hit last month when Mr Draghi ran into some stiff opposition to further substantial easing from a hard core of ‘Nothern Europeans’ and bond yields and the euro surged higher as a result. He may yet get a reprieve if the FOMC really does hike aggressively and, of course, he has since been quick to put a new spin on his ‘whatever it takes’ line. As in the US, European businesses are reluctant to invest and consumers to spend but excessive private debt is not the main reason while even those who are looking to borrow are still finding many banks rationing their lending as they cover up their nonperforming loans. QE in Europe is a bit like the proverbial pushing on a string. In the most recent Financial Times survey of European economists I was in both the minority camps on pessimistic economic prospects for 2016 (1.3% max GDP growth) and on further ECB loosening (more but limited rate cuts and an indefinite time extension of asset purchases). The most active European borrowers are, of course, governments (mainly but not only Southern) who are relieved to benefit not only from extremely low rates but also a buyer of first and last resort in the ECB. Chart 6 shows just how much of EZ sovereign debt has https://mail.zoho.com/mail/print.do?&m=2843005000007655001&iss=0
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negative yields and there is a knockon effect on maturities all the way out to 30 years. It is likely that the Italian and French governments, both facing important elections in 2017, are already relying on ECB funding while all the Germans can do is try to cap it. This is a conveyor belt that nobody can afford to get off without wrecking the market for EZ sovereign bonds or, indeed, threatening the Monetary Union itself. Ironically, this could provide the glue for Europe at a time when everyone is quarrelling over everything else. Luciano Pavarotti once described his spectacular singing to me as ‘ I takk beeg reesks’ and the same can surely be said of Mr Draghi and his song for Europe. Chart 6: Draghi the Great Redeemer?
Markets: best not to start from here Equities 2015 was a poor year for US equity indices with the big tech stocks managing to keep the Nasdaq Composite in the black. Considering the herd instinct amongst many market participants there were surprisingly short periods of volatility apart from the liquidity crisis that began on August 24 th and ended with a surging rally in October and a much milder unease in December as to whether a Santa Rally would materialise (it did not). It would, however, have been worse but for continuing flows of share buybacks and mega M & A deals (totalling $4.6tn in 2015 with 137 over $5bn). With corporate earnings falling away share buybacks could soon lose their appeal and some corporate executives may be tempted to cash in some of their share options but lack of organic growth should keep the M & A pot boiling. With the shadow of FOMC rate hikes looming it will require a lot of unexpected good news to push prices higher or perhaps some oldfashioned incurable Wall Street optimism. We can be sure that traders are well aware that prices typically bounce back after a flat year or worse (see Chart 7). Having said that, trading in indices or even individual stocks purely on the basis of market momentum looks as bad an idea for 2016 as it was in 2015. Chart 7: one for the bulls!
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Via @pdacosta Elsewhere, the penny seems to have dropped finally that the FTSE 100 is being pulled down by its resources sector rather constituent companies operating mainly in the UK itself and the outlook, therefore, remains bleak. In contrast the FTSE 250 performed relatively well in 2015 and should hold up again this year. The domestic Chinese markets have been exposed as rigged by the government in Beijing, which is also steadily trying to erode Hong Kong’s independence in most areas including its stock market. Other Emerging Markets have been having a tough time thanks to China’s slowdown and the FOMC’s rumblings and despite brave contrarian talk no relief is in prospect. The Nikkei has had a bumpy ride, making all its gains in October and November before ending the year on a downbeat and despite all the brave talk of a Japanese revival it is hard to look further than the USD/JPY exchange rate, which seems as unpredictable as ever. EZ equity markets also fared better than most on the back of weaker exchange rates and duly suffered in December when massive euro shorts were closed in response to the ECB’s nonevent. In fact, Chart 8 points to a high inverse correlation between the value of the euro and EZ equities over the last ten years. Within the EZ, somewhat surprising is the contrast between the struggling IBEX stock market while the Spanish economy is recovering briskly and the Milan MIB ending as the top performing major market of 2015 while the Italian economy continues to do very little. A weaker euro remains, therefore, the best bet for EZ equities rather than the economy kicking on further Reluctantly, one has to conclude that none of the major equity markets will start 2016 looking especially attractive as a whole and the best prospects look once again to be individual stocks. Chart 8: Spot the correlation: Euro Trade Weighted Index (TWI) vs. European Equities (MSCI)
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Source: Interfirma Bonds The US Treasury and gilt markets may be relaxed if not disdainful of future FOMC and MPC moves but there can be little doubt that the current miserable yields are very likely to go up over the life of most current paper in issue: i.e. maturing in more than 34 years’ time. This means potential capital losses. EZ sovereign bonds are even more vulnerable unless Mr Draghi is happy to stay on his current conveyor belt of QE purchases. EZ bank bond (AT1) holders currently enjoying higher yields face the different risk of being converted into equity if ECB stress tests and/or default looms. In the US there was an unseemly rush of ‘covenantlite’ new issues in 2015 in anticipation of FOMC tightening, accompanied by both a rise in defaults and surging yields for low –rated paper. Investors seem likely to be more selective in 2016 even if basic credit analysis has hitherto passed them by. Interestingly, there is reported to be a shortage of sterlingdenominated corporate bonds. Watch this space! Chart 9: higher bond yields healthy or worrying
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Commodities It all seems rather straightforward: there is a glut of just about everything now that China has put on the brakes. The only way to get prices moving up again is for producing countries to cut back but few seem to feel they can afford to do so. Oil, of course, is a more complicated story but prices will remain pressure as long as Russia and Iran are slogging it out with Saudi Arabia and it is in the US interest to keep these bad guys fighting even as Europeans are desperate for them to stop. Meanwhile, another year has passed with gold bugs failing to advance their case for holding it in times of low as well as high inflation. At least my friend @Smaulgld has persuaded me that bullion is the safest way to invest. Chart 9: all China’s fault?
Currencies Although already a crowded trade, it is hard to see the euro’s avoiding new pressure again if, as seems likely that the ECB keeps printing money through to 2017 and beyond. This should help reverse some of its December postECB gains and it should also add to the pressure on the pound. A combination of a softer euro, no interest rate hikes in sight, widening current account and trade deficits and Brexit angst should keep sterling weak even if the dollar does not strengthen much more. Cable has been traded lower relentlessly since the summer and Chart 10 shows a trend that many will wish to befriend to test $1.45 at the very least. Pound pounded! Chart 10: GBP/USD Spot the trend?
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Re twe e t
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Print | Close window From
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Alastair Winter
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Economic Insights
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Mon, 11 Jan 2016 00:31:15 +0800
Alastair Winter is Daniel Stewart’s Chief Economist. His weekly comprehensive ‘Economic Insights’ publication, uniquely covers global market sentiment, politics and macroeconomics. Unsubscribe from this email
Follow Economic Insights on Twitter @AlastairWinter 'Incrementum inveniendum est'
Week ahead Sunday January 10th 2016 Headlines · First week hangover: don’t blame it all on China · Coming up: more slowdown evidence · L’Europe en danger! Et ses femmes! · Brexit is hard to do · Markets: sauve qui peut! Every stock for itself!
First Week Hangover 2016 has got off to what can only be described as a rather poor start but I am sticking to my headline last week that we may well all be ‘doomed but just not yet’. China is currently getting most of the blame but, in fact, the real causes are problems carried over from last year: · The slowdown in growth is global and not only the fault of China’s manufacturing slump. · The central bank with most clout remains the US Fed even if others are more deluded. · China has almost nothing to do with the Syrian crisis threatening Europe. · All markets have become fragile and exposed to stampedes Alas, the hangover follows what was not even that much of a party. Much of 2015 went by with the Fed’s signalling its desire to remove the proverbial punchbowl and finally doing so just as Santa was expected with his proverbial rally. So, it should really be no surprise that things look grim right now and, unfortunately, there appears to be no equivalent to PG Woodhouse’s ‘Jeeves famous hangover cure’. Hangovers are wretched but they do eventually fade and I remain convinced the major stock markets will end 2016 not so far away from where they started, albeit they are more likely to take a few nasty tumbles on the way and from which not all may recover fully by next December. Having said that, last week’s rout in https://mail.zoho.com/mail/print.do?&m=2843005000007655001&iss=0
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equity markets included the worst ever start to the New Year in the US and has given new material to the soothsayers who routinely come out with such bonmots as ‘Santa Rallies’ and ‘Selling in May’. The latest sooth is ‘as the year starts, so it proceeds’ and this may well prolong the hangover for the more nervous. Why not take a look at Chart 1 and judge for yourself? Chart 1 S & P 500 in 2016?: Pick a number between ‐40% and +30%
Source: Pension Partners via Financial Orbit
Coming up: more slowdown evidence Two charts from last week highlight the current challenges to the global economy and provide a framwork for assessing data to be published in the coming weeks. Chart 2 from Caixin/Markit came out on Wednesday showing China’s Manufacturing, Services and the combined Composite PMIs for December. These surveys are widely regarded to be as close to being independent as any data from China.The shock was that the Services PMI had for the first time ever fallen below the 50 level that delineates expansion and contraction.Taken to extremes, which inevitably it was (especially by the new archetype gung‐ho investor, Mrs Wong), this could mean that the whole Chinese economy was contracting in December. So, forget the official GDP growth rate of 7% and the switch to Consumption! It is going to become increasingly difficult for the authorities to massage the next batches of data and so this week we can expect further softening in both Exports and Imports. Later in the month Retail Sales and Industrial Production in December may also be reported as softer but the authorities will probably try to tough it out with reporting 7% GDP growth in 2015 as a whole. Chart 2 Caixin China Output PMI: Services pooping the Party
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In contrast, at first sight the December US Labor Market numbers seemed very encouraging when they first came out on Friday: 292K new hires in the month, previous months revised higher, another nudge higher in the Participation Rate and also in Average Hourly Earnings. However, the doomsters have since been busy deconstructing the data. Chart 3 tells a similar story to the UK in so far as almost all recent new hires are in the Services sector, where many jobs are lower paid, unskilled and less productive. Indeed, average hourly earnings did not increase month on month from November. Perhaps even more worrying is that of the 292K incease in the December Non‐Farm Payrolls 281K represent an annual adjustment because of the Festive Season that may or may not be accurate. This week Industrial Production is almost certain to be soft again but there may be some cheer in Retail Sales, which are due for a good month after struggling over the last few months. In other words, whether the US is even close to growing at 2% per annum depends almost entirely on shopping. Chart 3 US cumulative new jobs by sector: some better than others?
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Here in the UK, Industrial Production may actually be better as the ONS seems to report good and bad numbers in alternate months but the year on year headline for Manufacturing Output is still set to show a deterioration. Also due for an uplift are British Retail Consortium sales in December (shopping again!). The MPC meets this week but the only question is whether Ian McCafferty will fall back in line with his colleagues and vote to hold Base Rates (probably not). The most interesting announcement will be the NIESR’s rolling 3monthly GDP estimate (not a forecast) which will cover Q4. The previous two rolling estimates came out at +0.6% which suggests an estimate for Q4 of no worse than +0.5%, which sets up a potential clash with the ONS’s first cut when it is published later this month. Chancellor Osborne will have to put up with the latter’s numbers but will not welcome any further downward revisions for previous quarters. His downbeat ‘poisonous cocktail’ speech last week, however, should be seen as a political rather than economic warning. Protocol prevents his giving hints to the MPC but Tory MPs need a wakeup call on Brexit risk and, of course, he must ensure that he gets none of the blame if his upbeat message of only one month ago turns out too optimistic. It should always be remembered that Mr Osborne is usually (but not always!) at least two moves ahead of everyone else.
Meanwhile in the EZ, mixed data suggests that although its economy is no longer getting worse significant recovery remains elusive. This week, with Italy and Spain taking centre stage, should add to this picture following last week’s Unemployment (slightly better), CPI (under pressure again), Industrial Production (stalling) and PMIs (slightly better).
L’Europe en danger! Et ses femmes! One thing that can be said for the EZ elite is that they take holidays very seriously. Sadly, there has been no avoiding the shocking accounts of muggings and sexual assaults in parts of Germany but who would guess that all the major problems are still festering. Greece is not and, to be fair, probably cannot, comply with the bailout conditions, Italy and France are trying to neutralise the Stability and Growth Pact, Germany is still trying to block the Single Bank Resolution, Portugal and Spain are without stable governments, Denmark wants no more integration, there is a NorthSouth dispute over gas pipelines from Russia, the Bundesbank is trying to subvert the ECB’s monetary policies und zo weiter. The Brexit negotiation must be a minor irritant by comparison. However, there is no doubt the Syria crisis represents the greatest threat to Europe and it has already undermined the Schengen agreement on free movement and returned high wire fences to Eastern frontiers. Migration generally brings direct economic benefits to all concerned: more jobs, more public spending but tax receipts taking over from initial social benefit outlays but this time the problem is so many migrants’ arriving at once. This point is made in a most civilised way in the following extract from an article by Klaus https://mail.zoho.com/mail/print.do?&m=2843005000007655001&iss=0
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Brinkbäumer, Editor in Chief of DER SPIEGE: No migrant leaves his or her home casually, frivolously or even with any kind of pleasure at all. It is a farreaching decision and all who pull up roots know it, even those who are still in their formative years. The migrants who come to us merit empathy and what choice do those people have who come from wartorn Syria? What would we do in their situation? There is proof for everything for almost every thesis as well as for its antithesis. Regions that have integrated many migrants in the past are prosperous today, but integration only works if the state doesn't lose control, and Germany at present has lost control. Of course there is a basic human right to asylum, but without an upper limit enforced, if necessary, with border controls it will be almost impossible to find a way out of the crisis. The political and social disruption is only just beginning and it is hard to be optimistic. Much is being made of the rise of extremist political parties but I would suggest that the most sinister longterm threat is to the status of women unless ‘multiculturism’ is made more sympathetic to them. Chart 4 Brexit voting intentions
Source: YouGov via The Times
Brexit is hard to do Full disclosure: both my head and heart are in favour of the UK staying in the EU. Heart is easy to explain as my father was an immigrant, my wife and I between us have family and friends in 8 other EU countries and I spend up to 2 months every year in Italy and France. Head (from an economic stance) is slightly more difficult if the postBrexit outcome is merely a ‘Swiss/Norway plus’ deal in a freetrade zone although I boggle at the logic of still being bound to most European Treaties without being able to participate in future decisions. The extreme solution of joining some sort of ‘AngloSaxon’ Englishspeaking trade group (specifically with multiracial https://mail.zoho.com/mail/print.do?&m=2843005000007655001&iss=0
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US, Canada, Australia and New Zealand) seems even more illogical as well as politically fanciful and economically reckless. At least our European partners value our trade! Nevertheless, it may well be that fear of migrants from Syria, Somalia, Afghanistan and Pakistan rather than Europe itself will tilt the balance in favour of Brexit, which would ironic in a number of ways, not least because we would need to increase trade with many such countries. Chart 4 from pollsters YouGov shows referendum voting intentions to be very finely balanced with a narrow split between both men and women. The party political differences are as one might expect, which means people in London, the North and Scotland want to stay while those in the English shires want to leave. There is a more fundamental polarisation between those educated to ‘A’ Level and above (stay in) and those below (out) and also those aged under 30 (stay in) and over 50 (out). There is less polarisation by social class: AB and CI would prefer to stay while C2 DE want to leave. As with most referenda the onus will be on those who want a change and xenophobia as opposed to lofty superiority traditionally does not go down well in the UK. A subplot may well develop in which it becomes a matter of confidence in David Cameron personally, which should stay the hand of many Tory Eurosceptics. I would like to think the pointlessness of Brexit might swing the balance.
Markets: Sauve qui peut. Every stock for itself OK, let’s get China and last week’s 10% belly flop out the way first. Foreigners are still not allowed to get much involved directly via the domestic stock exchanges and most are too smart to want to. With major shareholders subject to restrictive lockin regulations, the wild swings are all about ‘Mrs Wong’ and the authorities clearly do not know what to do about her, given the absolute priority of keeping the Communist Party in power. The international repercussions are to undermine confidence in global growth and corporate earnings while the clumsy devaluation of the renminbi is more of an issue for China’s trading partners amongst the Developing Economies. It is all very unsettling but investors will just have to get used to it while Mr Xi decides how much he wants to ‘embrace the markets’ as The Economist mischievously put it back in July or, as now seems more likely, prop them up! Chart 5: Xi ha!
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Some Emerging Markets are easier to get into than others but none look attractive right now and this highlights the problem of investing in broad asset classes and geographical markets. Where to get a positive return is proving increasingly hazardous for Japanese investors who are inclined to repatriate when risk is in the air but the resulting boost to the yen is counterproductive, especially for exports to China and other Developing Economies. European equities were fashionable last year but neither exports nor domestic demand are growing fast enough to encourage hopes for much further progress, albeit earnings multiples are still relatively modest compared to the US. In the UK the FTSE 100 looks a rather unhappy cocktail of beatenup overseas resources companies and UK standard bearers in sectors facing margin squeezes and/or enforced structural change. The FTSE 250 has so far proved to be a more solid representative of UK plc and the wider economy but even it failed to escape last week’s selloff. Chart 6: M & A to the rescue?
Source: Bloomberg Inevitably, one has to look to the US for investment ideas but even this is not clearcut. Valuations are historically very high especially when considering the prospects for future growth. After two soild years earnings of S & P 500 companies probably fell by at least 4% in 2015 and the outlook is still not encouraging. Share buybacks no longer look so attractive to corporate executives nor does holding on to their stock options. There may be a silver lining in the form of M & A deals although even these may involve significant equity swap elements. It is only once one starts digging deeper that slightly more hopeful signs appear. If one strips out the energy and materials sectors, average corporate earnings turn positive with Consumer Dicretionary, Healthcare and IT topping the bill. This is yet another reason not to invest only in assetclasses and market indices. Even better is to seek out individual companies that have a new story to tell and/or are temporarily off many investors’ radar screen. These stocks should be able to move independently of the general market or their sector but also be sufficiently liquid to enable short term trades. This approach is applicable elsewhere but the US and the UK offer the most accessible opportunities. This ‘stockpicking plus’ strategy is the principle on which we recently launced our DANTrade equity product. Of course, there will always be great companies to buy and hold for the longterm but that too is becoming increasingly subjectiveand risky! in the current skittish markets. Meanwhile some investors will continue, when all else fails, to rely on the Fed to bail us all out. Plus ça change ……. Chart 7 When you wish upon a star…….
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From jittery 2015 into even more unsettling 2016 Headlines on Sunday January 3rd 2016 · We are all doomed but maybe just not yet · Bear in a China shop · Global growth: shop or drop · Central banks: classic fail · Markets: best not to start from here · Pound pounded
We are all doomed but maybe just not yet One thing that can be said about 2015 is that it was a year of abundant forecasts. Most of them wrong, of course, and often published by people talking their own book. Chart 1 from Dent Research nicely captures the increasing polarisation between the shrill doomsters (bottom right) and the determined optimists, who as the good news runs out, are having to shuffle from top left to top right. For the record, I am wobbling just below top right but still reluctant to go much lower. There certainly are big problems being carried over into 2016 as I highlighted in Economic Insights last month and also at our Private Client Forum on December 1st. My main concern dating back to 2014 and intensifying ever since remains the financial markets themselves. It is really rather scary to realise that most traders and investors have never experienced economic and market conditions such as those currently prevailing. Understanding and managing risk has never seemed https://mail.zoho.com/mail/print.do?&m=2843005000007655001&iss=0
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more important. A cyclical downturn or even secular stagnation ought to be navigable but not if market participants panic. So, while there is as ever a need to ‘keep calm’ it would be wise not to ‘carry on’ as usual! Chart 1 The Human Model of Forecasting
Source: Dent Research
Bear in a China shop While the arguments rage about the truthfulness of official China data it is worth remembering that the country has been fuelling global growth for much of the last 25 years, especially in the last seven when it ‘heroically’ sought to make up for recession in the decadent West. China has become the largest or second largest trading partner for most of Asia, North and South America and Africa but now both imports and exports are falling. As one might expect from a centralised one‐party state, fear of losing power takes precedence over not just publishing inaccurate data but also prudently managing the economy itself. It could, of course, be argued that the task is almot impossible anyway with a population of almost 1.4bn spread unevenly over 3.7m square miles. For the last two years the government has been trumpeting a switch in emphasis from manufacturing, infrastructure investment and exports to consumption but more recently seems to have lost its nerve and reverted to type.The trouble is that so much of the new investment may well be unproductive as well as funded by debt and a rigged stock market. No doubt loss‐making debt‐laden state‐owned enterprises will be propped up but the government is going to have choose soon between continuing to open up the economy to market forces or battening down the hatches. Either choice will slow growth further for China and the rest of the world. Given the shamelessness of China’s leaders, we can expect throught 2016 a lot of pious waffle for international consumption and increased domestic control freakery (e.g. prominent financiers and business leaders ‘helping the authorities with their enquiries’). Chart 2 China matters
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Source: Boston Consultancy Group via visualcapital.com
Shop or drop So, while China is sorting itself out, where will global growth come from and in what form? A sudden revival in trade can be ruled out just because of China while government spending remains constrained indefinitely almost everywhere. More Business Investment would be most welcome but it depends on growth in profits and confidence and both seem at best flat in most major economies. The spotlight has, therefore, to fall on consumption. We are doing our bit in the UK but apart from Spain retail sales in Europe are somewhat patchy and dire again in Japan. This means that US consumers have to step up and at first sight Chart 3 suggests they are. However, the headline numbers have been made ‘real’ by being adjusted for inflation (not much of that recently!) and further analysis suggests that 18% over ten years is not very exciting , even allowing for a 3% drop after the Great Financial Crisis. Over the last five years it works out at only about 2% per annum allowing for compounding and it has been wobbling a bit of late. No surprise, therefore that US GDP has been struggling to get much above 2% over the same period, including 2015. Chart 3: can consumers continue to save the day?
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Source: St Louis Fed The trouble is that if consumers are to spend more they will have to borrow more too, which they may well not feel either inclined (because of low inflation on the prices of stuff) to do or, indeed sufficiently confident of their future financial position. Moreover, the banks may spoil the party through reluctance to lend because of past excesses (notably in Europe) or lending too much imprudently (in China and the US) and then repenting suddenly (as Hyman Minsky warned in the 1970’s and 1980’s). I have mentioned before the work of Professor Steve Keen on the correlation between debt and economic growth and what consumers do next is the key economic question for 2016. There may be a big boost from lower oil prices but consumers in the richer economies are increasingly worrying over healthcare and age care, which are two of the areas where inflation is picking up. Investors should worry too!
Central Banks: Classic fail Monetary policy is not really supposed to be understood by the likes of you dear readers, and me. It requires mysterious constructs such as Dynamic Stochastic General Equilibrium and mathematical models which are so logical that economic data often requires adjusting to make the models ‘work’. The great spanner in the works is something called the ‘Liquidity Trap’, which is when businesses become reluctant to invest and consumers to spend. The ‘classical’ avoidance solution is to make everyone feel good by slashing interest rates and printing money via Quantitative easing, which also should entice investors into taking bigger risks through switching out of cash, government bonds and mortgage‐backed securities. All this extra money being splashed about is supposed to reduce its value vs. goods and services: i.e. it generates inflation, which in moderation, helps to stimulate growth. Less publicised motives for QE are to bail‐out improvident banks and to devalue the national currency. True‐believers amongst central bankers argue that the lower official interest rates and the larger the QE programme the better. It is just a case of doing it for long enough and all will be well. Unfortunately, the models appear not be working any more, even if they may have at first: · Many companies have taken advantage of lower interest rates not to borrow for investment but to fund share buy‐ backs. · Most consumers, especially those with middle and lower incomes, have yet to be convinced that they should stop worrying about their jobs and their old age (see above) · Investors have been as likely to invest in foreign equities and bonds, commodities and currencies as backing domestic companies, creating large hot money flows. https://mail.zoho.com/mail/print.do?&m=2843005000007655001&iss=0
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· Competitive currency devaluations have become more common. It is proving very difficult to start tightening again either through ending new QE asset purchases or raising interest rates as financial markets have reacted unfavourably in each of 2013, 2014 and 2015. Traders and investors have become addicted to a powerful cocktail of low rates and large QE programmes. Somewhat theoretical studies at the Atlanta Fed have calculated ‘shadow’ Fed Funds rates to be as low as the equivalent of ‐3% (vs. the official target range of 0.00‐0.25%) in May 2014 by which time the FOMC had taken fright and started the taper that it had delayed in the previous year. Chart 4: Economic model not working, so change the facts?
Chart 4 (blue line) shows that after 7 years of zero interest rates and QE programmes totalling $4.5tn that the FOMC’s preferred measure of inflation remains close to zero after falling below the target 2% level in 2012. A quick tour of other major economies reveals headline CPI levels at similar levels, except (sigh) in China where it is currently at 1.5%, despite several years of Producer Price deflation. In my house this record wold be greeted with the lugubrious cry of ‘classic fail’. Two points need to be made here. First, the headline PCE and CPI numbers include energy and food prices, which when stripped out leave so‐called ‘core’ numbers that are considerably higher (green line on Chart 4). Naturally, the central banks now place greater emphasis on the latter even though the politicians have yet to take the hint and change the inflation mandates. Second, even the headline numbers are likely to increase sharply over the next few months as the first major slump in oil prices drop out of the calculation, which the central bankers are likely to gloss over while patting themselves on the bank. At this stage it seems almost churlish to mention Minsky’s theory that economies are inherently unstable and periods of apparent equilibrium are always temporary. So, I won’t! What next from central bankers? The FOMC continues to have a credibility problem despite, or because of, months of hand‐wringing over the first rate hike. Having at last proclaimed the return of economic normality, Dr Yellen et al would be damned if they faltered on the gradual tightening that they have themselves predicted. On the other hand, they will be damned if they do carry on hiking when there is no fundamental economic justification and markets are sending out alarm signals. There seems to be an unofficial truce that the FOMC will solemnly forecast three or four rate hikes in 2016 while markets will price in only one or two. Chart 5 from Bloomberg highlights how the damage inflicted by a 1% increase in interest rates has risen throughout the great bond bull market to $3tn on some $45tn investment grade issues (tracked by the BofA Merrill Global Broad Market Index). The doomsters are convinced that, faced with the threat of a market rout and a new recession. the FOMC will reverse last month’s hike and even launch QE4 this year. For now,however, it does https://mail.zoho.com/mail/print.do?&m=2843005000007655001&iss=0
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appear that the market’s expectation of one or two hikes is about right. Speculation will resume as soon as this week in the build up to Friday’s release of the December Labor Market numbers but these are unlikely to be conclusive. Chart 5 Don’t do it, Janet!
Here in the UK, the MPC is subject to gentle ridicule because despite its protests to the contrary its decisions on interest rates seem beholden to the FOMC’s. If there is any substance to this it is because the UK and US economies are experiencing similar rates of growth and inflation. It should be noted that the MPC stopped its QE programme as long ago as 2012 and has since been much more willing to debate its efficacy. Moreover, apart from some curious recent kite‐flying by Chief Economist Andy Haldane, the Bank has resisted any moves towards zero or negative official rates. Having said that, the MPC will not not want to tighten faster than the FOMC and may not raise rates at all in 2016 or merely stop at one symbolic hike. In Asia, the PBoC will have to do as it is told by the party leadership and further loosening can be expected. The bond market is growing rapidly but is not yet large enough to justify a QE programme similar to those elsewhere. There should, however, be large‐scale direct bail‐outs of state‐owned banks and other enterprises and the private sector, especially in the shadow banking sector where retail savings are at risk, is also likely to benefit from PBoC largesse. The policy of a weaker exchange rate will continue but not so aggressively as to jeopardise its growing international status. Government pressure on the Bank of Japan is much subtler than in China but it seems its QE programme will carry on indefinitely while inflation remains minimal and the yen does not weaken. The hunt for assets that the BoJ can buy has been quaintly extended to include ETFs that do not yet exist. All in all, more classic fails ahead! The Super Mario image took a major hit last month when Mr Draghi ran into some stiff opposition to further substantial easing from a hard core of ‘Nothern Europeans’ and bond yields and the euro surged higher as a result. He may yet get a reprieve if the FOMC really does hike aggressively and, of course, he has since been quick to put a new spin on his ‘whatever it takes’ line. As in the US, European businesses are reluctant to invest and consumers to spend but excessive private debt is not the main reason while even those who are looking to borrow are still finding many banks rationing their lending as they cover up their nonperforming loans. QE in Europe is a bit like the proverbial pushing on a string. In the most recent Financial Times survey of European economists I was in both the minority camps on pessimistic economic prospects for 2016 (1.3% max GDP growth) and on further ECB loosening (more but limited rate cuts and an indefinite time extension of asset purchases). The most active European borrowers are, of course, governments (mainly but not only Southern) who are relieved to benefit not only from extremely low rates but also a buyer of first and last resort in the ECB. Chart 6 shows just how much of EZ sovereign debt has https://mail.zoho.com/mail/print.do?&m=2843005000007655001&iss=0
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negative yields and there is a knockon effect on maturities all the way out to 30 years. It is likely that the Italian and French governments, both facing important elections in 2017, are already relying on ECB funding while all the Germans can do is try to cap it. This is a conveyor belt that nobody can afford to get off without wrecking the market for EZ sovereign bonds or, indeed, threatening the Monetary Union itself. Ironically, this could provide the glue for Europe at a time when everyone is quarrelling over everything else. Luciano Pavarotti once described his spectacular singing to me as ‘ I takk beeg reesks’ and the same can surely be said of Mr Draghi and his song for Europe. Chart 6: Draghi the Great Redeemer?
Markets: best not to start from here Equities 2015 was a poor year for US equity indices with the big tech stocks managing to keep the Nasdaq Composite in the black. Considering the herd instinct amongst many market participants there were surprisingly short periods of volatility apart from the liquidity crisis that began on August 24 th and ended with a surging rally in October and a much milder unease in December as to whether a Santa Rally would materialise (it did not). It would, however, have been worse but for continuing flows of share buybacks and mega M & A deals (totalling $4.6tn in 2015 with 137 over $5bn). With corporate earnings falling away share buybacks could soon lose their appeal and some corporate executives may be tempted to cash in some of their share options but lack of organic growth should keep the M & A pot boiling. With the shadow of FOMC rate hikes looming it will require a lot of unexpected good news to push prices higher or perhaps some oldfashioned incurable Wall Street optimism. We can be sure that traders are well aware that prices typically bounce back after a flat year or worse (see Chart 7). Having said that, trading in indices or even individual stocks purely on the basis of market momentum looks as bad an idea for 2016 as it was in 2015. Chart 7: one for the bulls!
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Via @pdacosta Elsewhere, the penny seems to have dropped finally that the FTSE 100 is being pulled down by its resources sector rather constituent companies operating mainly in the UK itself and the outlook, therefore, remains bleak. In contrast the FTSE 250 performed relatively well in 2015 and should hold up again this year. The domestic Chinese markets have been exposed as rigged by the government in Beijing, which is also steadily trying to erode Hong Kong’s independence in most areas including its stock market. Other Emerging Markets have been having a tough time thanks to China’s slowdown and the FOMC’s rumblings and despite brave contrarian talk no relief is in prospect. The Nikkei has had a bumpy ride, making all its gains in October and November before ending the year on a downbeat and despite all the brave talk of a Japanese revival it is hard to look further than the USD/JPY exchange rate, which seems as unpredictable as ever. EZ equity markets also fared better than most on the back of weaker exchange rates and duly suffered in December when massive euro shorts were closed in response to the ECB’s nonevent. In fact, Chart 8 points to a high inverse correlation between the value of the euro and EZ equities over the last ten years. Within the EZ, somewhat surprising is the contrast between the struggling IBEX stock market while the Spanish economy is recovering briskly and the Milan MIB ending as the top performing major market of 2015 while the Italian economy continues to do very little. A weaker euro remains, therefore, the best bet for EZ equities rather than the economy kicking on further Reluctantly, one has to conclude that none of the major equity markets will start 2016 looking especially attractive as a whole and the best prospects look once again to be individual stocks. Chart 8: Spot the correlation: Euro Trade Weighted Index (TWI) vs. European Equities (MSCI)
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15/18
1/12/2016
Zoho Mail Print
Source: Interfirma Bonds The US Treasury and gilt markets may be relaxed if not disdainful of future FOMC and MPC moves but there can be little doubt that the current miserable yields are very likely to go up over the life of most current paper in issue: i.e. maturing in more than 34 years’ time. This means potential capital losses. EZ sovereign bonds are even more vulnerable unless Mr Draghi is happy to stay on his current conveyor belt of QE purchases. EZ bank bond (AT1) holders currently enjoying higher yields face the different risk of being converted into equity if ECB stress tests and/or default looms. In the US there was an unseemly rush of ‘covenantlite’ new issues in 2015 in anticipation of FOMC tightening, accompanied by both a rise in defaults and surging yields for low –rated paper. Investors seem likely to be more selective in 2016 even if basic credit analysis has hitherto passed them by. Interestingly, there is reported to be a shortage of sterlingdenominated corporate bonds. Watch this space! Chart 9: higher bond yields healthy or worrying
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16/18
1/12/2016
Zoho Mail Print
Commodities It all seems rather straightforward: there is a glut of just about everything now that China has put on the brakes. The only way to get prices moving up again is for producing countries to cut back but few seem to feel they can afford to do so. Oil, of course, is a more complicated story but prices will remain pressure as long as Russia and Iran are slogging it out with Saudi Arabia and it is in the US interest to keep these bad guys fighting even as Europeans are desperate for them to stop. Meanwhile, another year has passed with gold bugs failing to advance their case for holding it in times of low as well as high inflation. At least my friend @Smaulgld has persuaded me that bullion is the safest way to invest. Chart 9: all China’s fault?
Currencies Although already a crowded trade, it is hard to see the euro’s avoiding new pressure again if, as seems likely that the ECB keeps printing money through to 2017 and beyond. This should help reverse some of its December postECB gains and it should also add to the pressure on the pound. A combination of a softer euro, no interest rate hikes in sight, widening current account and trade deficits and Brexit angst should keep sterling weak even if the dollar does not strengthen much more. Cable has been traded lower relentlessly since the summer and Chart 10 shows a trend that many will wish to befriend to test $1.45 at the very least. Pound pounded! Chart 10: GBP/USD Spot the trend?
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17/18
1/12/2016
Zoho Mail Print
Re twe e t
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