More red ink on markets overnight. This makes six days in a row the US markets have finished on a negative note.
Oil fell to US$37. A far cry from the US$120 price of a couple of years ago. Concerns about China’s economy are still weighing heavily on the markets.
For all the supposed upbeat talk about economic recoveries and improved employment data, global mining giant Anglo American announced 85,000 employees are to be given the ‘don’t come Monday’ letter. In addition to shedding more than 60% of its staff, Anglo American are putting 60% of their assets on the auction block over the next few years.
Why the drastic action? Falling commodity prices. Chinese demand is slowing.
Anglo American’s latest results were well and truly in the negative — posting a loss of US$1.9 billion in the first half of 2015.
The commodity slump (especially iron ore) continues to push BHP, Rio and others further into negative territory. The financial strain must be hurting a lot of indebted miners…it’s going to be a very nervous Christmas period for a lot of workers.
Less than a month ago the International Energy Agency warned the plunge in oil price would slash OPEC revenues from ‘US$1 trillion average in the past five years to US$550 billion’. Saudi Arabia will not reduce production levels unless non-OPEC producers do likewise.
The trouble is, a lot of those outside of OPEC are carrying a truckload of debt and need as much cash as possible. This creates a negative feedback loop…the more they produce to generate a dollar, the lower the oil price goes.
The European Central Bank moved interest rates further into the negative earlier this month. The ECB now charges banks 0.3% to hold cash overnight.
The theory is that banks, motivated by losing money, will lend rather than hoard cash. But if businesses and households don’t want more debt, how can the banks lend? Do we end up in a subprime environment were banks end up handing out money to anyone with a heartbeat?
Negative rates are summed up in one word — desperation. Virtually forcing banks to lend is dumb policy. But it shows just how ineffective the massive stimulus efforts have really been in generating genuine economic activity.
Politicians are picking up on negative social mood. According to the US Presidential campaign for’ The Donald’:
‘Donald J. Trump is calling for a total and complete shutdown of Muslims entering the United States until our country’s representatives can figure out what is going on.’
After the latest shooting rampage in San Bernardino, the Donald has picked up on community unrest. He’s playing to the crowd and feeding them back what they’re thinking. And it’s working. The latest polling results show he has a commanding lead over his nearest Republican opponent. This may not last, but he is tapping into a vein of discontent and it is being heard in heartland America.
In France the far-right (anti-immigration) National Front party has surprised the ruling elites with a strong showing in regional council elections. Results are still to be decided but National Front are on the verge of securing four councils (out of a possible 13). The best election result since the party was founded in 1972.
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Germany’s deputy Chancellor, Sigmar Gabriel comment on the election was ‘It is of course a shock when rightwing extremists achieve such a result and become the strongest political force in the first round of voting in France — one of the founding members of the EU in the heart of Europe.’
Italy’s Prime Minister Renzi said ‘Without a strategic design, particularly on the economy and on growth, populist movements will sooner or later prevail also in general elections.’
Populists movements. Rightwing extremists. This is the type of rhetoric used by mainstream political parties when trying to discredit a party that’s attracting a groundswell of support.
It’s difficult to see how social mood in Europe is going to switch from mildly negative to positive anytime soon.
Accepting a million refugees has a lot of teething problems — housing, food, welfare, employment, social integration with different cultures.
Naturally there is friction within the community over who’s going to pay for all this? The disruption to traditional culture, suspicion over the intent of these newcomers, are they going to take our jobs.
The architect of the refugee program, German Chancellor Angela Merkel, is coming under pressure from within her own party.
Her own finance minister, Wolfgang Schäuble, warned recently that Germany faced an ‘avalanche of refugees caused by a careless skier.’
If you think a million refugees is a problem, what about 20 million? Due to civil wars, drought and failed dictatorships in the Middle East and Africa, it’s estimated there are 20 million displaced persons seeking refuge.
When does Europe say enough?
Will it take another terrorist attack to create the social backlash that force the changes to Merkel & co’s open border policies?
Will it be rising youth unemployment leading to riots in the streets by both pro and anti refugee demonstrators?
I don’t know. Given the instability in the economic and social situation things in Europe could turn very ugly, very quickly.
Then what happens to the refugees locked out of Europe? How much bloodshed and human suffering can we stand before further pressure is applied to open the borders?
Will each country re-impose their national borders and restrict the free movement of people and trade — the very thing a united Europe was supposed to be all about?
Here in Australia the headlines tells us how wonderful our economy performed in the third quarter. However as my colleague Greg Canavan pointed out in last Thursday’s Markets and Money ‘The Aussie Economy is Already in Recession’:
‘Along with a few other minor adjustments, this more realistic measure of economic performance is called ‘real net national disposable income’. It actually contracted 0.1% in the September quarter and 1% over the year. So on a more realistic measure of economic wellbeing, Australia is indeed in recession.’
The real numbers — buried deep within the official data — show we are also in the negative.
What does all this negativity mean for investors?
When there are so many dots to connect, it is not easy to make exact predictions.
Will we see a sovereign default from an overly-indebted, commodity reliant emerging country?
Will we see a credit crisis in the junk bond market?
Will we see greater social upheaval in Europe leading to worsening economic conditions?
Will the slump in commodity prices continue and create greater deflationary pressures in the global economy and force rates even further into negative territory?
Plenty of questions but no definitive answers. There are just so many variables. The global economy is fragile and it will not take a lot to shatter confidence.
Global asset prices are vulnerable. Property and share markets owe their record price levels to US$14 trillion of central bank stimulus.
While it’s difficult to connect the exact dots, one thing we do know is over-valued markets eventually become under-valued markets.
When that process occurs is an unknown, but it will happen.
The following chart provides an indication of the return investors can expect from the US share market over the next decade. The blue line is the projected return (based on the market cap/GDP ratio) over the next decade. The red line is the actual 10 year return of the S&P 500 index.
The blue line indicates that investors can expect a NEGATIVE 1% per annum over the next 10 years.
Since 1949 there’s been a reasonably close correlation between the forecast performance and reality. For example, in 1999 the 10 year forward indicator was for a NEGATIVE 5% per annum. In 2009, the red line confirmed this indeed was the result investors achieved.
Source: Hussman Funds
The global negativity today is likely to translate into a tough decade for share investors.
Going up, down and sideways is going to be very frustrating for all the boomer retirees who believed the computer printouts showing them how a 7% per annum share market return would happily fund their retirement dreams.
Negative or negligible returns means retirees will chew up capital to fund lifestyles. The more capital values fall, the less likely boomer retirees will be able to go on spending sprees providing a consumer lead economic recovery.
The world enjoyed a very positive period of sustained growth due to the historic accumulation of debt. Now we have entered the period where we pay the piper.
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