The blog’s 6-monthly review of major stock markets highlights their continuing volatility.
Last September, all the markets were down between 7% – 22%. Germany (dark green column) was the biggest loser, whilst the UK/US (blue, red) were least impacted. Only the US 30-year Treasury bond (light green) had increased, as US interest rates fell.
Please click here if you would like to compare with that chart.
Today, all the major markets have risen between 5%-25%, with the exception of China (light blue):
• Germany is the biggest winner, up 25% since September
• It is still just below its level in March 2011
• China is the main loser, down 1% vs September and 17% vs March
• The US/UK are up 13%/11%, and 5%/2% vs March
• Brazil (pink) is up 16%, and equal to March
• Japan (purple) is up 12%, but down 5% vs March
• India (orange) is up 5%, but down 3% vs March
• Russia (lilac) is up 9%, but down 11% vs March
Only one market has increased in both 6 month periods. This is the US Treasury 30 year bond. It was up 14% vs September, and 28% vs March.
This highlights the major risk to the current euphoria. Stock market investors, led by the high frequency traders, continue to chase momentum – up and down.
But bond markets investors continue to focus on return of capital. Thus the US Treasury bond markets, and those of the other JUUGS, retain fundamental strength.
Interest rates are key to the direction of the global economy.
But not in the way that was true during the 1982-2007 economic SuperCycle. Then, there was a global surplus of savings, due to the vast numbers of people in the Wealth Creating 25 – 54 age group.
So interest rates reduced dramatically in most countries, with the USA leading the way. Its 10 year government bond rates reduced from 15% in 1982 to just 5% by 2007.
Today’s market is increasingly dominated by the New Old generation of people aged 55+. As one would expect, older people are more concerned about security rather than growth. They value ‘return of capital’ more than ‘return on capital.
Thus a new UK investor survey reports that “protecting the value of existing assets” was the main priority. In turn, this means that investors are very nervous about markets where governments are borrowing too much, and have no plan to repay their debts.
This is why investors now prefer the JUUGS (Japan, USA, UK, Germany, Switzerland) to the PIIGS (Portugal, Ireland, Italy, Greece, Spain). The chart above updates the position since the blog first launched the concept (today’s interest rates = red line; August 2011 = blue column) :
• In August 2010, rates in the PIIGS averaged 5.9%: now they are 14.5%
• Rates in the JUUGS were 2.05%, now they are 1.5%
These demographically-driven changes have confused even the world’s largest bond investors, PIMCO, who suffered a rare year of major under-performance in 2011. They worried (rightly, of course) about the rising level of debt in some of the JUUGS – but failed for a while to realise this was not investors’ primary concern.
The key question at the start of 2012 is what happens next in the Eurozone. As the chart shows, Greece’s interest rate has gone ‘off the chart’ at 38%. And now, the real threat is contagion to Germany. As the Financial Times warns:
“If the euro stays together, it will only be because Germany pays, one way or another – hurting their bonds. If the euro breaks down…German finances would be trashed by the need to rescue its banks”.
Nobody knows how this very serious situation may play out.
We can all hope for good sense and wise policy to prevail. But hope is not a strategy, and can easily turn into wishful thinking. The blog will continue to keep a very close eye on developments.
Financial markets have become increasingly nervous in recent weeks, since the blog last reviewed developments in global bond markets.
Its conclusion then was that investors are worrying more about return of capital, than return on capital, as we transition to the New Normal. This is because 272 million westerners are now over 55 years old, and they need security of income as they prepare for retirement.
The chart above updates market moves in the JUUGS (Japan, UK, USA, Germany, Switzerland) and the PIIGS (Portugal, Ireland, Italy, Greece, Spain). Since August (blue column), the 2 groups have seen very different interest rate trends for 10-year government bonds (red line):
• Rates in the JUUGS have been extremely stable. UK and Swiss rates have edged down 0.1%, whilst German rates moved up 0.1%. US and Japanese rates are unchanged.
• The PIIGS have been much more volatile. Greece is now paying 34% vs 22% in August: Portugal’s rate is 12% vs 11%: Italy’s is 6.4% vs 5.7%: Spain’s is 5.5% vs 5.3%: only Ireland’s reduced, from 8.8% to 8.3%.
This suggests Portugal will also need to default on its debts, alongside Greece. Otherwise the burden of interest payments will simply become too large, particularly as austerity programmes lead to recession.
Italy, of course, is the real problem child. It is a rich and large G7 country. But its interest rate is now also close to being unaffordable. Two key questions are looming on the horizon:
• Will it really now allow the IMF to dictate its economic policy?
• What will happen to French and German banks if investors start to question Italy’s ability to repay its debt?
Italy currently owes $416bn to French banks, and $162bn to German banks. It owes a total of $788bn to European lenders. This is the concept of ‘contagion’:
• If Italy’s rates move into the 6.5%-7% area, and remain there, then its default becomes almost certain.
• France, another G7 member, would then be in the firing line.
• Its 3.3% interest rate is already 50%+ higher than those of the JUUGS. This suggests underlying nervousness amongst investors.
The blog will continue to monitor the situation closely.
An abrupt change of direction is never a pleasant experience in global financial markets. Yet unfortunately, the blog’s regular 6 monthly review suggests this has started to occur since March.
Investors are beginning to fear we may not be be entering a new Supercycle after all. Some are also worrying that high oil prices may be leading to demand destruction.
The blog’s view remains that the ageing of the Western Babyboomers (those born between 1946-70) means we are entering a New Normal era. And there are certainly signs that bond market investors are now starting to accept the argument of Chapter 2 in its Boom, Gloom and the New Normal eBook, that we are following Japan’s model.
This is quite a change. Investors mostly took no notice of the blog’s article in the Financial Times a year ago, which suggested the consensus might be wrong. But as the above chart shows, the US 30 year bond (light green) is up 16% since March, due to the fall in US interest rates.
• Germany’s stock market (green) is the biggest loser since March, down 22%. A China slowdown will impact it badly, and investors fear it will have to pay for the costs of Greece’s looming default
• Investors also worry that other emerging economies are slowing. Brazil (pink) is down 14%, Russia (lilac) down 19%, India (orange) down 8% and China (blue-green) down 16%
• Japan (purple) is down 15% after the earthquakes and tsunami
• The US (dark blue) and UK (brown) are down 7% and 8%, as recent economic data has disappointed
Even the major investment banks are suddenly becoming cautious. Goldman Sachs has now cut its year-end forecast for the S&P 500 from 1400 to 1250, citing “heightened uncertainty in global equity markets“.
However, its commodities team is still on the bullish tack, forecasting that Brent will rise to $130/bbl over the next 12 months. They believe “emerging-markets demand for key commodities, including oil, is holding up well“.
Most of us have now heard of the PIIGS countries (Portugal, Ireland, Italy, Greece, Spain). They are the ones causing the Eurozone debt crisis.
Today, the blog introduces the JUUGS (Japan, UK, USA, Germany, Switzerland). These are the major countries that investors now love.
If you are worried about return of capital, rather than return on capital, these are the countries for you. They have deep and liquid debt markets, are politically stable and highly likely to pay their bills. Importantly, they are not reliant on flows of foreign money to fund government spending. 85% of US Treasuries, for example, are owned by Americans.
This is becoming mission critical for many investors.
The chart above shows the difference between interest rates for 10 year government bonds in the PIIGS countries (left) and the JUUGS (right). It also shows how rates have moved between August 2010 (blue column) and today (red line):
• Rates have shot up in the PIIGS
• Greece is now paying 16%. Even Spain and Italy are paying 5%
• But rates have dropped to historic lows in the JUUGS
• Japan/Switzerland are paying just 1%, and the others only ~2%
This is another clear sign that we are indeed entering the New Normal. It also supports the blog’s argument that changing demographics, particularly the ageing of the Western BabyBoomers, are leading to major changes in global demand patterns.
We explore this argument in more detail in Chapter 2 of our new free eBook, ‘Boom, Gloom and the New Normal’. We believe its argument needs to be better understood and debated, if the chemical industry is to reposition itself successfully for future growth.
Please click here if you would like to download a copy.