A Bit of Commentary
Earlier this year I began my update talking about Brexit, and the unexpected vote for the UK to exit the EU. Tuesday, Donald Trump was elected President of the United States, and just like Brexit, the establishment didn’t think it could happen… but it did. The gloom and doom predictions of the British economy going down in flames did not come to pass, nor will the dire predictions come true about Donald Trump; in fact the markets went up and did not experience a 10% correction as predicted. The UK voted to break free from the suffocating EU hold, regain their sovereignty and chart their own economic destiny.
Yesterday, American citizens elected Donald Trump to shake up Washington and break free from a smothering Federal government, so that individual states, businesses and citizens could regain the freedom to chart, their own course. Almost all the pollsters, media and many elected officials on both sides of the political isle were wrong in their assessment of American voters, because in reality, they don’t understand them. Brexit and the election of Donald Trump are two events which will change the world, however, they are only the beginning, as there are many more elections and referendums coming up in the next 3 to nine months and new leaders will emerge and more nations will likely exit the EU. If these things can happen in the UK and the US, they can happen anywhere. Like Bob Dylan wrote, “the times they are a changing” and citizens, nations and world markets should prepare for the changes coming their way.
So where are we after Donald Trump shook the world? Although most markets initially dropped, when all was finished: US, Asia & EU markets were up, except for Spain, and most commodities were up except for oil. What’s going to happen next in the financial markets? Most don’t have a clue, nor have they had time to assess what Trump’s unexpected win means, but the initial reaction seems to be cautious optimism. I believe there will be turbulence ahead and I suspect that US Federal Reserve Chairman Janet Yellen is looking at early retirement in 2018, when her term expires. Trump will have the ability to appoint Federal Reserve members and very likely will be a proponent of reigning in the Fed’s independence from congressional oversight; a direction congress is also headed. President elect Trump spoke frequently of dealing with the US debt and fiscal irresponsibility, and since his party has majorities in both the House and the Senate, he has a genuine opportunity to apply fiscal discipline instead of more central bank stimulus which created artificial market bubbles that cannot be sustained.
After Brexit and Trump, Populists Target Next Dominoes in Europe (11-9-16) http://www.bloomberg.com/news/articles/2016-11-09/after-brexit-and-trump-populists-target-next-dominoes-in-europe
Fed Faces Overhaul as Washington Braces for Trump-Led Shakeup(11-9-16) http://www.bloomberg.com/news/articles/2016-11-09/fed-faces-overhaul-as-washington-braces-for-trump-led-shakeup
Central Banks
The Federal Reserve did not raise interest rates in their November meeting a week ago, but they said conditions are such that they expect to do so in December. This is the same familiar chorus they’ve sang at every meeting for the last four years, however, they have only raised rates once, a mere quarter point, last December and it sent markets into a tail spin. Sooner or later the US is going to have to deal with their artificially low interest rates and government spending and apply fiscal reality. When they do, things will become more difficult before they get better. Markets will spiral down, but that is inevitable at this point, no matter what course is taken, the question is how do we best manage this impending reality.
Hours after the Bank of Japan’s announcement not to lower interest rates, the Federal Reserve left its rates unchanged, but also said the case for increased rates had strengthened. Though U.S. job growth is healthy, inflation is stuck below the Fed’s 2% target and bond investors expect it to stay there. The eurozone is in the same boat, the European Central Bank (ECB) has pushed interest rates below zero in an effort to boost inflation, which, even excluding food and energy, is below 1%.
The ECB is sticking to their signature policy: negative interest rates, however they also indicated they weren’t intending to go lower. Two senior ECB officials warned that subzero rates could, over time, cause banks to reduce lending to the economy—the opposite of what the central bank hopes to achieve. The Daily Reckoning wrote, “Central bank balance sheets exploded from $6 trillion pre-crisis to a flammable $18 trillion at present. And the mad scientists can’t uninvent the monetary A-bomb they created. Unwinding their balance sheets would almost certainly cause a financial detonation to dwarf 2008.”
Bloomberg reported that, “Bonds are set for their worst month since 2014, as a brightening economic picture bolstered speculation that major central banks will shift away from ultra-tight monetary policy. Meanwhile global company bond sales have already topped $41 billion this week as investors seek refuge from more than $10 trillion of negative-yielding debt created by easy-money policies in Japan and Europe.”
Bonds Fall Dollar Jumps as Traders Mull Waning Stimulus (10-27-16) http://www.bloomberg.com/news/articles/2016-10-26/asian-shares-poised-for-mixed-open-as-china-banks-come-in-focus
The End of the Great Experiment (10-13-16) Daily Reckoning | https://dailyreckoning.com/end-great-experiment/
ECB Officials Express Concerns Over Effect of Negative Rates on Lending (10-4-16) WSJ http://www.wsj.com/articles/ecbs-praet-says-weak-bank-shares-create-danger-1475571857
Janet Yellen is a Clueless Economist Says Stockman (10-3-16) http://video.foxbusiness.com/v/5138984343001/stockman-janet-yellen-is-a-clueless-economist/?#sp=show-clips
Central Bank Tools Are Losing Their Edge (9-21-16) WSJ http://www.wsj.com/articles/central-bank-tools-are-losing-their-edge-1474501934
The Bank of Japan said it would target a zero yield for 10-year government bonds—deploying a new tool in its fight against deflation. Gov. Haruhiko Kuroda, who also has cut short-term interest rates below zero, said controlling the yield curve was now the central part of his plan.
There are some potential negative effects of this plan however. The BOJ’s bond buying has brought long-term borrowing costs close to short-term costs, this is known as flattening the yield curve, in a way that the central bank says, “may have a negative impact on economic activity,” the WSJ reported. The article went on to say, “Extremely low interest rates on long-term lending could reduce banks’ incentive to lend money because they aren’t making money on charging interest. It also poses a problem for very long-term investors, like pension funds, by reducing the return on the government bonds these funds buy. For instance, this summer, the 10-year bond yield got down to nearly minus 0.3%, only a hair above where short-term bills stood.”
The WSJ said, the BOJ wants their 10-year yield to be around zero, allowing the bank to have negative yields on short-term debt, while maintaining a gap between short and long—especially some of its very-long-dated debt. By doing so, it can help the banks, insurers and pension funds that objected to the previous policy. The BOJ is going where few central banks have gone before. The best-known example was in the U.S. after World War II, when the Federal Reserve tried to keep interest rates low to reduce the burden of wartime debt. One worry expressed by Japan economist Marcel Thielant is that, “In theory, they could be forced to buy an unlimited amount of bonds.”
Understanding the BOJ Decision in Six Simple Questions (9-21-16) WSJ | http://www.wsj.com/articles/why-japanese-bond-investors-will-get-nothingand-like-it-1474466356
Bank of Japan Sets Bond-Rate Target in Policy Revamp (9-21-16) WSJ | http://www.wsj.com/articles/boj-changes-policy-framework-after-review-of-measures-1474432869
At a hearing in the European Parliament in Brussels, ECB President Mario Draghi warned of adverse side effects of keeping interest rates low for too long, saying ECB action was “not enough for delivering real and sustainable growth in the long term. It’s quite clear that other policies should complement [central-bank] action.”
Luigi Speranza, an economist with BNP Paribas in London, said Draghi’s comments indicated that further interest-rate cuts by the ECB were unlikely. “The ECB’s call for other policy makers to play their own part has become louder and clearer of late, reflecting an acknowledgment that monetary policy has its limitations but probably also some frustration that the burden of supporting the economy is largely left to the ECB alone,” Mr. Speranza said. The European Central Bank needs to change the rules of the game if it wants to keep playing in the bond market, because, like Japan, they will skew the EU bond markets if they don’t.
ECB Faces Bond-Buying Shuffle With QE Extension on the Cards (9-6-16) http://www.bloomberg.com/news/articles/2016-09-06/ecb-faces-bond-buying-shuffle-with-qe-extension-on-the-cards
Draghi Urges Eurozone Governments to Help ECB Boost Economy (9-26-16) WSJ http://www.wsj.com/articles/draghi-says-eu-is-weathering-u-k-s-brexit-impact-1474901245
Russian Central Bank Governor Nabiullina is one of the few that are not addicted to artificial stimulus. In a Bloomberg interview she said:
“Quantitative easing was initially conceived as a temporary policy, to win time for structural changes. We see that it’s being carried out for quite an extended period and negative consequences of the policy are accumulating. … The unprecedented tools used by central banks to fight deflation and fire up growth didn’t serve the global economy well, and once they’re gone, they aren’t coming back. Besides spillovers that are inflating asset bubbles in different segments of global markets, another consequence of ultra-easy settings is that investment has poured into projects that are hurting productivity. The outcome is a further drag on economic growth and trade that’s reverberating worldwide. For Russia, we don’t yet see grounds to use such non-traditional measures. We have absolutely opposite goals. Our inflation is high and we need to lower it. Where global central banks went awry is by trying to administer a monetary cure to imbalances for which the best solution may lie elsewhere and that ultimately accounts for the sluggish economic growth and low inflation. Monetary policy alone can’t cope with these imbalances. For the effort to be effective, what’s needed is a good mix, a good combination of fiscal and monetary-policy and structural changes.”
Russia’s By-the-Book Central Banker Sees QE Vanishing for Good (10-13-16)http://www.bloomberg.com/news/articles/2016-10-13/russia-s-by-the-book-central-banker-sees-qe-vanishing-for-good
Signs of Recession
While reports show jobs are growing, the trend in the unemployment rate has flipped from improving to deteriorating. September’s jobs report contained a sign that investors should be on alert for a US recession. For most people, the economy’s ups and downs are best measured by famous indicators like monthly job reports and quarterly releases of gross domestic product, but students of the arcane took special notice earlier this month when the Bureau of Economic Analysis released some disturbing data that didn’t make anybody’s front page. In August, domestic heavy-truck sales fell 29 percent from the same period in 2015, the weakest month in over three years. Any drop that dramatic could always be an anomaly, but heavy-truck sales have been slipping for two years now. Broad weakness in this category has historically been a reliable hint that a recession is on its way. Nine restaurant companies representing 14 chains have filed for bankruptcy since December: Garden Fresh Restaurant, Restaurants Acquisitions, Cosi, Logan’s Roadhouse, Fox & Hound, Champps, Bailey’s, Old Country Buffet, HomeTown Buffet, Ryan’s, Johnny Carino’s, Quaker Steak & Lube, and Zio’s Italian Kitchen. US Industrial production fell another 1% in September, the 13th consecutive contraction.
Shallow Contraction Continues IP Falls for 13th Straight Month (10-17-16) http://www.alhambrapartners.com/2016/10/17/shallow-contraction-continues-ip-falls-for-13th-straight-month/
One of Jeffrey Gundlach’s Favorite Recession Indicators Just Got Triggered (10-7-16) http://www.bloomberg.com/news/articles/2016-10-07/one-of-jeff-gundlach-s-favorite-recession-indicators-just-got-triggered
Here’s Some Compelling Data about the Next Recession (10-5-16) SMC https://www.sovereignman.com/trends/heres-some-compelling-data-about-the-next-recession-20289/?inf_contact_key=88c42fbd7aaadbe322a14fd7148b11bd324983e642eca57c8354c1e07cd26640
Restaurant Industry, Leading Indicator of US Economy Sours, Bankruptcies Pile up (10.3.16) http://wolfstreet.com/2016/10/02/restaurant-industry-bankruptcies-restaurant-performance-index-rpi/
18-Wheeler Alert Heavy Truck Sales Down 29% Y/Y (9-30-16) Bloomberg https://www.bloomberg.com/view/articles/2016-09-28/as-heavy-truck-sales-go-so-goes-the-economy
Debt
Global debt issuance is on course to hit a record high in 2016 as figures showed sales this year topped $5 trillion (£3.9 trillion) at the end of September. Debt issuance rose to $5.02 trillion in the nine months leading up to September 22, according to Dealogic, putting 2016 on course to beat the all-time high of $6.6 trillion recorded in 2006. Bloomberg reported that Egypt just secured an additional $2B loan from the IMF.
The WSJ pointed out the main reason auto sales have bubbled over is due to the continuous degradation of lending standards over the past 6 years, fueled by the Wall Street securitization machine. Ford executives admitted on a recent conference call that US auto sales have reached a plateau. Just like in 2008, Wall Street is starting to bet against the bubble they created, as S&P warns that downgrades of certain subprime securitizations are imminent in the face of mounting delinquencies and write-offs. “The auto industry has also become intensely competitive, which has led to price competition, loosening of credit standards, and higher charge-offs,” S&P said.
Egypt Secures $2 Billion in Financing as IMF Deal Nears (11-10-16) http://www.bloomberg.com/news/articles/2016-11-10/egypt-secures-2-billion-in-financing-as-imf-approval-nears
Slumping Used Car Prices Spell Disaster For Subprime Auto Securitizations (10-27-16) http://www.zerohedge.com/news/2016-10-27/slumping-used-car-prices-spell-disaster-subprime-securitizations
More Americans Falling Behind on Car Loan Payments, S&P Says (10-12-16) http://www.bloomberg.com/news/articles/2016-10-11/more-americans-falling-behind-on-car-loan-payments-s-p-says
Global Debt Climbs Towards Fresh High As Companies And Countries Keep On Borrowing (9-27-16) The Telegraph | http://www.telegraph.co.uk/business/2016/09/26/global-debt-climbs-towards-fresh-high-as-companies-and-countries/
UK Keeps Bucking Dire Brexit Predictions
For the second quarter in a row, the UK economy is preforming above expectations and ignoring doom & gloom Brexit predictions. The UK’s biggest banks and financial firms could gain an additional 12 billion pounds ($14.6 billion) a year in revenue from Britain leaving the European Union, according to a report from a pro-Brexit lobby group.
In a report published Sunday, the UK Leave Means Leave campaign said, “Leaving the 28-nation trading bloc and ending membership in the EU single market for trade and services would help Britain cut stifling Brussels red tape and help UK-based financial firms grow sales.” London will also avoid a banking crisis and a fight for the survival of the euro area, the group said.
Most UK bankers believe London will remain Europe’s pre-eminent financial center after Brexit, according to consulting firm Synechron Inc. About 72 percent of financial professionals agreed that the City of London would retain its role as the main hub for finance in the European Union for at least five years, Synechron said, citing a survey of 80 financial services executives working in capital markets in the district. The EU is already meeting with Japanese and Chinese officials and crafting post Brexit trade agreements.
Britain Holds Talks With China to Seek Investment After Brexit (11-10-16) http://www.bloomberg.com/news/articles/2016-11-10/britain-holds-talks-with-china-to-seek-investment-after-brexit
U.K. Bankers Confident City Will Remain Finance Hub After Brexit (11-2-16)http://www.bloomberg.com/news/articles/2016-11-02/u-k-bankers-confident-city-will-remain-finance-hub-after-brexit
U.K. Banks May Gain $14.6 Billion Yearly Leaving EU, Says Lobby (10-29-16) http://www.bloomberg.com/news/articles/2016-10-30/u-k-banks-may-gain-14-6-billion-yearly-leaving-eu-says-lobby
U.K. Growth Shows an Economy Resilient to Brexit (10-27-16) http://www.bloomberg.com/news/articles/2016-10-27/u-k-economy-proves-resilient-to-brexit-with-hollywood-s-help
British Economy Bounces Despite Brexit Blues (9-30-16) WSJ http://www.wsj.com/articles/british-economy-bounces-despite-brexit-blues-1475226388
EU Banking Problems
The EU is planning to give authorities new powers to tackle the derivative clearinghouse problem, in order to prevent potential default from wreaking havoc throughout the financial system. Draft EU legislation seen by Bloomberg sets out rules on saving or closing the clearinghouses that would apply to firms such as London-based LCH. The proposals cover everything from the creation of resolution authorities to the powers they would have when winding a company down, including writing down shares, debt and collateral.
Deutsche Bank is struggling to recapitalize, but with $47 trillion in derivatives there is little chance they can regain stability. “Eight years after Lehman Brothers’ collapse sparked the financial crisis; Europe’s banks still have 1.2 trillion euros ($1.3 trillion) of non-performing loans and will probably be stuck with them for decades to come, according to KPMG LLP. Anemic economic growth across the region is making it harder for lenders to off-load toxic assets, hurting profitability,” said the WSJ.
European Banks Stuck With $1.3 Trillion of Bad Loans, KPMG Says (10-30-16) http://www.bloomberg.com/news/articles/2016-10-31/european-banks-stuck-with-1-3-trillion-of-bad-loans-kpmg-says
Germany’s Banking Problem Is Bigger Than Deutsche Bank (10-12-16) http://www.wsj.com/articles/germanys-banking-problem-is-bigger-than-deutsche-bank-1476264606
No Party for Old Europe’s Banks (10-18-16) https://www.bloomberg.com/gadfly/articles/2016-10-19/europe-s-banks-may-fail-to-match-wall-street-s-ficc-revenue
Italy Wags Finger at Germany Over Deutsche’s Woes (10-9-16) WSJ http://www.wsj.com/articles/italy-wags-finger-at-germany-over-deutsches-woes-1476042006
EU Readies Plan for Clearing Crisis, the New Too-Big-to-Fail (10-5-16) http://www.bloomberg.com/news/articles/2016-10-05/eu-readies-plans-for-clearing-crisis-the-next-too-big-to-fail
IMF & World Banks
Bloomberg wrote, Eight years after the financial crisis, the world is suffering from a debt hangover of unprecedented proportions. Gross debt in the non-financial sector has more than doubled in nominal terms since the turn of the century, reaching $152 trillion last year, and it’s still rising, the International Monetary Fund said. The figure includes debt held by governments, non-financial firms and households. Current debt levels now sit at a record 225 percent of world gross domestic product, the IMF said. EU draft law calls for resolution authorities to be created with a standard set of powers that would override national regimes. The IMF flagged the euro area and China as economies where it’s particularly important for deleveraging to occur.
China’s yuan officially entered the IMF’s basket of reserve currencies Saturday, which is another step to gain international legitimacy for China. The US Dollar (USD), euro, yen and British pound and now the yuan will be used as one of the IMF’s official lending currencies in emergency bailouts. Central banks have only just begun to increase their stocks of China’s yuan since the IMF last year announced its decision. It’s a justifiable acknowledgment of the country’s development into a global economic powerhouse, …and irreversible path towards opening up, integrating into the global economy and playing the economic game by the rules,” said IMF Managing Director Christine Lagarde.
The Global Banking Crisis 2.0 (10-21-16) Harry Dent http://economyandmarkets.com/harry-dent-the-global-banking-crisis-infographic/
The IMF Is Worried About the World’s $152 Trillion Debt Pile (10-5-16) http://www.bloomberg.com/news/articles/2016-10-05/a-record-152-trillion-in-global-debt-unnerves-imf-officials
China Marks Milestone with Yuan’s Entry into IMF Reserve Basket (9-30-16) WSJ http://www.wsj.com/articles/china-marks-milestone-with-yuans-entry-into-imf-reserve-basket-1475260422
Global Markets
Bloomberg reported, with all the uncertainty fund managers especially in the US have raised their cash balances to 5.8 percent of their portfolios in October, up from 5.5 percent last month, matching levels not seen since the aftermath of the Brexit vote. The cash position in these funds hasn’t been that high since November 2001. In October, global investors were exiting Japanese stock at the highest levels since 1987, as their hope in Abenomics (a term coined to describe the Japan’s Prime Minister Abe) is faltering.
The Dow has fluctuated throughout 2016 without any significant gain or loss from its 17,823 start at the beginning of the year. The Stoxx Europe 600 Index recently sank to its lowest level in almost four months, led by plunges in banks, automakers and energy producers. Western European equity markets fell, the greatest decline was Italy’s FTSE MIB Index which fell 2.5 percent, since August.
The outlook is good for many emerging markets in 2017. Bloomberg reported that India is headed for its third straight year as the fastest-growing major economy in the world, with the IMF projecting a 7.6 percent jump in gross domestic product. China, whose economic takeoff preceded India’s, has a trickier management job, because its phase of hyper-growth is ending. The IMF projects 2017 growth of 6.2 percent, down from an estimated 6.6 percent this year. President Xi Jinping is trying to shift the economy toward consumer spending and away from corporate capital investment, infrastructure spending, and exports. That’s good for Asian nations that make goods that the Chinese buy, but bad for European, Japanese, and American companies that sell high-tech machines to Chinese manufacturers, Bloomberg reported.
In an October 20th, article Bloomberg reported, In the EU, Germany’s excess of exports over imports forces plants to close in countries running trade deficits. Italian Prime Minister Matteo Renzi told the Council on Foreign Relations in NY that, “Stressing austerity means destroying Europe. Which is the only country which receives an advantage from this strategy? The one which exports the most is Germany,” Global trade this year and next is forecast to grow at the slowest pace since the 2008 financial crisis. “The division is between people who think the future is a place of hope and the people who think it’s a trap,” Prime Minister Renzi said during a visit to New York. Columbia Business School Dean Glenn Hubbard has also said: “We run the risk of slow growth turning into a crisis.”
Junk-Bond Sales Cool in Market’s Worst Slump Since February (11-3-16) http://www.bloomberg.com/news/articles/2016-11-03/junk-bond-sales-chilled-amid-market-s-worst-slump-since-february
Drops Worsen for Europe Stocks in Longest Losing Run Since ’14 (11-2-16) http://www.bloomberg.com/news/articles/2016-11-02/drops-worsen-for-europe-stocks-in-longest-losing-run-since-14
HSBC There’s Now a Very High Chance of a Severe Fall In US Stocks (10-12-16) http://www.bloomberg.com/news/articles/2016-10-12/hsbc-there-s-now-a-very-high-chance-of-a-severe-fall-in-u-s-stocks
Global Markets Stumble Into a High-Debt, Low-Investment 2017 Next year will be Mediocre at Best (10-20-16) http://www.bloomberg.com/news/features/2016-10-20/global-markets-stumble-into-a-high-debt-low-investment-2017
Since Investor Cash Levels Jump Toward Levels Not Seen 9/11 (10-18-16) http://www.bloomberg.com/news/articles/2016-10-18/investor-cash-levels-jump-toward-levels-not-seen-since-9-11
Global Money Flees Japan Stocks at Fastest Pace Since 1987 (10-18-16) http://www.bloomberg.com/news/articles/2016-10-18/global-money-is-fleeing-japan-stocks-at-fastest-pace-since-1987
Conclusion
There are so many pieces spinning, it is difficult to concentrate on just one thing or one set of things. Global markets, central bankers, new leaders, immigration issues, political upheaval, Islamic terrorism and international conflicts are all interwoven, creating uncertainty and volatility. Unsustainable debt levels are growing on almost every level in nations, central banks, commercial and consumer banks, as well as individual consumer debt. The debt level of the world is already far higher than world’s assets. Thankfully, there are nations and places of refuge, where debt levels are sustainable, governments aren’t deficit spending and banks are well capitalized, but we will leave that discussion for a future update. We’ve seen much change in 2016 already, and in the next 3 to 9 months, many more national elections and referendums will further alter the political and financial landscape. So hold on and keep a watchful eye so that you can best position yourself to take advantage of the turbulence, and not be caught off guard.
Fulton's Perspective on Global Economies, Markets & Political Events 