The blog’s 6-monthly review of global financial markets highlights some interesting developments. It began 4 years ago, and was followed by the co-ordinated G-20 stimulus programme in March 2009. This ran out of steam by April 2011, leading the blog to launch its IeC Downturn Alert.
The slide above shows market performance since then. The period covers the €1tn ($1.4tn) LTRO programme from the European Central Bank, and the US Federal Reserve’s Operation Twist, as well as more recent announcements of further market support:
• The 4 BRIC countries (Brazil, Russia, India, China) are worst performers
• Russia (lilac) is down 28%; China (blue) down 27%
• Brazil (pink) is down 12%; India (orange ) down 7%
• Japan, UK and Germany are also all negative
• Japan (purple) is down 10%; UK (red) down 5%; Germany (green) down 4%
• Only the US stock market (dark blue) is positive, up 5%
• The big winner has been the US 30 year bond (dark green), up 36%
Three conclusions stand out from this.
One is that the export-development model of the BRIC countries is under great pressure. They took a seeming ‘short-cut’ to GDP growth by focusing on exports at the expense of domestic demand. Now the ageing of the Western BabyBoomers means that demand is disappearing, probably forever.
The second is that the unprecedented stimulus programmes in the West have not worked. As the blog will discuss tomorrow, the balance sheets of the major central banks are now are unprecedented levels. But they cannot create demand when people don’t want to buy.
One final conclusion is that people do want to save, with a ‘safe’ government. The JUUGS (Japan, UK, US, Germany, Switzerland) continue to be the destination of choice for investors. They now clearly prioritise return of investment versus return on investment.
The arrival of the internet should make it easier to source key data from around the world. But instead, it seems to encourage Twitter-like behaviour, where everyone simply repeats what has already been said.
How else to explain the almost universal view that government bond yields in countries such as the US and UK are in a major asset bubble? Almost no serious commentator dares to suggest an alternative view.
Yet detailed yield data for UK government bonds is available from 1900, and for US bonds from 1926, in the annual Barclays Equity Gilt Study. As the chart above shows, this gives a completely different picture:
• UK government bonds (blue column) averaged 3.7% between 1900-49
• US government bonds (red) averaged 2.7% between 1926-49
Yields then began to increase as the Western BabyBoomer generation (born 1946-70) created a surge in demand. They reached a peak in the 1970s-90s, when UK rates averaged 10.4% and US rates averaged 8%.
But since then, they have returned to more normal levels. Since 2000, they have averaged 4.2% in the UK and 4.5% in the US – still higher than the pre-1950 pattern. This suggests they are reverting to the mean, as usual with major investment classes, rather than in an asset bubble.
This matters enormously for the global economy:
• People will have to save much more money for their pensions
• They will therefore have less money to spend before they retire
• Income levels in retirement will also be lower
• Thus growth is likely to be slower than in the 1982-2007 supercycle
This also confirms our argument in chapter 2 of Boom, Gloom and the New Normal. There, we suggest that Japan’s experience over the past 20 years is not unique. Its BabyBoom took place earlier than in the West. And therefore its society is already well down the path of adjusting to a world of lower growth and much lower inflation.
Global bond investors have found a new worry. 10 year interest rates in Spain, the world’s 12th largest economy, have risen alarmingly in recent weeks. As the chart shows, they are now above 7% (blue column) compared to 4% when the blog first focused on the Eurozone crisis (red).
7% is a critical level, as it marks the point at which countries can usually no longer support the burden of interest cost involved. During the current crisis, it has also marked the moment when countries such as Ireland and Portugal have had to receive a bail-out.
This is why the blog has continued to argue that there are sound reasons for the current record differentials between interest rates being paid by the PIIGS (Portugal, Ireland, Italy, Greece, Spain) and the JUUGS (Japan, UK, USA, Germany, Switzerland).
Interestingly, some major bond fund managers have recently begun to express similar views. Thus Jeffrey Rosenberg, chief fixed income investment strategist for Blackrock (who have $3.7tn under management), noted recently in respect of the low interest rates in the JUUGS:
“You’re not talking about a bubble because a bubble is about greed. That’s not a reflection of ‘I expect prices to go higher and I have to jump in,’ that’s a reflection of ‘I want to preserve my principal.’ Negative yields reflect fear.”
The blog’s Boom/Gloom Index (blue column) reaches its 3rd anniversary this month.
It was introduced to help monitor sentiment in financial markets, on the basis that “many markets are clearly being ruled by sentiment”. It has since done a good job in identifying peaks and troughs:
• Peaks have been focused on periods when central banks have rushed to provide liquidity via quantitative easing and other stimulus programmes
• Thus the Index was strong from June 2009-June 2010, and from September 2010-June 2011
• The main trough has been seen since August 2011. This highlights the key flaw in the central banks’ thinking
• Their Quantitative Easing and bank lending programmes wrongly assume that markets face liquidity problems, rather than solvency risks
The Austerity measure (red line) in the chart highlights this issue. It shows how governments are increasingly being forced to abandon stimulus programmes, due to lack of cash. Investors increasingly worry that countries such as the PIIGS (Portugal, Ireland, Italy, Greece, Spain) will never repay their debts.
Thus June sees a sharp jump in the Austerity reading, back to levels last seen in May/June 2010 when the Eurozone crisis first properly erupted. In turn, this has pushed the Index below its neutral 4.0 reading and back into Gloom territory.
This highlights how the stimulus policies have been able to create short-term economic growth and major asset bubbles (oil/commodities prices, China real estate etc). But they have not created the conditions for sustainable long-term expansion.
The blog’s series on the VUCA world today reaches C for Complexity.
Interest rates are key to company profitability. They determine rates of return for new investments, and their affordability. They also have a major influence on consumer spending patterns.
The debate over their future direction is just one example of current Complexity:
• Financial investors mostly argue that rates will go higher, perhaps much higher, in the major economies
• The world’s largest bond fund, PIMCO, even argued in January 2010 that UK bonds were sitting on a ‘bed of nitro-glycerine’
The blog has never agreed with this view.
It argues that the ageing Western population means investors now focus on return of capital. They also need to save more and spend less, as they are uncomfortably aware that their pensions are too small to fund their extra decade of life expectancy compared to previous generations.
It also coined the term JUUGS to describe the countries whose bonds would be perceived to provide the greatest safety – Japan, UK, USA, Germany and Switzerland. It has since followed their progress by comparison with the PIIGS (Portugal, Ireland, Italy, Greece, Spain).
The chart above shows 10-year interest rates today (blue column) in the PIIGS and JUUGS versus May 2010 (red):
• Average rates in the PIIGS were 5.8%, double the 2.7% in the JUUGS
• Today, they average 12% in the PIIGS, and just 1% in the JUUGS
• Rates have risen in all the PIIGS, whilst falling in all the JUUGS
The blog originally set out its argument in the Financial Times in September 2010. It was then developed further as chapter 2 of Boom, Gloom and the New Normal last June.
It argues that Japan is the role model for what is happening today. The JUUGS’ interest rates are only following the path taken there in recent decades. The reason for the correlation is that Japan’s own babyboomer generation are ~10 years older than in Western countries.
Of course, it could be that the blog has simply been lucky so far with the results of its argument. And it agrees rates could certainly jump if demand ever returned to Supercycle levels, as expected by the market consensus.
Thus the debate over interest rates highlights the Complexity of the financial world. Those whose judgement turns out to be wrong may well lose a large amount of money as a result.
Some things are too ‘obvious’ for highly-paid professionals in the financial world to accept. If life was this simple, then clients might ask why their fees were so high. Therefore they maintain a fiction that what is obvious is not the full story.
Interest rates are a classic example of a simple issue which is over-complicated by the professionals. They really depend on just one factor:
• Do I trust you to repay the money?
If the answer is ‘no’, then I won’t lend the money. This is what happened to Greece, and now threatens the other PIIGS (Portugal, Ireland, Italy, Greece, Spain). As the chart shows, their interest rates have risen sharply since May 2010, when the blog began warning of the crisis ahead.
Spain’s new prime minister summed up the issue this week, when he warned:
“Spain is facing an economic situation of extreme difficulty, I repeat, of extreme difficulty, and anyone who doesn’t understand that is fooling themselves.”
Spain is the 12th largest economy in the world. Its $1.4tn GDP is larger than S Korea’s ($1tn), and similar to India’s ($1.6tn). If it is in “extreme difficulty”, then any investor is going to become even more concerned about return of capital, rather than return on capital.
Investing with the JUUGS (Japan, UK, USA, Germany, Switzerland) thus becomes an even simpler decision. As the chart also shows, their interest rates continue to fall, as more and more savers seek safety.
It really is that simple.