Have you got your answer ready if someone asks you just what's going on?

Thursday 21st January 2016

Have you got your answer ready if someone asks you just what's going on ?

ref :- "Stock exchanges across the world plunge into bear market territory" , the Financial Times, p.1

After days like yesterday, already referred to in some quarters as "Black Wednesday" (yes, another one ..... they'll soon need to be more specific) , there's always a danger that someone might ask you out of blue what your take is on why what's just happened, happened. That's a difficult question given how many different factors are in play, all the more so since most of them are linked, but if you don't want to come across as a total fraud it may pay to have an answer to hand. Fortunately, it doesn't have to be one full of inspirational insights and if you roll out a few of the more straightforward and accepted areas of deep concern, you may just get away with it. So, how about .....

1. China

2. Global economic growth prospects

3. Sliding commodity prices, especially OIL

4. Doubts over whether central banks remain willing to act as a backstop

You may be unlucky enough to have to explain your thinking. To take them in turn :

China ..... the staggering growth in the economy over the last 25 years has been squarely based on investment and infrastructure, but now has to change ..... after all, how many dams can you build ? The move to an economy driven more by services and consumers is a difficult one and a slow process , and it's not a surprise that it's having a marked effect on Chinese growth. Q4 GDP was recently released at 6.8%, giving an overall figure of 6.9% for 2015. This is the lowest headline number for 25 years, and that's if you believe the official data ..... many don't and would suggest the number might be nearer 5.0%.

Global economic growth prospects ..... with China and the emerging nations it so directly affects to the fore, the IMF has lowered its forecasts for global growth to : 3.4% in 2016, down from 3.6%, and 3.6% in 2017, down from 3.8%. World trade is tailing off, best illustrated by the Baltic Dry Index  --  a measure of the cost of transporting goods by sea  --  at a lifetime low (it was set up in 1985).

Sliding commodity prices, especially OIL ..... plainly falling prices are bad news for commodity producers, but it's often asked why is the collapse in crude oil viewed so negatively by the markets ? Surely most developed nations are net importers and this should be a boost for growth ? Not so .... the disinflationary effects of lower commodity prices are a real dampener for the markets. Deflation encourages hoarding and discourages spending and investment. Also, the emerging commodity producing nations are often largely reliant on higher prices  -- price falls can undermine the health of an entire regional economy, and from a strictly market-perspective, provoke large scale selling of overseas investments to enable the repatriation of funds to those newly cash-strapped nations. And then there's the energy industry ......

Doubts over whether central banks remain willing to act as a backstop ..... not just are they willing to, but are they able to ? We've often spoken about how it shouldn't be the job of a central bank to support asset prices. Nobody should wish for a return to the days of the "Greenspan Put", when investors thought themselves protected from losses by the strategy of the then Fed Chairman Alan Greenspan of cutting rates to prop up prices. Nonetheless, it would be seen as irresponsible for a central bank, and most particularly for the Fed, to ignore the state of the global economy and market turmoil. The Fed's December hike (and stated intentions to continue the path to higher rates) would seem to signal to some that Fed will leave the markets to find their own levels. And besides, with rates in so many developed nations at near zero, and levels of other easing measures such as QE so high, how much ammunition do central banks have left even if they wanted to help.

Hopefully that might do it, but if you wanted to add a contrary note to proceedings you could mention a couple of things :

 re : China .... the lowest GDP growth in 25 years may grab the headlines, but a little perspective might be in order here. If something grows the same amount in volume terms this year as it did last year, in percentage terms it will be a lower figure  --  that's just simple maths. So it is with China's GDP. Paul Sheard, chief economist of Standard and Poors pointed out in yesterday's FT that if China's GDP grew 6.3% this year (to pick a number LESS than the official version), that would be the equivalent of about 14% growth in 2009, in terms of the increment to global GDP. Or to look at it another way, taking the official data the growth in 2015 equated to more than the entire GDP of Sweden, and to just a little less than that of Switzerland.

re : Doubts over Central Banks ..... the divergence between rising rates in the US and easing elsewhere will continue to be a theme in 2016. For emerging markets, higher US rates and the consequently stronger dollar are a double-whammy, up to their eyes as they are in dollar-denominated debt. Capital outflows from emerging markets severely undermine their chances of a return to strong growth. But in the current circumstances few believe that the Fed will be able to implement four 25bp hikes this year, as they themselves have been predicting. In fact, futures markets (and let's face it, the markets have been much better than the Fed at forecasting lately) now suggest that the total of 25bp rate hikes we will see this year is .... just one.

Hope it helps....