Goldman Sachs, Jeffrey Gundlach and Bill Gross have all
collectively sounded risks alarm on rising equities and bond markets http://www.bloomberg.com/news/articles/2016-08-05/goldman-gundlach-and-gross-are-worried-about-the-markets-time-to-get-out. The huge disconnect between stocks and bonds
is particularly disturbing. Of late, the 10-year bond market is wildly
volatile, notably in the US and post Brexit UK. One class of investors will be
proved dangerously wrong and the time for the market accounting of the “truth”
might just be around the corner. If the bond market is correct, we are in for a
deflationary tsunami with stocks and asset values having big downside for years
to come. In the event of equities market being correct, the end of the bond
market rally is within sight and interest rates will rise in the US threatening
to derail US housing recovery, consumer spending and debt-laden emerging
economies.
Despite the better-than-expected July employment figures,
the US economy is NOT doing well. http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm
. Flash estimate from the Bureau of Economic Analysis put the US 2nd
qtr GDP growth at 1.2% annual rate and it also revised downwards the US first
qtr GDP growth to 0.8 %. 2016 to date is the most tepid post-War recovery – compared
to 2014 and 2015. It has been 3 quarters of productivity decline and 5 straight
consecutive quarters of falling profits, the longest since 2009 GFC. http://www.smh.com.au/business/markets/volatility-bets-point-to-renewed-us-equity-rally-20160809-gqounm.html The quality of growth is also deteriorating. Defensive sectors like communication,
technology and commercial services front-loaded the 2nd qtr GDP
growth while economy –sensitive sectors like consumer durable/non durable
spending, transportation, healthcare, energy & materials and financial
services lagging far behind. http://money.cnn.com/data/markets/.
It is the same in
Australia. No surprise in there. Globally, ZIRP, NIRP transferred wealth from
savers to borrowers, notably central banks. Consumers riddled with leveraged
balance sheet have little to spare on discretionary consumption. For OPEC,
revenue inflow is declined 75% at 10 year low. http://money.cnn.com/2016/08/08/investing/opec-special-meeting-oil-prices/index.html?iid=Lead
. Oil dependent economies are in dire straits dragging down global growth
instead of lifting GDP gains as most analysts wrongly predicted. Even
transportation and health care are slow growth sectors in stronger economies
like US and Australia.
With 86% of the S & P 500 2nd qtr earnings
reporting now in, the key earnings score sheet looks decisively weak. https://www.factset.com/websitefiles/PDFs/earningsinsight/earningsinsight_8.5.16
It was a compressed margin season of sales growth of up to 28% gain rather than
earnings growth. http://www.marketwatch.com/story/were-in-another-lousy-earnings-season-but-these-companies-have-grown-sales-by-at-least-28-2016-08-04
Last quarterly earnings growth took a
tumble of 3.5% decline - this is the first time of 5 consecutive quarters of
year-over-year declines since the last GFC. Business conditions remain
sluggish. Information technology provided most of the upside earnings surprise.
Energy was the dog. Forward negative earnings guidance exceeds positive
earnings guidance by a ratio of two to one. Forward P/E 2017 valuation is also
significantly over-extended at 17X, above the 5-yr average of 14.7X and 10-yr
average of 14.3X – the risks is on the downside of over-valuation. Analysts are
forecasting no upside of economic upturn until the fourth quarter of 2016 –
seasonal factors assisting, no doubt.
Supply side economics acknowledged energy and materials
sectors are bearish of outlook. Oil price is on the brink of another spell of
bear market. Brent crude was US$43 per barrel now after 20% decline since early
June. http://business.financialpost.com/news/energy/the-energy-glut-strikes-back-as-oil-returns-to-brink-of-bear-market?__lsa=d751-4e65.
Iron ore – a steel-making commodity – staged another surprise rebound to
US$60/t in July. http://www.woodmac.com/reports/metals-global-iron-ore-short-term-outlook-july-2016-40917727.
Wood Mackenzie forecast a H2 forecast of only US$49/t CFR with a low point in
the final quarter. This writer took a quick check on the share price of Australian
iron-ore producers – most are trending downwards. That is to say, investors are
convinced the most recent rebound in iron-ore price was built on fragile
fundamentals and unlikely to sustain.
FTSE, DJIA, SPX and Nasdaq indices are at 12-months high.
The strength of US equities surge is underpinned by debt-funded buybacks and
falling bond prices. Goldman Sachs said S&P 500 companies spent $163
billion on buybacks in the first quarter—the second-largest quarterly
expenditure in history. http://www.marketwatch.com/story/investors-now-penalize-companies-addicted-to-share-buybacks-2016-08-02.
To fund this continuing financial engineering, US corporate went on a borrowing
orgy, sold a staggering $70 billion of bonds with compressed yield spread in
the six-day stretch in August. http://www.marketwatch.com/story/companies-defy-logic-with-record-bond-issuance-and-tighter-spreads-what-gives-2016-08-09. Forbes/Bloomberg reported the Japan’s Central
Bank, BOJ, have been directly buying Japanese stocks. http://www.forbes.com/sites/adamsarhan/2016/04/25/central-banks-are-directly-buying-stocks-does-anyone-care/#11d360f71cb1 Is BOJ alone of this unprecedented buying
action to prop up stock prices?
The Nikkei 225, Shanghai Composite Index, DAX, CAC and Stoxx
indices are way off their 52-week,
suggesting that central bank buying of stocks, outside their mandate, have
largely failed of “leaning against market” direction. Investors have fled to
other “safe” haven such as gold but found only modest return since June despite
a brief spike following the Brexit upheaval when bullion was chased to US$1,360
per oz. Bullion backing exchange-traded trusts funds have now exceeded 2,039.5
tonnes – the highest since July 2013 according to Bloomberg source. https://www.bullionvault.com/gold-news/gold-prices-080820162.
This compares with GFMS estimate of global gold production of 3,155 tonnes in
2015 and declining. Without another major geo-political event or an economic
tremor, gold price seems exhausted of its steep run of H1 2016 – the massive
influx of speculative money notwithstanding.
The summation of narrative reads raging bull equities market
in US, a bubbly global bond market, a very tired global economy and an
exhausted gold bull sharing the commodity space with a threatening oil bear.
This writer is fearful of a bear turn in economic cycle falling into a
recession engulfed by an extended financial cycle lasting more than 16 years
now. The metastasis of cancer spread is the negative interest rate environment,
betting on the worst of deflationary pressures and central banks, unwittingly
abetting, are partying on seemingly unlimited appetite for bond buying.
ECB’s President’s “whatever it takes” of
quantitative easing to save the euro may
have gone too far and too deep that it no longer can consider the
“irreversibility” walking back to economic sanity of all debt has or needs a
borrowing costs attached to in rational economic logic. http://www.bloomberg.com/news/articles/2015-07-27/draghi-s-whatever-it-takes-marks-three-years-proving-enough
In that interval since, the euro has lost 20% of its value relative to the US
dollar but there was no visible economic turnaround.
Instead we see an aggravation of banking crisis looming – a
deeply-troubled sector which corporate businesses in EU so desperately leaning
for its financing needs to lit up its economic recovery cauldron. The ECB
expands the scale, scope of its stimulus support in March this year – citing
downside risks of both the EU and the global economy. http://www.bloomberg.com/news/articles/2016-03-10/ecb-cuts-all-rates-as-qe-boosted-to-80-billion-euros-a-month Repetitive terror-related geopolitical events
add pressure to EU’s economic woes even before Brexit. There is precious little
ingredients of optimism in EU forward – post Brexit has unknown lingering adjustments
and maligned impacts of trade and investment flows.
Over in Asia, Chinese July trade figures just released is
concerning. Despite a quiet Yuan devaluation of nearly 8% since last August,
exports have not performed – pointing to continued sluggish export markets.
Recent stimulus-led growth spiked and seems to have dissipated just as fast as
well.
Michelle Lam from Lombard Street Research presented these insightful
observations https://www.bullionvault.com/gold-news/china-stimulus-072920161
“The divergence between narrow and broad money growth just
highlights how difficult it has become for Beijing to generate growth by
throwing money at firms that are unwilling to invest. Stimulus has boosted
growth but has few second-round effects, and money is just not being passed
around."
July trade figures vindicated her insightful analysis. In
US$ terms, export slid 4.4% year-on-year on the back of a 4.8% decline in June.
Imports declined 12.5% year-on-year following an 8.4% decline in June. The July
import figure is more disconcerting – suggestive of weakening in domestic
consumption function as income from manufacturing-led export drive faltering
off the cliff. That calls for further ineffectual stimulus spending again to
hold up the economy to targeted growth rate. Repeated Chinese stimulus is
reliable of a momentary relief and ended up like a cracker burst needing to
ignite yet another. With credit
stimulus, renewed crisis erupts when the stimulus ends because the money
vanishes. Where to find the next income stream from defunct stimulus-fed
economic activity to service debt liabilities including borrowing costs? It is
GDP growth funded from the wrong side of the balance sheet 7 years after the
GFC. The Chinese are trapped – just like Japan – perhaps on a bigger scale. Professor
Chris Balding warns of insolvency risks. http://www.bloomberg.com/view/articles/2016-08-07/why-china-can-t-solve-its-debt-problem.
Capital Economics warned of lost Chinese growth momentum ahead, amid mounting
domestic debt mountain weighing against the rocky state of global economy. http://www.marketwatch.com/story/chinas-economy-likely-lost-more-momentum-amid-mounting-debt-2016-07-13
The preceding 4 quarters saw the Japanese economy
alternating between little growth and comatose. http://www.tradingeconomics.com/japan/gdp-growth
. On the edge of a recession, Brexit proved to be a big nasty shock despite
insignificant trading relationships linking these two large economies.
Investors seeking safe haven fled to the Yen, driving it to levels not seen
since 2013. Heightened volatility in financial markets adds upward pressure on
the Yen is corroding the export competitiveness of its all-important
manufacturing sector already pressured by weak external demand. http://www.focus-economics.com/countries/japan.
Bogged down by tepid domestic consumption, weakened exports to China,
aftershocks from Brexit and renewed deflationary pressure, Japan announced a
US$276 billion stimulus package in early August. It can only be a pain
reliever, not going to be a cure as Japan has long found structural reform of
its economy too hard a basket to handle just like China is now confronting. http://www.ft.com/cms/s/0/d4ea5848-5896-11e6-8d05-4eaa66292c32.html#axzz4GqTYzoVP
The US$100 trillion bond market is telling us what Bill
Irving, Fidelity Investments, said http://www.bloomberg.com/news/articles/2016-07-14/the-bull-market-you-haven-t-seen
“There’s just an uncomfortable feeling that we’re in a low-growth
world and it may continue to get worse. That’s why there’s demand for bonds.”
This is precisely what I see now of tired economies from US,
EU, China, Japan and OPEC – big and rich economies. Can we ignore the grim
prognosis from the bond market, noting that US equities are a raging bull now?
Equities are more whimsical of volatility, rotational of speculative play,
affected by manipulative share buybacks, short-term earnings announcements, M
& A actions, innovation breakthrough etc, etc. Bond market, however, is institutional
stabilized, far more deliberate of sustained direction, affected by consistent
central banks’ monetary policy changes tied to long-term interest rate
objective, growth and inflation outlook etc. “Smart money” trusts bond market over
equities looking at economy and financial market direction whenever there is a
huge disconnect between the two markets as is happening now. Jeffrey Gundlach
described the state of the bond market as in a state of “mass psychosis
starving for yields”. US 10-yr Treasury bond touched 1.32% on July 6 – an
all-time historical low - and now a month later, it is nearly 1.57%. Yields on
10-yr bonds, outside the US, in Japan and EU are negative.
Financial markets are trading bonds like equities and
equities like bonds as global economies continue to sink. BlackRock thinks a
lot of that is momentum trading on heightened volatility. http://www.marketwatch.com/story/bonds-have-never-been-this-expensive-but-investors-keep-piling-in-2016-07-13
Bill Gross dislike both the bond and the
equities markets now because central banks are ignored the dark side and
downsides of low interest environment, http://www.cnbc.com/2016/08/03/bill-gross-i-dont-like-stocks-or-bonds.html
Alan Greenspan, former Fed Chairman is similarly nervous about the bubbly bond
prices even as near-term risks to the US economy he sees is dissipating.
Greenspan is worried about the threat of stagflation. http://business.financialpost.com/investing/global-investor/we-ought-to-be-somewhat-nervous-about-bond-prices-warns-long-time-fed-chair-alan-greenspan?__lsa=695a-cce3
Sliding earnings escalates US equities forward valuation
beyond relative historical bandwidths. At the same time, negative bond yields
in EU/Japan made the US 10-yr Treasury yield at 1.57% currently extremely
attractive. Despite some hawkish pronouncements from the FED, another modest
interest hike is the most likely outcome in the final quarter of 2016. But that
will be treading treacherous water, particularly if 3rd qtr GDP stalling
and corporate earnings continuing of backsliding. The US must take the lead
even though the US economy has clearly lost its recovery momentum and the
prospect of recession risks in 2017 is real. One analyst warned that “”a recent
Stifel survey showing restaurant-industry sales decelerating “simultaneously”
across all categories “is a harbinger to a U.S. recession in 2017.” http://www.marketwatch.com/story/coming-recession-could-be-worst-ever-for-restaurant-stocks-2016-07-26?siteid=bigcharts&dist=bigcharts
There got to be some serious rewinding of the financial
cycle before the Chinese credit bubble burst and central bank balance sheet
globally needs re-balancing. Without another US interest rate hike in 2016,
financial market will bet against a collapsed surrender of central banks’
ability to manage financial cycle and the global economy – a disastrous
consequence unthinkable as of now. This
has some urgency of time pressure and return to sanity in financial markets.
Beyond the usually negative-correlated equities/bond market moving in
convergence, we are now also seeing highly correlated assets are displaying
widening divergence in July. The MSCI Emerging Market Index and commodities index
are moving in OPPOSITE direction. http://www.marketwatch.com/story/one-of-these-two-risk-assets-is-sending-the-wrong-signal-but-which-one-is-it-2016-08-10?siteid=yhoof2
It defies logic because emerging economies in South America, Indonesia, Africa
& Russia are big suppliers of commodities. Falling commodities prices means
emerging economies are in dire straits, how can their stock market are surging
heady in northerly direction when their GDPs are sinking and peasantry
struggling in dire poverty?
Corporate junk bonds are having a field day too, despite
current US junk bond, led by energy, default rates is at 6-year high. Big
successful fund managers with solid track records in both equities and bond
markets and a former central banker are warning of the alarming market psychosis of indifference to high
risks/low return momentum trading
oblivious to inflated equities market unsupported by fundamentals . They are
right. The high octane surging US equities market leaves me unimpressed. It is
fuelled by a comparative relative unsupported irrational optimism in financial
markets, in a sea of its own dismal economic fundamentals and contrasting
deteriorating conditions found in global pessimism everywhere. The next crash
of US equities could come with a loud bang bigger than the infamous Black
Monday, October 19, 1987 when global stock markets crashed in unison wiping out
huge values within minutes of market opening. https://en.wikipedia.org/wiki/Black_Monday_(1987).
Seeing and experiencing it is believing of the speed and horror of that
carnage.
So what is this financial cycle? By that, I meant the interactions of risk
attitude to debt and borrowing behaviours. Central banks and corporate are the
biggest culprits in this prolonged credit binge. Have we past the point of
irreversibility? Terrified, I admit I don’t know for certainty, except to say
the longer this excessive indulgence stays, the higher the mountain of debt will
grow, the deeper the global economy will sink in and, correspondingly, the
harder to turn this titanic around and prevent it from sinking killing most on
board. Equities market in UK, much of Asia, Australia and US defies fundamental
logic. And the bond market in EU/Japan defies all conventional finance
theories. Paying your debtor interest for the privilege of lending him/her disincentivize
productive work and business investment – everyone wants to borrow and
speculate on inflated financial asset bubbles from commodities, to equities to
bonds to real estate – none of them justifiable of economic fundamentals.
Without productive work and business investment, where is the consistency and
security of real wealth to support the debt obligations of assets bubbles
bought with ever escalating debt obligations? The world is living on the wrong
side of the ledger and hallucination that cash-flows from debt raising and
borrowing is real assets when it is liability instead,
The next economic cycle downturn is going to be far more
difficult of handling for compelling reasons. Sovereigns are heavily in debt,
much worse than the last GFC. It is NOT just a balance sheet recession for
heavily debt-laden corporate, particularly in the energy and materials space
but also for central bankers and retrenched households trapped with underwater
assets of all descript. No economy saddled with a banking crisis in the last
GFC has regained their long-term sustainable growth rate - a clear evidence that the damaged global economy is still a walking wounded – a
legacy of notoriety and mischief of excesses of the financial cycle irrational
exuberance. 7 years since the GFC, 11.9% of US housing market are still more
than 25% underwater of estimated market value matched to outstanding mortgage
liability. http://www.marketwatch.com/story/9-cities-that-cant-seem-to-recover-from-the-housing-crisis-2016-08-11.
The biggest fear and risks are the onset of next economic cycle
recession coincides with the rewinding of the financial cycle already set in
motion of raising interest rate – governments and central bankers will be
caught fighting the fire on two fronts simultaneously in perfect harmony of
contradictory monetary policy agenda/objectives of reversing the suicidal
financial (credit) cycle addition and desperation survival recovery immediate
pressure of even further quantitative easing to forestall economic collapse and
financial market mayhem calamity. Financial cycle are much longer term policy
decisions, it must take priority. Economic cycle is much shorter term
macro-economic consideration and sometimes it is necessary and desirable to
undertake very painful short-term economic adjustments to restructure imbalances
in the economy.
In an environment of any sudden raising of interest rate in
a weak global economy like now, we can expect massive deflation of asset values
– particularly interest-sensitive capital-intensive sectors from airlines
transportation, to utilities like energy pipeline to commodities and share
valuations as speculators unwinding their positions.
For households, it would be their over-inflated properties –
globally, the banking sector is
hamstrung by tighter prudential supervision operating within tighter margin
spread in negative interest rate environment has less scope for re-greening of
difficult loan portfolio. Central banks have been wary of asset bubbles
implosion with various tough cooling measures put in place in Hong Kong,
Singapore, restriction of foreign buying in Australia and recently a 15%
additional tax on foreign property buying in Vancouver. In Singapore, more
property developers are offering the wealthiest-end-of-town prospective buyers
of luxury penthouses the privilege of “stay first, pay later” option. https://sg.finance.yahoo.com/news/more-developers-offering-penthouses-where-000000383.html.
It speaks volumes of how fearful property developers of a market crash. Cooling
measures in place speaks of proactive of damage control these governments are
of broader sustained economic risks contingencies in a real estate implosion
similar to what happened in the last GFC in Europe and US. Post-GFC, global
economies of US, EU, Japan and China will never be the same of optimism,
vibrancy and resurgent growth we saw before 2009 of artificiality of growth
achievements and a sea of “irrational exuberance”. A lot of urban property
investors/speculators are still dreaming and hallucinating of endless party of “Past
Tense” that no longer exists and won’t come back.
Big storm is ahead in a low-growth, toxic-laden turbulent
economic environment. I see predominantly downside risks in property and
interest sensitive investments. Called it survival basic instinct, the fantasy
“castle-in-the-air” aspiration is definitely not in my financial calculus - my portfolio search for investments is now
focussing on foods, energy and healthcare sectors. Anyone disagreeing or wants
to offer better ideas I can learn from?
Zhen He
Disclaimer – the writer in this research piece implies no
recommendation whatsoever either for or against particular investing. The
information published is intended to encourage an invigorating discourse from
readers, seeks to inform, not lead it and is welcoming of alternative
viewpoints. Interested readers inclined to invest should consult their own
investment advisors, financial planners, bankers and/or accountants for
suitable advice.
