“The ultimate result of shielding men from the effects of folly is to fill the world
with fools.” ~ Herbert Spencer, English philosopher (1820 – 1903)
Financial Markets have been Calm since 2012
Since the European debt crisis in 2012, things have been relatively “calm”. Investor sentiment has improved. Central bankers did what they know best – inflate the money supply. An impressive and extended rally in stock markets around the globe continues. The recovery story seems to have broadly been accepted, albeit with some bumps.
Over the past few months, a change of mood has started to transpire. After the arrival of the emerging market crisis earlier this year – i.e. slower EM growth, currency gyrations, capital outflows – the crisis in Crimea has led to some market uncertainty. Across the board, investor expectations no longer shine as brightly as they did in 2013. The cracks in the recovery story have been noticed. This needs to be considered and kept a close eye on in the coming months.
I don’t agree with the panic mode some commentators have recently fallen into – even James Rickards, generally a moderate commentator, speaks of a financial system collapse and a 90% loss in the dollar. However, at BFI, after last year’s impressive performance in stocks, we too do expect some turbulence ahead and a sideways movement in global stock markets at best, for the next one or two quarters.
Why so cautious? Stock markets have been holding up fine…
Stock markets have recuperated rapidly from the correction in January, and despite the Crimea upset and China worries, they didn’t go into a nose dive.
First of all, stocks in general are high-priced at this point. The rally went on longer and further than could be expected. At this point, there are very few “low hanging fruits” left. And, when stock markets are technically toppish, they are more easily tipped to the downside.
Secondly, there are a number of geo-political developments – and not just Crimea – that could easily work toward the aforementioned tipping point. In that context, we need to take James Rickards’ concerns seriously as to the geo-political power games currently revolving around the US dollar.
Clearly, the efforts of replacing, or at least complementing, the dollar in its role as the world’s number one reserve and trade currency continues. Several economic power houses – China, India, Russia, Iran – are actively negotiating and building a currency framework that reduces their dependency on the Greenback. To some degree, this has been a factor in the continued depreciation of the dollar.
Currently, the factor that appears most prevalent and on the minds of investors globally is the slowing of growth in emerging economies and, most of all, that of China. Western economies do very much need China to grow. And it is…still at an estimated 7.8%! Unfortunately, the fundamental health of developed economies would prefer more.
The concerns regarding China’s growth was confirmed by Barclay’s most recent quarterly survey of professional investors conducted by Barclays. The slow growth of developed markets, combined with the slowing of GDP growth in emerging markets, and in China in particular, was clearly seen as the greatest risk for the global economy and financial markets.
Chart: Greatest risks, as perceived by professional investors: Q4 2013 vs. Q1 2014
Source: Barclays survey, Q1 2014
What is interesting about the results of the aforementioned survey by Barclays is the fact that concerns over Fed withdrawal policies have subsided largely. In other words, while until last year every word uttered by Ben Bernanke was followed hypnotically by financial markets, and the Fed in fact at times appeared to be the sole driver of stock markets, tapering concerns have given way to those regarding overall growth concerns and geo-political concerns.
Debtor nations continue to pile more new debt on to old debt, keeping their economies and finances afloat with increasingly stark monetary expansion – irrespective of what Janet Yellen and her central banker colleagues are trying to make you believe.
Skepticism about the Economic Recovery
Piling up new debt just to re-finance old debt – much like Madoff…
I know, being skeptical about the sustainability of the economic recovery or cautious about the rally in stock markets is about as unpopular as dropping a word in favor of Putin. Alerting investors to the possibility that the implications of the debt crisis might not yet be resolved quickly puts you in the camp of fear-mongers and party poopers.
However, fundamentally, not that much has changed since 2008. The fundamental issues discussed at length, namely the flaws of a fiat currency system, the decades of loose monetary policies, the resulting effects of large-scale capital MISALLOCATION and credit bubbles, and finally the mountains of public debt, remain the dominant concerns and key drivers moving forward.
In a recent study conducted by rating agency Standard & Poor’s, it was calculated how much more debt – in other words, commercial borrowing – the debtor nations of the world would require in order to satisfy their re-financing needs and to remain liquid, i.e. remain alive.
Chart: Top 10 Gross Commercial Long-Term Borrowers: Forecast for 2014 (% of Total)
Source: Standard & Poor’s, 2014
And the winner is…: Of course, the USA. America leads the ranking by far. Of the total (100%) refinancing needs, the US makes up 31.6%. Almost every third dollar, which is “created” for the purpose of global public refinancing needs, goes straight to the coffers of the US Treasury.
Not all that far behind is Japan. Their re-financing needs will make up roughly 25.6% of the total. Italy comes in as third, with 4.7%, while the Euro zone overall makes up roughly one-tenth. Amongst emerging markets, China and Brazil account for about 4% each.
The recovery and tapering talk has been misleading all along. In this context, it becomes even less credible. It is impossible to conceive how the world, and America in particular, should be able to do away with its debt problems and credit bubbles by merely creating more debt and credit.
How much money are we talking about? S&P estimates that for the 127 countries for which an S&P rating is calculated, a total of approximately US$ 7’100 Billion of medium- to long-term debt paper (exclusive of money market / debt instruments of one year or less) will be issued. That amount is 2.7% higher than in 2013.
That governments are indebted has become a generally accepted rule. Particularly in times of low interest, debt-financing appears to be the least painful means for liquidity and certainly a measure politicians will generally favor over austerity, or spending less.
The recent past (European debt crisis), however, has unveiled the volatility and consequences an economy is exposed to when its government lives beyond its financial means. Every cent must not only be repaid, but it also must bear interest. Of the US$ 7.1 Trillion of new debt acquired this year, roughly 61% are there exclusively for the re-financing of old debt!
Reaching the end of a deceptive lull in global markets
In my view, we are nearing the end of a deceptive lull. The general perception: All is back in order; central bankers have saved the world. Well, that perception will turn out to be false. The “party” is losing steam and the comfort of the lull is quickly coming to end. Central bankers, if anything, have made things worse.
We are now headed back into more volatile territory. It is certainly worthwhile to consider a more cautious asset allocation in your portfolios, or to implement more extensive risk management measures, ranging from stop losses to put options.
Frank R. Suess
BFI Wealth Management (International) is an independent wealth management and investment advisory firm with offices in Switzerland. BFI specializes in providing their upscale international clientele with a single point of contact for an array of multi-jurisdictional wealth services and solutions. BFI Wealth Management is a subsidiary of BFI Capital Group, a company with 20 years experience in offering a unique array of premium risk and wealth management services to private and institutional clients.
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