Financial and economic market developments

A notable development these last few weeks has been the change of forward guidance coming from the Federal reserve. The Fed has gradually turned away from indicating that they will have 4 instances of rate hikes. This “dovish” talk has caused the dollar to lose value (relative to global currencies), which means capital may flow into the US and equities can only hope for better performance in coming quarters. First quarter earnings results have been terrible for corporate US.

I’ve been following the negative developments in Venezuela and the following has happened :-

1.     The country is facing runaway inflation, Zimbabwe-style.

Inflation has forced the government to use up its now dwindling cash reserves. Unofficial data indicates an annualised inflation rate of 397.4%

The government will no longer be able to afford printing money yet the President still denies inflation.

Mr. Maduro recently imposed a 2-day work-week for public servants in Venezuela arguing that keeping them home would save energy.

2.     In the face of the low oil prices, the economy is expected to shrink by 8% this year.

3.     There’s a real negative turn that seems to be only getting worse by the days.

Searching Venezuela news on Google right now (09/05/26) will bring up news of a people working to oust Maduro in a referendum petition. A story that is currently fresh on Reddit will appear that the leader of a regional opposition party leader has only just been assassinated. It gets very grim very quickly down the search results but we can only hope for the best for the people of Venezuela.

In a tide of social unrest that’s getting underway, people are getting desperate for basic necessities like food and medicine.

I expound on a few global risk items and concerns to watch for in the coming quarters as highlighted initially by Preston of The Investors Podcast :-

1.     The impact of negative rates for banks in Europe (Particularly Deutsche Bank)

As I’ve written previously, negative rates are still quite a ‘new’ phenomenon and their effects on the financial markets is one that we have to continually keep watch on. How long will banks in Europe sustain having to pay central banks to hold their excess reserves? How much new lending are banks actually doing? How long will banks accept eroded profits? How much longer will inflation remain low in Europe? Answers to these questions are still developing and so we wait.

2.     A strong Yen pushing Japanese stock prices lower

Japanese stocks and exports that depend on a weak yen are being hammered. The recent major earthquakes in Japan have necessitated a postponement of the tax hike that's expected to be coming Japan's way as well as a delayed early election possibility. 

3.     Chinese Commodity prices returning to reality (because the PBOC pushed commodity prices into outer space during the first quarter)

Action by the PBOC to pump credit into the Chinese economy is a definite watch. The image below courtesy of Stan Druckenmiller through Zero Hedge tells very many stories. A fact for the day from Stan on China would be, “since 2012 the Chinese banking sector has allowed credit to grow by the amount of the entire Brazilian GDP per year!”

4.     Potential impacts of the Saudi currency de-pegging from the US dollar due to the speed and impact of their domestic reserves being spent.  Could cause the dollar to strengthen and put more pressure on US Stocks.

Given that Saudi’s 80% revenue is oil-dependent, prolonged low prices in oil may break Saudi’s peg to the USD some way or another. Although still quite an unlikely event given their still ‘deep’ reserve pockets, markets are pricing a riyal devaluation very highly at the moment, as the Bloomberg currency forward image showed (December 2015). If the Saudi riyal is de-pegged or loosened, the impacts to the global economy would certainly be catastrophic given their position as the biggest OPEC member. The reason Saudi Arabia may want to think about de-pegging would be to prop up revenue as a devalued Riyal would be a great welcome boost. The Saudi oil minister Ali al-Naimi was ousted on Saturday 07/05/16. Mr Naimi had led calls to help re-balance the struggling oil market so his removal may indicate a slower price recovery.

5.     Watch the 2^nd quarters US earnings trends.  If earnings continue to slip into the second quarter, things could get ugly for US Stocks.

As Preston, of Investors Podcast noted, US reporting data from quarter 1 was terrible. Fundamentally, growth continues to slow in the US, corporate profit margins continue to decrease and international markets continue to struggle (particularly the Bank of Japan, the PBOC, and European Banks).  Although the market could even run higher, the upside to downside risk/reward continues to be asymmetrical.

6.     Brexit: This could be a big concern for trade and US stocks.

Instability due to an exit of Britain from the EU would be a real concern. The June 23^rd referendum is one that all eyes are eagerly going to be watching soon.

7.     High yield debt.  The oil industry supposedly has 3 trillion or more in debt with as much as 50% being estimated as junk.  Some really interesting things could happen here if global demand continues to slip in energy and prices start heading lower again.  I think this is a major concern moving forward, but there is no way of knowing if this trend will return for sure. 

Some expect that this trend will continue but it could go the other way as well. Oil prices are showing some signs of recovering but Iran's recent stint to crank up production may compel Russia and the Saudis to ramp up production as well. These actions would go some way to reverse the current upward trend.

Reference links provided within the post in grey.

A economic market review of the last 3 weeks

The last three weeks have seen central banks do what one would probably simply describe as “amazing” stuff as follows; 

§  the Sweden Cut Rates to minus 0.5% from minus 0.35% – in its battle to revive inflation and keep the krona from appreciating. How this works is that lowering the rate to larger negatives is intended to impose a charge on banks when they make their deposits with the central bank. This charge will encourage them to lend thus stimulating the economy and then pushing inflation higher. This doesn’t worry the central bankers because Swedish banks are well leveraged and highly profitable for the charge to be too much of a disincentive in their business.

In terms of the currency, krona, the Swedish central bank, the Riksbank is seeking to control the exchange rate in lowering interest rates as well. How this happens is that negative rates will discourage foreign investors from holding krona and pushing the krona value down which in turn pushes import prices up which gives inflation a further kick.

§  the People’s Bank of China (PBOC) did a series of eye-popping liquidity injections in that same period;

o   starting with a $1.5 billion injection,

o   then another Yuan Devaluation and a $54 billion injection,

o   then another $49 billion injection,

China’s PBOC is releasing extra cash to ensure China’s cash machines are continually oiled. This is a way to ease monetary policy without using the traditional toolkits like interest-rate cuts. By continuing to devalue, China is hoping to encourage investment as they seek acceptance into the international monetary system. A lower yuan means more foreign demand for yuan, boosted export demand due to the devalued prices. Hopefully then a devalued currency will gain the favour of outsiders and economists as China seeks to push on to join the basket of Special Drawing Rights currencies.

§  the ECB cut rates and added more Quantitative Easing (money-printing). The ECB has also sent rates further into the negative territory (-0.4% now from -0.3%) with the hope that it would stimulate bank lending and QE raised to 80 billion Euros from 60 billion a month to provide a boost in liquidity and prevent deflation. Things are not looking so great for the ECB as inflation is moving nowhere as desired and the uncertainties in the world economy are still with us.

§  Norway cut rates to 0.5%. Norway being a big oil producer continues to hurt from the low oil prices.

§  the Reserve Bank of New Zealand cut rates in a shock move that economists didn’t seem to expect. The NZ dollar fell 1% from the announcement but the main reasons to cite for the reserve bank wanting to maintain the lowest interest rate at 2.25% is weak China demand and global growth uncertainties.

§  the US FED cut the number of interest rate hikes for 2016. The sentiment from Janet Yellen the Fed Chis is that the pace at which the FED will hike rates will slow down in 2016. Expectations for growth and inflation have been cut and eyes are on the rate at which the US economy will travel for the remaining year.

Key themes in the world economy continue to be oil, inflation fears and the Fed. The Fed’s decision to weaken the dollar has put great pressure on Europe and Japan (we may even see more devaluations). European banks are in a tight squeeze with the ECB lowering rates and adding more QE as this means they will not be profitable in 2016. These pressures could be negative in a global sense if things worsen. With a weakening USD, commodities (as they strongly correlate to the USD) have gained strength and this has put relief on US banks and lenders that provided capital to the commodities complex. Oil at $40 though may not be sustainable so it will be very interesting to watch what happens in the coming months. 

Reference: Stig and Preston updates for pointers.

Some visuals from the Australian Federal Budget 2015-16

A 5-page visual of interesting picks arising from the 2015-16 Australian Federal Budget! 

The 'dull' budget can be summed up as an attempt to bring Australia to surplus (Government Revenues > Expenditure) in about 5 years mostly through spending cuts to buckets such as education, welfare and health sectors.

A few Nobel Prize facts and reflections on economics

Perhaps the most stunning of the Nobel Prize statistics is the fact that for every 1 woman that has won, 18 men would have already won the prize. The common explanation to this 'boy's club' question over the years has been that there have been far fewer women in science than have men, a field in which the Prize is heavily skewed. Assuming that the whole world provided similar opportunities for all and social expectations shifted to accommodate a world where women are treated the same as men, perhaps we shall see more women on the forefront of science, literature and peace in the years to come.

Another interesting conjecture to note is the role economics has played over the years, since 1901. One of the cornerstones of economics is a theory referred to as the rational-expectations theory, the idea that people make choices based on their rational thinking, available information and past experiences. Economists then go ahead and extend this theory to come up with the efficient-market hypothesis, the absurd idea that financial markets reflect all available information and therefore inherently tended towards efficiency and stable risk dispersion. These two theories have been central to mainstream economics for more than 40 years. Most followers of economics can see that these models blind economists to reality and certain that the universe was unfolding as 'in equilibrium', they failed both to anticipate the financial crisis of 2008 and to chart an effective path to recovery. The economic crisis has produced a crisis in the study of economics – a growing realization that if the field is going to offer meaningful solutions, greater attention must be paid to what is happening in university lecture halls and seminar rooms.

Perhaps a great starting point in this reformation exercise should be a denouncement of rational expectations and efficient-market modelling and considering what behavioural economics has to offer; which embodies the mindset that people could actually sometimes be have irrationally and contrary to predictions of economic models. Notable individuals that have won Nobel Prizes in behavioural economics are laureates Gary Becker (motives, consumer mistakes; 1992), Herbert Simon (bounded rationality; 1978), Daniel Kahneman (illusion of validity, anchoring bias; 2002) and George Akerlof (procrastination; 2001).

References: FT website, The Nobel Prize official website.

[DK 15/03/15]

Don't blame the whole 'dismal science'!

In response to this interesting article from Business Daily Africa, Why development economics is biggest challenge to growth, I'd say:

It's the massive generalisations within the 'dismal science' that are of concern and that's what should really come under fire, not the whole science. I still think there's some hope if economics is done a little differently. For instance, I'd go straight for the famed General Equilibrium as an example of one massively broken theory that's taught to new economics students so religiously. If you choose to do the unorthodox qual and quant economics (which is what Behavioral Economics mostly stands for and that I'm quite a fan of), I believe the results will be much more palatable to current affairs. For instance - as mentioned by a previous commenter adopting a different risk management methodology, or viewing public and private debt in the truer way that that debt should be looked at in stead of masking it frivolously in the way current  governments are doing (or should have learned not do having been burnt by the recent crisis).Then I believe you will still have some pretty strong cases to lobby the body politic with i.e. call them to action issues like the massive rising income inequalities of the present times, debt escalations (because as clearly experienced in the US with the largely sub-prime loan-backed crisis, when debts rise above a certain threshold, debt deflation kicks in [poor Eurozone is experiencing deflation at the moment], and then asset prices go to the floor).