THE GLOBAL ECONOMY –
CHINA & BOND MARKET ARE QUICKSANDS
http://www.tremeritus.com/2015/01/21/global-economy-quagmire-quicksand-part-13/. Goldman Sachs (GS) preferred a much more
benign positive outlook, forcasting global growth poise to accelerate and US
striking above-trend growth – China slowing.
http://www.goldmansachs.com/our-thinking/archive/2015/
. GS was slightly more positive of gold raising its 2015 average price forecast
for gold to US$1,262 per oz. http://www.reuters.com/article/2015/01/23/metals-goldman-forecasts-idUSL1N0V21PS20150123.
By July, GS’s Jeffrey Currie, Head of Commodities Research, took a decisively
bearish stance to gold, predicting that
the metal is likely to trade below US$1,000 per oz. “Going forward if we continue to see improvement in U.S.
economic growth we tend to maintain downside risk in gold," he added http://www.cnbc.com/2015/08/26/not-seeing-weak-deamand-in-energy-goldmans-currie.html . The
presumption is that gold value as an asset class with no interest yielding is
countercyclical to economic strength.
Gold, in fact, turned out to be far more resilient till now,
in spite of a much stronger dollar, and the US economy actually turning softer
than expected – evident in patchy manufacturing, weaker employment data, and
recent months declining retail sales, and more tellingly, housing starts/building
permits. http://www.tradingeconomics.com/united-states/housing-starts... The Fed Reserve
growth forecast for US economy this year is only 2.1% and 2.3% for 2016 – far
below the long-term growth rate of 3.2 in recovery phase. http://www.marketwatch.com/story/imf-trims-global-forecast-as-brazil-canada-outlooks-deteriorate-2015-10-06 With only
one qtr remaining, it is stunning that IMF has revised global growth for 2015 (and
2016) forecast by 0.2% to 3.1% from its
July revised forecast of 3.3% against a year beginning forecast of 3.5% -
noting of weakened conditions in China, Brazil – both heading for their fifth
straight year of declining growth. http://www.imf.org/external/pubs/ft/weo/2015/02/index.htm Both GS and IMF have been more optimistics of
global economic outlook than warranted.
THE YEAR TO DATE IN RETROSPECT
Volatility in the global economy and financial market,
indeed, proved to be far more pronounced this year than 2014. Right from the
beginning, we saw a 42% sudden rise in Swiss franc in January followed by steep
fall of the Euro. By early March, the Euro sank to the 12-year low against the
US dollar – no thanks to the Greece contagion effect and the declared divergent
strategies intent of the US Fed Reserve to raise interest rate. http://www.theguardian.com/business/2015/mar/11/euro-12-year-low-gainst-the-dollar Then came next is a mini crash of the German
bund (bond) in May (the steepest upward climb in a quarter of a century). The yield
on Germany’s 10-year bunds was a mere 0.059% on 17 April rocketed up to 0.70%
by the first week of May. By historical standards, yields were still incredibly
low, but the spike up was visible even with a long-term 10-year view on the
chart. http://www.businessinsider.sg/germanys-bund-yields-boomed-at-the-fastest-pace-in-a-generation-this-week-2015-5/#.Vg0rZeyqooI
.That sent shivers to peripheral eurozone bond markets, the euro, 10-year US
treasury yield and commodities market.
http://blogs.ft.com/gavyndavies/2015/05/10/bund-tantrum-warns-of-future-accidents/.
The bund tantrum caught financial market by surprise – 10-year bond yields had seen steep decline
since January in the wake of collapsed oil price, raging firestorm warning of
deflationary threats, euro us dollar exchange rate saw continuing pressure.
There was no expectation that the European Central Bank QE to taper off in such
dismal economic outlook prevailing. Nominal yields of Bunds below 7 years
duration was negative – suggestive of a bubble in the bond market. Was the
shock rebound a “psychologically triggered”, not wholly explained by
fundamentals – other than a fear of exit illiquidity?
Fear of illiquidity left financial market prone to
evaporation of values. IMF’s Global Financial Stability Report warned of this. http://www.imf.org/external/pubs/ft/survey/so/2015/pol092915a.htm
Regardless, there is strong evidence of hard assets mispricing of risks which
brings with it risks of sudden extreme volatility that this writer predicted to
erupt in 2015.
Risk is, to my mind, a volatility construct, rather than
financial construct – much harder of estimation quantification & forcasting
despite the academic finance teachings - much debunked now. The impact is necessarily
financial, and at times, really huge.Indeed IMF warned of this - If financial conditions worsen or investors become
weary of a particular asset class or financial market, market liquidity and
value can quickly evaporate. We saw the shares in Glencore PLC tanked
29% in a single day on Monday 28 September but rebound within the next 5
trading days enjoy a bounce-back to more than recover all the losses. http://www.cnbc.com/2015/09/28/glencore-tanks-another-25-whos-next.html.
What is less capable of explanation in this strength of confident rebound is
why Glencore’s US$36 billion bonds were then being traded at pricing akin to
junk bond in financial market. http://www.cnbc.com/2015/09/30.
With deeply contentious view of the group’s equity might be worthless unless
commodity pricing picks up swiftly, one side could be badly wrong as the
gyrations in commodity pricing continues to escalate in growing
uncertainty. The mystery unresolved is
this – is the equity market in Glencore shares ‘deceiving” the commodity market
feeding its volatility or the volatility and downward pressure in the commodity
market misleading the equity valuation and debt borrowing costs of Glencore in
the equity market. The focus of deeply divided perspective on Glencore is on
China and implicitly the global economy –specifically the state of its economy
as the key driver.
There is little doubt in my mind that China is in deep
trouble. Few would have predicted the quagmire China found itself in since late
June. It stock market saw a meltdown in
June and August with the Shanghai Composite
Index now standing at 3052 points compared to its peak of 5166 of 12 June 2015
– an awesome bloodbath of 40% loss of bubbly value. China claims 7% GDP growth
in the first half but not everyone is convinced. Some of the evidence is anecdotal inside China
– foreign businesses are complaining of slower economy than China officially
admits. With imports falling and declining PMI manufacturing consistently in
negative territory for most of 2015, scepticism about the accuracy of official
data has intensified. China’s factories
are still struggling. The government's official
purchasing managers' index hit 49.8 in September. http://money.cnn.com/2015/09/30/news/economy/china-pmi-manufacturing/index.html?iid=obnetwork.
Any number below 50 represents a deceleration in the
manufacturing.Caixin and Markit showed manufacturing PMI dropped to 47.2 in September,
a slight decline from 47.3 in August and 6.5-year low, now been below 50 for
seven consecutive months. The Caixin China services purchasing
managers index fell to a 14-month low of 50.5 in September. http://www.marketwatch.com/story/china-caixin-services-pmi-falls-to-14-month-low-2015-10-01?link=MW_home_latest_news
Dragged by the
insipid property sector, growth in China's fixed-asset investment, one of the
crucial drivers of the economy, slowed to 10.9 percent in the first eight
months of 2015 - the weakest pace in nearly 15 years. https://sg.finance.yahoo.com/news/china-august-factory-output-6-054640890.html.
Barclay Bank economists cut China’s GDP growth rate to 6.6% this year and 6%
for 2016. http://www.smh.com.au/business/markets/china-is-leading-us-into-a-global-recession-says-citi-chief-economist-willem-buiter-20150915-gjms00.html.
Finance Professor Michael Pettis at Peking University reckons the attainment of
GDP growth target in the coming years beyond 3% - 4% is practically impossible.
http://news.sky.com/story/1559985/china-faces-lost-decade-of-economic-growth.
Considering a revised downward GDP growth in 2014 to 7.3%, the weakest in 24
years, any decline in 2015 GDP growth to the predicted 6.6% must be viewed with
increasing concern. Remember, the PBOC has cut interest rate 5 times since last
November besides reducing reserve requirements three times for most banks to
support lending. https://sg.finance.yahoo.com/news/china-grapples-risk-economic-hard-landing-044131334--finance.html It would signal the ineffectiveness of
quantitative easing in juicing up the economy, pointing to the apparent
acceleration of descent of sustainable growth for China and suggestive of
increased risks of a hard landing next year.
China faces 3 bubbles and a long
shadow of weak manufacturing – the stock market bubble, the real estate bubble
and the debt bubble – the first two have imploded or at least freezing and the
debt bubble still being expanded by monetary easings to contain the adversity
impact of the two formers.There is very little buffers left of policy
adjustments in managing the mother of all bubbles. Activity in China’s factory
shrank again in September with new orders dwindled. http://www.reuters.com/article/2015/10/14/us-china-economy-inflation-idUSKCN0S804H20151014. Consumer inflation is subdued and producer prices declined for
the 43 consecutive months raise concern of deflationary pressures unabated. Weichai
Power, China's largest manufacturer of engines for heavy-duty trucks used in
mining and construction warned its nine-month net profit could fall 75-85
percent due in part to the weakening economy.
Outside China, the evidences of eroded weaknesses are
staggering. South Korean industrial export of intermediate goods to China is
fizzling out. http://blogs.wsj.com/korearealtime/2014/08/21/south-koreas-exports-to-china-game-over/
Australian dollar hit a 6-year low against the US dollar on China fears. http://www.smh.com.au/business/markets/currencies/australian-dollar-hits-sixyear-low-on-china-fears-20150901-gjczj9.html
Yet given this competitive currency leverage, throughout Australia’s heartland,
factories are closing and China is not buying minerals exports like coal,
iron-ore and other commodities no matter how cheap the prices are. http://www.smh.com.au/business/markets/australia-pays-the-price-for-relying-on-china-20150924-gjulu2.html
Brazil suffers the most from China’s
recent devaluation as 50% of its iron ore, oil and other commodities landed in
Chinese ports. http://www.businessinsider.sg/china-devaluation-hurts-brazil-most-2015-8/#.Vg1IEOyqooI
. Exports to China tumbled by 19% in the first 7 months of 2015. http://www.wsj.com/articles/how-brazils-china-driven-commodities-boom-went-bust-1440728049
The Brazilian Real came under intense pressure hitting the all-time low at R$3.9901
to the dollar recently. http://www.ft.com/intl/cms/s/0/88903fac-6081-11e5-9846-de406ccb37f2.html#axzz3nKEGGDDZ.
The falling Real prompted the Brazilian Central Bank to publicly state that it
is willing to use the country’s US$370 billion foreign-currency reserves to
defend the Brazilian currency. http://www.wsj.com/articles/brazils-real-strengthens-against-dollar-1443125945.
Brazil is not the only deeply troubled by falling currency amidst growing fears
of Chinese slow down. Among emergent economy facing high inflation or huge
foreign currency debt, falling currency spells disaster. Indeed there is carnage
out there, notably in South Africa, Turkey, Indonesia and Malaysia. http://www.cnbc.com/2015/09/25/its-carnage-out-there-for-emerging-markets.html.
During her press conference on 18 September decision not to raise interest
rates, Fed Chairwoman, Janet Yellen invoked China 16 times in one hour. This is
how serious China’s diminishing growth prospect has become the epicentre of
global growth narrative within the Fed, IMF, World Bank, OECD etc. http://money.cnn.com/2015/09/18/news/economy/china-yellen-global-economy-worry/.
This is in spite of the fact that US-China trade account for less than 1% of
the US GDP statistics but it is China’s trading relationship with the rest of
the world is alarming. A recent Brooking-FT index report warned of "sharp
divergences in growth prospects between the advanced economies and emerging
markets, and within these groups as well", notably resourcess rich
economies like Russia, Canada and Brazil
already mired in recession. The danger is that emerging economies ‘leading the
world economy into a slump.” http://www.cnbc.com/2015/10/04/emerging-market-turmoil-flashes-warning-lights-for-global-economy.html
Janet Yellen spoke of these words – it is no secret that
China’s economy is slowing….. The question is how much it will impact the rest of the world,
including the United States….. Canada, a major U.S. trading partner, is already
in a recession, largely because China is no longer buying commodities like it
once did. Many emerging markets like Brazil are also struggling for the same
reason.” The truth is that China’s
growth cannot be independent of protracted subdued conditions in the developed
world and the emergent world even more vulnerable to downward pressures. Many
of these economies are severely leveraged on China’s continued growth but now exhausted.
It is a vicious self-reinforcing circle.
Alcoa slashes its outlook for China's production of cars & heavy duty trucks are good
bellwhether. http://www.marketwatch.com/story/alcoa-slashes-it-outlook-for-chinas-production-of-cars-heavy-duty-trucks-2015-10-08?dist=tbeforebell
The “macro softening” in China’s economy is taking hit on
US corporates, suddenly souring their outlook of Yum Brands, even Nu Skin
Enterprise Inc. - China accounting for 26% of its revenue base. http://www.marketwatch.com/story/china-could-become-a-big-problem-for-us-stocks-again-2015-10-07
. The fear forward is weak consumer demand inside China will infect US /global
corporate earnings alongside a weakening Chinese services sector. No where is this Chinese
economic slowdown more clearly felt as in Caterpillar Inc. http://www.marketwatch.com/story/10-worst-sp-500-stocks-led-by-caterpillar-decline-2015-09-24
Caterpillar planned to cut its global work force by some 10,000 through to
2018.With sales declining for three straight years so far,
Caterpillar CEO Doug Oberhelman said Caterpillar was facing “a convergence of
challenging marketplace conditions” in mining and energy – implicitly all
mining & oil and gas jurisdictions from Canada, Australia, Brazil, South
Africa, Middle East, China and USA itself. Mining provides the raw material for
construction and manufacturing and energy is needed to drive production,
distribution of input/output and consumption – without recovery of both adversity
of challenging convergence of market
conditions, Caterpillar Inc. at the forefront,
is telling us no economic recovery forward is in sight for the next 3 years. The World
Bank sees China slowing for the next 2 years. http://www.marketwatch.com/story/world-bank-sees-china-slowing-over-next-2-years-2015-10-05. Some Asian currencies are plummeting to
multi-year lows including Singapore, Malaysia and Indonesia. Corporate
Indonesia is likely to face enormous pressure in 2016 to roll over US$42
billion of foreign currency denominated debts – an ominious reminder of
possible repeat of the 1997 Asian Currency Crisis. http://www.cnbc.com/2015/10/04/indonesia-inc-faces-tough-time-rolling-over-debts.html.
IMF’s Global Stability Report warned the “excess” of emergent market corporate sector
over-leveraging to the tune of US$3 trillion in the last decade. A wave of
default in a credit crunch of higher interest rate environment could imperil an
already weak global economy. Policy-makers has no margin of error in navigating through the inevitable
normalisation of interest rate and market conditions, any miscalculation risks
wiping out economic growth for the next 2 years. http://www.telegraph.co.uk/finance/economics/11916485/3-trillion-corporate-credit-crunch-looms-as-debtors-face-day-of-reckoning.html
Export-dependent Germany, eurozone’s key economic engine, is also sputtering. http://business.financialpost.com/investing/global-investor/germany-the-eurozones-economic-engine-is-sputtering-as-its-biggest-companies-struggle. A steep decline in manufacturing orders over
summer from outside the eurozone tells of bleaker economic outlook ahead – the
advantage of 20% depreciation of euro against US dollar through 2015
notwithstanding.Anaemic conditions in EU & Japan depress their currencies,
juice up their economies but little to show even short term growth. IMF warned that the euro depreciation
will restrain US and China for years, reducing 1% of the US GDP and China by 2%
respectively.http://blogs.wsj.com/economics/2015/04/14/imf-euro-depreciation-will-restrain-the-u-s-and-china-for-years/.
The mighty US dollar in a decade has already sent its August exports to a
3-year low. http://www.marketwatch.com/story/us-exports-fall-in-august-to-three-year-low-2015-10-06
World trade volume grows modestly,
slower than global real GDP – hinting of weak demand compounded by growing
uncertainty and turmoil in financial and currency markets. http://www.gbm.scotiabank.com/English/bns_econ/forecast.pdf The downside risks to growth still dominates
outlook going into 2016.
WHAT DOES THE
COMMODITIES MARKET TELLS US?
http://www.smh.com.au/business/markets/investors-brace-for-stocks-to-fall-again-ahead-of-us-earnings-20151003-gk0hdw.html . It is hard to argue for a strong case for a price recovery in commodities in 2016. Only 3 commodities – rice, cocoa and cotton – all agricultural and supply shortfall-induced escaped the 2015 carnage and the worst deflationary price decline was lumber. http://www.marketwatch.com/story/only-3-commodities-have-managed-to-escape-2015-carnage-2015-09-29. Industrial metals like aluminium, copper, platinum and energy -relevant Brent crude featured on the top end of price fall. Together with rubber, they tell a compelling story of underlying economic fundamental also told by Caterpillar Inc. & Alcoa. Historical natural rubber price chart showed a steep declining secular downtrend since February 2011 http://www.indexmundi.com/commodities/?commodity=rubber&months=60 and on a 12-months chart read, it exhibits a sharp cyclical decceleration in price since June 2015. http://www.indexmundi.com/commodities/?commodity=rubber&months=12. China’s January-August rubber imports down 4.4 per cent to 1.66 million tonnes. India’s natural rubber imports slumped 32 per cent on YoY basis to 33292 tonnes in August http://globalrubbermarkets.com/37258/geofin-comtrade-daily-report-on-natural-rubber-september-28-2015.html. India and China account for roughly 30% of the world’s automobile production. Nearly 70% of the natural rubber is used in automotive industry. Growth of Chinese car sales slowed right from the start of CY2015 compared to CY 2014 as slowing economy weighs on the world’s largest auto market. http://www.wsj.com/articles/china-car-sales-get-a-tap-on-the-brakes-1425972198. That trend continued weaker for the rest of 2015 – purchase in July was a 17-month low after the steepest rout in Chinese stock market since 1996. http://www.bloomberg.com/news/articles/2015-09-09/china-auto-sales-rebounded-in-august-as-discounts-lured-buyers. Given these weak numbers and supply/demand imbalance, it is no surprise of the lagged fall in crude oil price, behind the deteriorating weakness in rubber. The evidence pointed to incipient investing class lost a lot of money and reduced capacity to spend on consumption forward. http://fortune.com/2015/09/09/china-economy-trouble/. China’s and global economy are in deep trouble navigating in uncharted waters.Caterpillar Inc knows that and retrenching 10,000 through CY2016 – citing a convergence of challenging conditions in mining and energy markets. http://www.miningweekly.com/article/caterpillar-restructuring-to-see-more-than-10-000-retrenchments-by-2016-2015-09-25
Until I see a
rebound in rubber, platinum & lumber prices, I cannot see a rebound in the
global economy. Some 70% of natural rubber found its use in tyre and platimum –
outside jewelry market – is largely consumed in catalytic converters in car
manufacturing. Other than Japanese, China already accounts for more than two-thirds of platinum
jewelry globally and further consumer penetration might be limited – therefore
it is most unlikely for platinum price to recover without a recovery in the
auto sector. http://www.kitco.com/news/2015-09-02/Barclays-Foresees-Strong-Chinese-Imports-Of-Precious-Metals-Over-Next-Several-Years.html
If consumers in EU and China cannot afford to buy cars (and rubber &
crude oil), how can they afford to buy mortgage-financed real estates in an
environment of higher interest rate forward?
Lumber price is a good forward proxy of the housing and construction
sector – notably in US and China – and it is falling since year beginning. http://www.nasdaq.com/markets/lumber.aspx?timeframe=3y.
US new housing starts near an 8-year high in July but permits fall.
Weyerhaeuser (WY) reported deteriorating Chinese & Japanese housing markets
in summer aggravated by stronger US dollar aggravating its export volume –
China is its biggest export market. http://www2.laufer.com/falling-west-coast-exports-dampen-loggers-sales.html
. (WY), one of the world’s largest owner timberlands, saw its share price
collapsed. http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=wy&insttype=&freq=&show=
New home orders by builders like D.R. Horton &
Lennar Corp trend upward, but the annual rate for new single-family houses sold
is not at pre-recession high. http://www.wsj.com/articles/homebuilding-industry-after-the-recession-1443671769 - Their share prices
appear to have peaked.The US housing sector recovery since the last GFC has
been shallow and could tipping over ahead of rising interest rate.
The simple truth revealed in falling lumber prices is that
the Asian economies of China and Japan are slowing. Japan’s industrial output
dropped by 1.2% in August over July, far steeper than earlier anticipated 0.5%.
http://www.marketwatch.com/story/japans-factory-output-slumps-hints-at-recession-2015-10-15 The US recovery story is sluggish at best,
marked by tepid consumption, slower consumer inflation and falling producer’s
price index in September, even as gasoline prices at multi-year low. http://www.cnbc.com/2015/10/14/consumers-shutting-down-as-us-economy-deflates.html
Buried in the minutes of the Fed’s
meeting of 16-17 September disclosed a pessimistic economists forecast within
the Fed of a much subdued economic growth averaging only 1.74 % over 2015 –
2020. http://www.marketwatch.com/story/buried-in-the-fed-minutes-is-another-downgrade-to-the-us-economy-2015-10-09. Chinese
Finance Minister Lou Jiwei over the weekend at the International Monetary
Fund's annual meeting of 9-10 October 2015 warned that the US “is not yet in
the condition for an interest rate hike”- indicate Beijing's unease about the
impact that the move might have on the Chinese economy. http://www.marketwatch.com/story/chinese-finance-minister-says-us-shouldnt-raise-rates-yet-2015-10-12.
China’s imports collapse in September,
exports remaining weak. http://www.cnbc.com/2015/10/12/china-exports-imports-continue-to-fall-in-september.html.
Any interest rate rise in US will lift its dollar (indirectly the Yuan) and its
tailwind likely to undermine the Yuan’s competitiveness relative to the rest of
the world. Relative to rest of major competitive currencies like the Euro, Yen,
and Chinese Yuan depreciates less against the muscular US dollar in the last 20
months.
SO WHAT IS THE OUTLOOK
FOR CHINA & GLOBAL ECONOMY?
THE CHINESE DEVALUATION CONUNDRUM
My suspicion is that these are not the end of the Yuan
devaluation, never mind the Chinese Central Bank have been burning its foreign
reserves to prop up the Yuan and hold on to its US dollar currency peg. Bigger
shocks are ahead, once Chinese Yuan is internationalized, if any. Foreign
Central Banks are likely to re-balance their foreign exchange holdings of the
Yuan, the buying of Yuan could drive Chinese Yuan higher, severely undercutting
Chinese exports’ global competitiveness and raising import prices fueling
domestic inflation, risking further erosion of domestic consumption demand. In
a weak growth environment, that spells big trouble for China’s external
competitiveness and the rest of the world of shrinking Chinese demand. China is
by far Australia’s biggest trading partner. Investment banks warned of
overly-inflated property bubble burst leaving worst damaging consequences than
recession triggered by further fall in demand for Aussie commodities exports in
the event of a Chinese hard landing. The Yuan’s exchange rate volatility will
have major impact on Australian property investment. http://www.smh.com.au/business/the-economy/housing-bust-now-the-greatest-recession-risk-say-investment-banks-20151012-gk6pjz.html.
Australia don’t want a hard landing of its economy accompanied by a hard
landing in its property market as strong demand by cash-rich Chinese had been a
big factor driving economic actvity as mining slowed. China’s economy is in a
much weaker state than it publicly acknowledged officially. Adjusted for
inflation-fueled stimulus spending impact on construction and consumption – which
China cannot engage in these periodic timely fiscal stimulations to boost
spending demand forever – the underlying real growth in Chinse GDP is probably
closer to 3% or 4% at most. Falling
commodities prices cannot alone explain the entire decline in recent Chinese
Yuan-denominated imports and despite almost uninterrupted falling producer’s
price index (ex-factory prices) since 2012; Chinese exports have not soaring in
tandem. That tells me that China’s transition from a heavily investment and
export-driven dependency to a domestic consumption economy had been
excruciating more difficult of balancing achievement than economic modelling
and theorising had predicted. The takedown of this economic rebalancing can be
seen in falling official GDP growth since the GFC. Overcapacity keeps
reinforcing and further fiscal stimulus will only adds to this weight – all too
apparent to global mining industry. In most recent times, we read of Glencore
shutting or reducing production in South Africa, Peru, Kazakhstan, Peru, DRC
following other big mines closures such as NMG’s huge Century zinc mine in
Australia and Irelan’s Lisheen, owned by India’s Vedanta. For the first time in
a decade, Chinese steel production has contracted. http://www.reuters.com/article/2015/09/11/us-china-steel-ahome-idUSKCN0RB20I20150911 Industrial overcapacity is "the largest problem facing the
Chinese economy now," according to Xu Shaoshi, chairman of powerful state
planning body the National Development and Reform Commission.We see a persistent
trend of negative Chinese PMI manufacturing statistics, punctuated by brief spikes,
have worsen of late, and recently, this downtrend accelerating since the June
stock market swoon.
THE LUNACY OF MERGERS
& ACQUISITIONS – ASSETS FINANCIALISATION MANIA
Directly or indirectly, the developed economies consumed
most of the world’s production of commodities. Plummeting prices across
industrial metals, even foods, speak of soft demand in weak advanced economies.
Consumer deleveraging is continuing, matched by even greater excess of
corporate leveraging binge salivating on cheap money made readily available
through successive quantitative easings in all major economies. We saw big
mergers and acquisitions, perhaps a record in 2015, in value terms often cemented
by paper valuation rather than the discipline of cash from past retained
earnings – the eye is on burning redundant competition and squeezing efficiency
to uplift profits in the face of stagnation of demand revenue flow. Carl Icahn
pooh-poohed these mergers & acquisitions as “financial engineering at its height,”
http://blogs.wsj.com/moneybeat/2015/09/29/carl-icahn-is-skeptical-of-the-ma-boom/ . These combinations
create no wealth but ultimately destroy the acquiror’s balance sheet when the
acqusition fails to deliver of expectations. In practical world, most
acquisitions turn out to be costly failures. Clearly what is missing of this
economic equation is one word – production and its lack stems from weak demand.
In the next downturn, what would you be selling? An inflated asset valuation in
circumstances of insolvency? Economists forgot this tragic fact – while the
world’s Central Bank’s money printing have staunched losses in the financial
sectors, they failed to achieve the final objective of creating credit to
stimulate demand and re-ignite the global economic engine of recovery. Post GFC
quantitative easings only inflates asset price, lower exchange rate in parts of
global economy (and uneven), bails out banks, foster financial interest
differential arbitrage of carrying trade and resolves no underlying
overcapacity.
THE PSEUDO-GLOBAL ECONOMIC RECOVERY QUAGMIRE
Post-GFC of 2009, US’s real GDP growth was 2.2% at an annual
rate, eurozone barely limping at half that rate at 1.2% annual growth and
Japan’s start-stop economy hardly reaching 1%. – all sub-par recovery rates
after a recession. Note that these dismal rates of growrh start from a low
recessionary base and fertilized by unprecedented mountain of quantitative easing
manure for all economies except in US where QE 3 ended in 2014.If the US economy
is strong, how come the strongest listed entities are buying back their own
shares instead of investing in new/growth businesses and also retrenching
employees at the same time? http://www.marketwatch.com/story/companies-are-cutting-jobs-and-buying-back-stock-at-the-same-time-2015-10-02
There is practical no self-sustaining life in developed economies. China has
failed to reverse or at least support from falling its own economic slowdown
after 5 interest rate cut and repeated easing of its required reserve
requirements since November 2014? http://www.bloomberg.com/news/articles/2015-10-02/oil-bulls-lose-faith-in-recovery-as-russia-adds-to-global-glut China
is the main prop supporting emergent economies – now found itself sinking at a
time when the rest of the world is trapped with
sinking commodities prices, currency depreciations and US$3 trillion of
corporate credit crunch of “over borrowing” over a decade according to IMF
study . http://www.telegraph.co.uk/finance/economics/11916485/3-trillion-corporate-credit-crunch-looms-as-debtors-face-day-of-reckoning.html
With interest rate rise looming, they
are facing the prospect of another financial crisis not disimilar to the Asian
currency crisis of 1997. In the event of mass defaults, global economic growth
will be imperiled as no economy – be it China’s manufactured exports or
developed economies will be spared of this mayhem. In the best of circumstances,
the global economy is locked into a gear of modest to moderate growth. The
Singapore Government Investment Corporation, in its 2015 Annual Report, warned
of modest global growth and even negative return on some asset investments for
the next 5 to 10 years. http://www.gic.com.sg/report/report-2014-2015/?confirmeng=1
Former Fed Chairman, Alan Greenspan warned in October 2014
that he does not believe the normalisation of interest rate to market
conditions can be achieved without turmoil in the financial market, after years
of extraordinary stimulus. http://www.bloomberg.com/news/articles/2014-10-29/greenspan-sees-turmoil-as-qe-boost-to-markets-unwinds.
I agree with him. There will be economic tantrums in different parts of the
global economy and Janet Yellen faced exactly that in September this year.
CHINA'S STOCK MARKET
BUBBLE BURST – SIMMERING IMPACT
Few people would be aware of this Bloomberg news leak - Zhou Xiaochuan, governor of China’s
central bank, said three times to a G-20 gathering that a bubble in his country
had “burst,” Japanese Finance Minister Taro Aso said. http://www.bloomberg.com/news/articles/2015-09-04/china-s-zhou-kept-repeating-the-bubble-burst-at-g-20-meeting. This was before the US Fed reserve
meeting of 16-17 September to decide on US interest rate. The PBOC, China’s
Central Bank, came up with clarification that Zhou was referring to the Chinese
stock market, not the economy. I believe the fate of the Chinese stock market
is indeed hanged in suspended animation – the real blood will spill once all
the restrictions on securities trading are lifted. It could be really ugly if
global conditions spiral downwards – just like Malaysian stock market found
post the 1997 Asian currency crisis. A lot of cash strapped entities
disappeared from listing while others severely financially- impaired, unable to
raise new capital in lost market confidence, were taken over in rescue
restructuring. I will watch the Chinese banks closely.
A CNNMoney
survey among economists has penciled a third-quarter GDP growth of 6.7% and for
2015 as a whole at 6.8%. http://money.cnn.com/2015/10/13/news/economy/china-economy-growth-survey/index.htm. Next year, the outlook is dimmer at
6.5%. Germany’s sputtering economy have just reported its August exports fell
by 5.2% compared to July – its biggest monthly decline in 6 years and that was
before the outbreak of Volkswagon debacle and much cheaper Euro
notwithstanding. German economist identified soft emergent market, especially
China – another sign of burst stock market bubble hurting Chinese domestic
consumption. German manufacturing output and new industrial order also slowed in August. IMF forecast German economy to grow
by 1.5%, slightly lower to Eurozone growth of 1.6% in 2015 – its growth
momentum as an economic power house has evaporated. China, like Japan in the 1980s,
the exports-led high rate of savings has contributed to China’s real estate and
stock market bubbles. The Japanese economy suffered the wreckage of
its real estate and stock market bubbles and unable to recover since by
exporting its way out of malignancy. The Chinese stock market bubble burst
leave it little option but also exports its way out of this guagmire and
quicksand. The harder it struggles, the deeper it will sink in the quicksand
faster and drowns Japan and the rest of the world – this is what I fear most.
The signs are already there to see - China is Japan’s second-largest trade partner, accounting
for 18.3% of exports in 2014, closely behind the U.S., at 18.6%. The volume of
Japan’s exports to China fell 9.2% in August from a year earlier, and available
indicators for July — industrial production and machinery orders — have also
come in much weaker than expected. http://bruegel.org/2015/09/chinas-woes-could-derail-abenomics/. So who is lifting the world out of
this sinking guagmire? Countries with big current account surplus, small budget
surplus and price deflation – Japan, Germany and China could fit this descript.
http://www.cnbc.com/2015/10/11/who-can-rev-up-the-world-economy-china-germany-or-japan.html Germany is sputtering, drag by the rest of
Eurozone and now its weakest link, Abenomics is falling apart at its core
pilllars and China is riddled with stock market bubble burst and debilitating
real estate bubble – no one can afford any more fiscal stimulus on the scale
prevalent in the last GFC and since. The quarter just past was marked by the
worst global equities performance in 4 years, notably Chinese stock market
crash. http://business.financialpost.com/investing/global-investor/global-stocks-rally-on-final-day-of-worst-quarter-in-four-years
My bet on the gambling table is
a recession waiting in 2016 – coming out of China, this time.
NEGATIVE
INTEREST RATE POLICY - PARASITIC SPECULATION, NOT PRODUCTION
And even if pessimism is
overdone & China escapes the worst fate, its de-acceleration will be
painful for the rest of global economy. Canada, Brazil, Argentina, South
Africa, Australia are either in recession already or in feeblest growth rate
since 2009. Post GFC, China is the main prop of global economic resilience for
emergent economies and faltering. Within
sickly EU, Germany is sputtering. Abenomics is about the taste the best
medicine of derailment and the US Fed fearful to even raise a modest token of
its Fed fund rate –almost 6 years since the GFC. What is scary is this – even the Fed is in
quiet contemplation of delving into negative interest rate to fight any further
downturn of the US economy. “Some of the experiences [in Europe] suggest
maybe can we use negative interest rates and the costs aren’t as great as you
anticipate,” said William Dudley, the president of the New York Fed chapter.
http://www.marketwatch.com/story/fed-officials-seem-ready-to-deploy-negative-rates-in-next-crisis-2015-10-10. What a
shocker of monetary devils residing inside the Fed. It is not the question of
the costs – if at all clearly measurable in isolation but its ineffectiveness
but leaving a continuing trail of future unknowns that all the quantitative
easings already damaged the global economy structure. In Europe, the massive
ECB bond buying of “whatever it takes” mantra has no impact on asset price,
consumer spending , or business lending
as EU banks continue shrinking, economic
resuscitation but adding to volatility in currency, bond, commodities and
equities market. The commonality of
adversities includes growth in financialisation, parasitic speculation than
production. Even former Fed Chairman, Ben Bernanke admitted as much – it
wouldn’t be a panacea but a support to a weakened economy. The tantalizing
prize – illusory as it may be – is that aggregate demand is no longer a
scarcity. There will be no savers, more spenders.
BOND MARKET
QUICKSAND
The
biggest danger is that money flows away from negative yield investments into
junk bond and highyield corporate bonds of equivalent junk bond grade. Added to
that risk is the likely drag of downward pull of longer-dated 10-yr treasury
bonds yield, fueling a bond market rally that is unsustainable. Retail
investors don’t understand that bond investments are the trickest investment
risks. http://www.neamb.com/finance/bonds-risky-investment.htm.
The bond market is thin, institutions-dominated and Central Bankers the main
sellers and buyers – everyone else is peripheral. Such
financial instruments are illiquid, mispricing is dangerous because yields
might spike when everyone rushes for the exit door in a panic when there is no
buyer except Central Banks. We saw the bond market collapsed in May & June
this year. http://business.financialpost.com/investing/why-no-one-should-be-surprised-by-the-bond-collapse-that-has-wiped-out-2015-gains. As one fund
manager put it this way - “What
we’re seeing is a repricing of the ultra-low interest rates to where they
should be….the new normal is going to be price discovery — figuring out where
bond yields are actually supposed to be, because at zero or even negative
yields is obviously not right as the market has realized.” And the consequences
of bond market collapse? Norway’s $900 billion sovereign wealth fund announced
on April 29 that it would exit long-term euro bonds in its $328 billion bond
fund. This was after it degraded its European bond exposure to 40% from 60% the
preceding October. Obviously their clients demand higher rate of return than
zero or worst still negative returns. In conditions of extreme volatility,
which Central Bank will step in to buy? What about those managed funds which face
disgruntled retail investors seeking redemption in extreme market volatility in
the bond market? In those circumstances,
fund managers sells equities – the era of cheap, even negative interest rate,
is going to end up in a bubble burst crashing bang!
The easy money of falling interest rate to near zero on risks asset investment in equities and real estate is behind us, the page that is facing investors forward is fraught with sudden dangers of inmense severe impact. Quantitative easing has NOT worked for US, EU, Japan or China. Huge trillions were printed thrown at the economy and disappeared without a trace. Central bankers have lost control over monetary policy and fiscal stimulations have limited life-span of safety-net support as economies dip in rotation. In China, it simply adds to overcapacity way overloaded, exacerbates the crisis of economic instability and financial turbulence in rotation – transmitting from the equities to the bond, commodities and currency markets and recycling within this closed loop. Government bond rates are stubbornly low in the sea of deflationary pressures and credit spread, as a measure of default risk, is silently rising. Very few retail investors in the high-yield bond market understand the financial calculation involved in risks pricing implied of capital loss in the event of actual default.
The easy money of falling interest rate to near zero on risks asset investment in equities and real estate is behind us, the page that is facing investors forward is fraught with sudden dangers of inmense severe impact. Quantitative easing has NOT worked for US, EU, Japan or China. Huge trillions were printed thrown at the economy and disappeared without a trace. Central bankers have lost control over monetary policy and fiscal stimulations have limited life-span of safety-net support as economies dip in rotation. In China, it simply adds to overcapacity way overloaded, exacerbates the crisis of economic instability and financial turbulence in rotation – transmitting from the equities to the bond, commodities and currency markets and recycling within this closed loop. Government bond rates are stubbornly low in the sea of deflationary pressures and credit spread, as a measure of default risk, is silently rising. Very few retail investors in the high-yield bond market understand the financial calculation involved in risks pricing implied of capital loss in the event of actual default.
Investors are aware of the extent of corporate/institutional
debt leverage but not the earnings base to justify this risks escalation,
notably in some sectors like shale gas
and industrial metals which are the most
economically sensitive to downturn. Corporate high yield bonds are really junk
bonds. A 5% default rate implies investors expect to average a 5% loss of 5
cents in each dollar of principal invested. Adjusted for time value of money –
if the 7-yr “risks free” US Treasury rate is 2% - the lenders (bond buyers) are
assumed the risks that he/she is going to get a capital return equivalent to
70% of invested capital. That is to say, a 7-yr low quality high-yield bond
offered by a corporate issuer at 7% return is NOT an attractive return at all
for the investor. If the corporate bond offers at a higher rate than this – it
means the risks of default and bankruptcy is much higher than 5% default risks.
Glencore corporate bond, otherwise is
blue chip investment, is priced as junk bond grade risks pricing. How many of
the shale gas entities in the US are staring at death now unable to generate
cash flow to fund even on-going drilling/fracking operations, forget about interest
and loan repayments? Banks in China exposed to overcapacity sectors are riddled
with huge non-performing loans. Without the implicit but unsustainable
guarantee of support against insolvency, how many of the behemoth Chinese
State-owned enterprises riddled with over-capacity will survive the next
downturn and credit life line from Chinese Government? In a slow-growth
environment, you can’t grow earnings and financial reserves to pay off your
ballooning debt. IMF warned of “sudden evaporation” of asset values in emergent
economies, notably China where corporate debts borrowing including
high-yielding (read junk) bonds far exceeded their market capitalisation.
http://www.telegraph.co.uk/finance/economics/11898936/World-set-for-emerging-market-mass-default-warns-IMF.html
China’s 42.2
trillion yuan ($6.7 trillion) bond market was flashing red hot in August when
its equity market crashed. Investors practically shifted from one bubble to
another bubble even as corporate earnings shrinking. http://www.bloomberg.com/news/articles/2015-10-08/if-you-thought-china-s-equity-bubble-was-scary-check-out-bonds. Overall corporate debt as estimated by
Commerzbank is 161% of its national GDP base in the first quarter of 2015. http://www.marketwatch.com/story/are-bonds-markets-telling-us-that-gloom-over-china-is-overdone-2015-10-12?page=2.
Interest rate cut is ineffective in lifting
a debt-heavy Chinese economy.
Low
interest rate and worst still, negative interest rate policy, pursued by
central bankers, are toxic inducement of flawed economic policy. Because of
excess supply and cheap availability, borrowers arbitrage for gains in sectors
of easy over-supply to seeming escalating demand. Like power surges damaging
electrical appliances, supply surges of money in oversupplied markets (the
global iron & steel, oil and gas sectors for example in the fast receding
commodities super-cycle) is dangerous. They kill the industry, kills the
borrowers/investors, the economy and society.
THE WORLD OF
PSEUDO-RECOVERY, DEBT TSUNAMI AND DEFLATION THREAT
The world is in that precarious brink now, can’t afford any misstep. We are living in a new era of pseudo-recovery, swimming in a sea of debt tsunami, volatile bond/commodities market, inflated asset bubbles of equities and real estate, financial fragility in emerging economies and a real threat of deflation. Imprudent debt leveraging beyond financial affordability can take a lesson from this Fed’s instruct – “.It is appropriate for monetary policy to take a step back from the emergency measure of zero interest rates.” http://www.marketwatch.com/story/feds-mester-says-economy-can-handle-rate-hike-2015-10-15?link=MW_home_latest_news Even the Fed Reserve Chief agrees the risks around China and global (read China) outlook is daunting – she said “The situation abroad bears close watching,”. Never before have the Fed mentioned of these heightened concerns of growth in China & frailty of emerging market economies its deliberations of interest rate policy. The Fed knows that China has been a major contributor of low-inflation global growth for nearly two decades – that is gone or will be gone soon.
The world is in that precarious brink now, can’t afford any misstep. We are living in a new era of pseudo-recovery, swimming in a sea of debt tsunami, volatile bond/commodities market, inflated asset bubbles of equities and real estate, financial fragility in emerging economies and a real threat of deflation. Imprudent debt leveraging beyond financial affordability can take a lesson from this Fed’s instruct – “.It is appropriate for monetary policy to take a step back from the emergency measure of zero interest rates.” http://www.marketwatch.com/story/feds-mester-says-economy-can-handle-rate-hike-2015-10-15?link=MW_home_latest_news Even the Fed Reserve Chief agrees the risks around China and global (read China) outlook is daunting – she said “The situation abroad bears close watching,”. Never before have the Fed mentioned of these heightened concerns of growth in China & frailty of emerging market economies its deliberations of interest rate policy. The Fed knows that China has been a major contributor of low-inflation global growth for nearly two decades – that is gone or will be gone soon.
China
and/or the bond market are quicksands which can tip us over into a deep recession.
Beyond the temporary false prosperity
boom fed by the steroid of quantitative easings globally which must end, what
comes next behind these dark shadows?
