8
Mar

The 7 Big Risks Facing The Global Economy

by Riaan Nel in Global Economy

 

Tail risk

 

Recently Nouriel Roubini wrote an article about the 7 risks he sees that are plaguing the US and global economy.  I want to provide a summary of the article and share some of my thoughts about the issues he raises.  I agree with Roubini that we potentially might be entering an era of volatility that is more serious than anything since 2009.  There are currently seven sources of global “tail risk.”  Tails are the end portions of distribution curves represented by bell-shaped graphs showing the statistical probability of a measured event.

Risk 1: The slowdown in China.  According to Roubini China is more likely to have a bumpy landing as its economy is slowing down.  I agree that it seems like the policies the Chinese government have used to manage the process of a slowdown and to manage the restructuring of their economy from and export led model to a more domestic consumption based model, seems to be running out of steam.

Risk 2:  The emerging world is plagued by currency weakness which has the dangerous consequence of increasing the real value of trillions of dollars worth of debt these economies have built up over the last decade.  As a long term trend I continue to believe the emerging world will be one of the main engines of growth fueling the global economy in the future.  But currently these economies are in serious trouble.

Risk 3:  Roubini thinks the Fed erred when they increased interest rates in December 2015.  He sees tighter financial conditions via a stronger dollar, corrected stock market, and wider credit spreads that are threatening US growth.  He is, of course, right about the tighter financial conditions, and that remains a risk.  Although, I don’t think the Fed erred necessarily.

Risk 4:  Roubini points to many simmering geopolitical risks.  There are always geopolitical risks.  I don’t see anything currently that I would classify as a tail risk.  But his point about the uncertainty created by the prospect of a long term cold war between Sunni Saudi Arabia and Shia Iran is worth thinking about.

Risk 5:  Declining oil prices is definitely a major issue.  Although it is counter intuitive that cheaper energy should be a “risk,” it creates the following problems.  It damages US energy producers, which comprise a large share of the US stock market, it imposes credit losses on energy exporting economies and energy firms, and regulations restrict market makers from providing liquidity and absorbing market volatility.  So each shock becomes more severe in terms of risk-asset price corrections.

Risk 6:  Global banks are challenged by lower returns.  New financial technology is disrupting their business models and there are rising credit losses on bad assets (energy, commodities, emerging markets and fragile European corporate borrowers.)

Risk 7:  There are massive problems facing the Eurozone.  Roubini thinks the European Union could be ground zero for global financial turmoil this year.  Their banks are challenged, the migration crisis could end the Schengen Agreement (which represents a group of countries allowing the free movement of people), Britain might exit after their referendum in the summer, and Greece and its creditors are again butting heads.

I’ll end with this paragraph from Roubini:

“In the past, tail risks were more occasional, growth scares turned out to be just that, and the policy response was strong and effective, thereby keeping risk-off episodes brief and restoring asset prices to their previous highs…  Today, there are seven sources of potential global tail risk, and the global economy is moving from an anemic expansion to a slowdown, which will lead to a further reduction in the price of risky assets worldwide.”

9
Feb

70 Is The New 65: Demographics Still Support ‘Lower Rates For Longer’

Demographic spendingIn many of my public presentations I address the impact of demographics on political and economic outcomes.  I am a firm believer in the adage that demographics are destiny.  I am also a believer in the savings glut theory that posits excess savings in the world are depressing interest rates.  This savings glut was also a contributing factor leading to the global financial crisis in 2008.

A recent study by PIMCO has shed some interesting new light on the savings glut phenomenon.  Matthew Tracey and Joachim Fels state the following in their study:

“Is global aging about to end the savings glut?  Some observers think so. More and more baby boomers are reaching retirement age, and they will soon not only save less but also start to dump their accumulated assets to fund retirement … or so the story goes.  If this were true, the consequences for interest rates would be profound… and what we here at PIMCO call The New Neutral might soon be history.  We strongly disagree with that thesis of an imminent demographics-induced savings drought.  Rather, we have argued in recent work that the global excess supply of savings… is not only here to stay but likely to increase further in the coming years…”

Here is a link to the study: https://www.pimco.com/insights/viewpoints/in-depth/70-is-the-new-65-demographics-still-support-lower-rates-for-longer

 

 

 

 

 

 

30
Jan

Outlook 2016 – Embrace The Routine

Outlook 2016

 

LPL Financial has released their Outlook 2016.  As they look forward to 2016, the LPL Research team expects a return to routine for some key areas of the economy and market, but by a path that may catch some investors unprepared. Investors will need a solid plan to navigate the changing landscape as they adjust to changes like the start of Federal Reserve (Fed) rate hikes, a maturing economic cycle, and the 2016 elections.  Some of their expectations for 2016 include:

  • U.S. economic growth of 2.5–3%.[1] The mix of that growth may look different than in 2015, with manufacturing, business capital spending, and net exports taking larger roles. Labor markets are almost back to long-term expectations, and inflation may be poised to accelerate. An extraordinary extended period of loose monetary policy in the United States should start to normalize.
  • Mid-single-digit returns for the S&P 500.[2] Stocks, we believe, will not collapse, as many think, or soar, as many hope, but may offer near historical routine returns. Earnings may start to normalize, and oil markets should find their equilibrium. International markets may re-emerge as a more viable investing opportunity. But we are still in the second half of the economic cycle, and investors need to be vigilant about monitoring pockets of volatility and potential signs of an economic downturn.
  • Limited returns for bonds. The year as a whole may look similar to 2015, with bond prices facing the challenges of high valuations, steady economic growth, and the prospect of interest rate hikes. Still, bonds play a vital role in investors’ portfolios to help with risk mitigation and diversification.

 

 

[1] Our forecast for GDP growth of between 2.5–3% is based on the historical mid-cycle growth rate of the last 50 years. Economic growth is affected by changes to inputs such as: business and consumer spending, housing, net exports, capital investments, and government spending.

 

[2] Historically since WWII, the average annual gain on stocks has been 7–9%. Thus, our forecast is in-line with average stock market growth. We forecast a mid-single-digit gain, including dividends, for U.S. stocks in 2016 as measured by the S&P 500. This gain is derived from earnings per share (EPS) for S&P 500 companies assuming mid- to high-single-digit earnings gains, and a largely stable price-to-earnings ratio (PE). Earnings gains are supported by our expectation of improved global economic growth and stable profit margins in 2016.

 

6
Aug

2015 Midyear Outlook – Some Assembly Required

2015

LPL Financial recently released their midyear economic and market outlook.  Their theme is that investors should pay close attention to portfolio construction going forward.  The economy has delivered six consecutive calendar years of positive returns for stocks since the end of the Great Recession.  However, constructing a strategy for the remainder of the economic expansion will require a tricky assembly.  Divergent monetary policies reveal an uneven global recovery that has triggered an uptick in stock market volatility.  A few important pieces requiring assembly for the remainder of 2015 include:

  • How the US economy pieces together the components needed to bounce back from its lackluster start of the year?
  • After successfully delivering the US economy out of the recessionary “warehouse,” how does the Federal reserve assemble an exit strategy from its six-year policy of zero interest rates?
  • Corporate earnings growth continues to search for that spark to ignite equity advances.

A key point made by the LPL Financial report is the importance of diversification.  Diversification detracted from market returns in 2014, but the beginning of 2015 witnessed the return of diversification benefits.  With volatility poised to rise in the second half of 2015, the potential benefits of diversification should hopefully continue to materialize.

The last point I want to highlight is LPL Research predicting another positive year in the US stock market as measured by the S&P 500 Index.  Their forecast range is 5-9%.

To read the entire report click here:  http://lpl-research.com/outlook/Midyear-Outlook-2015_Spread.pdf

 

 

22
Jun

Grexit – Do We Have A Deal?

by Riaan Nel in Global Economy

Greek Prime Minister

Sky News from Britain provides a nice overview of the potential deal between Greece and her creditors here (http://news.sky.com/story/1506133/hopes-raised-of-eu-deal-over-greek-bailout.)  However, most of the pension cuts will be funded by increased employer contributions, i.e. tax cuts.  I think Greece are being pushed too hard to institute austerity measures.  Austerity should be phased in over a longer period of time.  This, notwithstanding, the Greek government will have to cut pensions.

Midway through the article there is a nice little video on the Grexit.