Banks are prone to making the odd sensationalist comment every now and then. Sometimes it’s warranted; other times not so much. But rarely does a bank come out with a line predicting the end of the world. Anytime it does, as the Royal Bank of Scotland did this morning, it’s time to sit up and take notice.
The RBS raised alarm today when it warned clients of a ‘cataclysmic’ year ahead. What we’re seeing playing out across markets today are echoes of 2008. What may follow over the next 12 months could send the world into a new financial crisis.
RBS highlighted some notable events it forecasts taking place this year. For one, it reckons oil prices could slump to US$16 a barrel. Crude oil currently trades for US$36 a barrel. Of course, oil markets are difficult to gauge accurately. Market share strategies among key oil producers are artificially lowering prices. Even small cuts in production could send prices rising. But with market share dictating what Big Oil does, 2016 could be another year of weak prices.
Elsewhere, RBS reserved perhaps its most damning claim for shares. It reckons stock markets could plunge by up to a fifth this year.
The net effect of all these pressures could send the globe into a deflationary crisis. Not a pretty outlook for the world then.
Even more startling was the advice it gave clients. It suggested investors should sell (almost) everything. The one exception was high quality bonds, which they advised investors keep hold of.
RBS suggested investors are better off getting a return of capital, and not a return on capital. If things play out according to its forecast, that might be the best investors can hope for.
Granted, not everyone agrees with RBS’ grim outlook. Some analysts have already had their say. One even labelled the assessment as the ‘worst recommendation you could make.’
But is it really that off the mark? Or are RBS just saying what many of us feel, but are too afraid to admit to ourselves?
Like most other people, RBS is being very cautious about the state of the global economy. China continues to hang over the world like a black cloud, through little fault of its own. The global economy became too reliant on China for its success. Now we’re all victims to its economic shift away from exports, which is something that must play itself out.
Either way, China’s slowdown should drag on for the next 12 months at the least.
In the view of RBS analysts, China’s debt fuelled expansion has now reached its limit:
‘We are deeply sceptical of the consensus that the authorities can ‘buy time’ by their heavy intervention in cutting reserve ratio requirements (RRR), rate cuts, and easing in fiscal policy.’
In fairness, the Chinese have more scope for easing. Both from a fiscal and monetary standpoint. But the key point RBS make there relates to the buying of time. All the Chinese are doing at the moment is buying time. Heck, we could say the same for the rest of the world too. As it happens, China is one of the few nations influencing the global economy to any great degree. Even if everyone else is in the same boat, China has to appear as if it’s managing fine. Should the world realise China’s barely keeping its head above water, the next major crisis wouldn’t be far behind.
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China’s effect on the global economy
Already you’ll have seen the effects of China’s slowdown cause a decline in global trade. Both it, and the issuance of new loans, has declined over the past six months. Over 35% of Australian exports make their way to China. And commodities make up a significant portion of that trade.
In turn, we’ve seen slowing economy activity weigh on market sentiment right around the world. From China, to Europe, the US and Australia, every market is down. And what was before 2016 got off to the worst start of the year for equities in living memory. The ASX has already dropped below 5,000 points.
The Shanghai Composite Index twice tested China’s failsafe last week, having lost 7% in daily trade.
Have we seen the worst of it, or is it likely to get nastier?
According to RBS, both US and European markets could slump 10–20% this year. The FTSE (UK) could go even lower, as it relies on energy and commodity stocks.
The bank made no direct forecasts for the ASX. But you can put two and two together. If the FTSE’s outlook is that bad, the ASX can’t be far behind it. Remember, materials and energy account for 20% of the ASX.
There’s an interesting quote from RBS, which might interest Aussie investors:
‘[The London FTSE] is vulnerable to a negative shock. All these people who are ‘long’ oil and mining companies thinking the dividends are safe are going to discover that they’re not at all safe.’
Were they not explicitly referring to the FTSE, you’d think it was describing the ASX. That could apply to a number of blue chip ASX mining stocks. No one’s suggesting BHP Billiton [ASX:BHP] or Rio Tinto [ASX:RIO] are going out of business. But their generous dividend yields are a big part of why investors stick with them. Yet maybe these mining giants are under bigger pressure than we care to admit.
RBS criticises US monetary policy
The RBS also waded in on US policymaking in its 2016 outlook.
While figures aren’t available yet, the bank believes US GDP growth may have slowed to 0.5% last quarter. Were that the case, the US interest rate hike might look slightly premature. RBS did criticise the Federal Reserve for hiking rates at a time of uncertainty. It accused the Fed of adding fuel to the fire by tightening credit. The rate rise would have less effect on the US economy than it would the global one. That’s because a rise in US rates is likely to coincide with capital outflows elsewhere.
Perhaps the most surprising verdict on interest rate hikes was that it could already be over. RBS reckons the Fed’s brief affair with rising rates is over before it ever really began. Instead, it expects the Fed’s next move will be to cut rates.
The crisis is already in motion
Slowly but surely, banks and markets are realising there’s little hope for avoiding another crisis. We’re walking head first into a furnace that threatens to upend the global economy.
Another bank, UBS, also changed its outlook last week, shifting its stance dramatically. Like RBS, it warned clients to lower their exposure to stocks. And it suggested investors cut exposure to emerging markets too.
Yet these are just two voices in a growing chorus of market bears.
The rate at which the next crisis unfolds will depend on what happens in China. Unless there’s a batch of positive data over the first quarter, it could set the stage for a new global crisis.
China is determined to prevent that from happening. So you can expect to see policymakers do everything in their power to ensure the economy stabilises. That’ll mean more rate cuts, more fiscal spending, and more easing in general.
Yet as Western economies have found out all too well, there are limits to easing credit.
The potential for a major crisis won’t go away by kicking the can down the road. It’ll only postpone it. Credit expansion is a policy that’s rooted in debt. While you can keep the ruse up for a while, eventually things come full circle. US, European and Japanese markets know the consequences of this all too well. Years, even decades, of deflation and low economic growth.
Ultimately though, Chinese economic data may have no bearing on what happens next. There is as much likelihood that markets change their tune regardless of what happens in China. If the mainstream narrative on the global economy catches up with what we’re seeing taking place, there may be nothing that can stop the next global crisis.
Junior Analyst, Markets and Money
PS: China’s unfolding slowdown raises the prospects for a recession in Australia.
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