“Central banks have created a debt-fuelled ‘Ring of Fire’, and we will no doubt have felt many tremors (large and small) as a result, by the time my next 6-monthly update appears in September“.
That was my forecast for world stock markets back in March, and I imagine few would argue with it today, as we review developments since then. Central banks have spent almost $25tn since the Crisis began in 2008 in the belief they could kick-start global recovery by boosting asset markets, particularly stock markets. As then US Federal Reserve chairman Ben Bernanke explained in November 2010:
“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
Today, 5 years later, it is hard to see why the policy was adopted. It was meant to be a temporary support, whilst economies recovered. But instead it has become semi-permanent, with the world’s major financial organisations now warning against even a 0.25% US interest rate rise next week:
What was the point of spending all this money, and building up so much debt, to have achieved so little?
Even in stock markets, the impact has been underwhelming, as the chart above highlights, showing the percentage change in major financial markets since their pre-Crisis peak:
- The best performer is the US 30-year bond, up 38%, as investors focus on the risks of deflation
- Germany’s DAX is up 26% as a ‘safe haven’ from the Eurozone crisis
- The US S&P 500 is up 24% – but has fallen 6% since my March update, with the IMF warning that prices ”are approaching levels that may be hard to sustain given profit forecasts“
- BRIC member India is up 23%, but down 13% since March as premier Modi’s reform programme seems to stall
- Japan has seen zero growth, despite its $480bn/year stimulus and 50% devaluation versus the US$
- The UK is down 8% as its London housing bubble starts to burst as foreign buyers rush for the exits
- The other 3 BRICs were supposed to lead the world out of recession – but Brazil is down 37%, China down 48% and Russia down 68%
Today’s globally ageing populations and falling fertility rate are inevitably having a major impact on the economy. But unfortunately, politicians have wanted to believe that printing money would somehow change the fact that the BabyBoomer-led demographic dividend has now become the demographic deficit of the future.
Financial market developments over the past 6 months are warning us that we will all pay a heavy price if this wishful thinking continues to dominate economic policy.
Nobody would imagine that the SFr 800bn ($840bn) Swiss pension scheme could go bankrupt. But Swiss pension experts suggest it “will be bankrupt within 10 years (without)…a radical overhaul of the retirement system.” The problem is simple – a combination of low/negative interest rates and an increase in life expectancy.
A major analysis in the Financial Times sets out the key details:
- Prof Martin Eling of St Gallen University estimates that “occupational pension funds will face a SFr 55bn ($57bn) hole in their funding by 2030 if the government does not overhaul the system“
- The reason is that funds have been required to pay an annuity of 6.8% on retiree savings since 2003
- But this is simply unaffordable today: life expectancy at age 65 is now 19 years for men, and 22 years for women
- And the problem is made even worse with Swiss bond markets now paying only negative interest
One solution would be to cut the annuity rate and increase employee contributions into pension funds. But this was rejected in a 2010 referendum. Another solution would be for employers to pay more into the funds. But they are already seeing higher bills, with bank Credit Suisse likely to take “a hit to capital of SFr 500m” this year, due to the impact of interest rate moves on the pension fund. As long as this stand-off continues, bankruptcy threatens.
US SOCIAL SECURITY AND MEDICARE FACE SIMILAR PROBLEMS
Of course, Switzerland is not the only country where pension schemes are facing bankruptcy. .
The non-partisan US Congressional Budget Office (CBO) again highlights the problem for Social Security in its latest report. It warns that annual spending has been exceeding income since 2010, and that the gap will average 17% of tax revenues over the next 10 years. Its forecasts for Social Security and Medicare are confirmed by the Trustees, who include the US Treasury, Labor and Health & Human Services Secretaries.
The problem is easily explained – US fertility rates are already below replacement level at 2.0 babies/woman, so there are relatively fewer young people to pay into the trust funds. And at the same time, more and more Boomers are retiring every year. Thus the CBO forecasts:
- The US Disability Insurance trust fund “will be exhausted in 2017“
- The main Old Age and Survivors Insurance trust fund “will be exhausted in 2032″
- If the Old Age fund is used to bail out the Disability fund, the combined funds “would be exhausted in 2030“
Worryingly, the US Medicare program faces the same problems, and is currently also forecast to go bankrupt in 2030.
Pensions are not just a cost, of course. They provide the money that retirees spend. So consumption and economic growth will take a major hit if pension funds do go bankrupt. More than a quarter of the economically active Swiss population are now aged over 65, as are 23% in the USA, according to the OECD Pension Handbook.
The current failure to tackle this issue thus creates massive risks for the economy, as well as for the pensioners themselves. As US investment magazine Barron’s warned 18 months ago:
“It is difficult enough to put 50-year-olds on notice that entitlements they expect at 70 will probably not be available. To give them this bad news when they’re 60 or 65 is inhumane.”
As promised yesterday, the blog looks today at the impact of today’s high prices on oil consumption growth.
As the chart, based on BP data shows, the ‘easy money’ policies of the central banks have only partially mitigated the impact of the oil price rally since 2009. Consumption growth has not fallen to the 0.8%/year level since during the second oil crisis after 1979. But nor has it regained the 1.7%/year level seen during the Boomer-led SuperCycle. Then prices averaged $27/bbl in money of the day, and $41/bbl in $2014.
Overall, the big winners over the period since 2009 have been the traders (including the commodity desks at the investment banks) and oil producers. Consumers have paid the bill.
THE TRADER VIEWPOINT
Oil proved a fantastic money-making opportunity from 2009 onwards. A totally new trading product was developed titled ‘contango crude’. This was crude that was stored in tanks all around the world to take advantage of pension funds’ sudden desire to buy crude on the futures markets.
For a cost of only $1/bbl per month, the early deals made total returns of $30/bbl – sometimes after as little as 3 months. Storage companies also loved the story, and rushed to build more tanks to support it.
But today, the ‘contango trade’ is dead and buried. Brent oil for supply next month closed Friday at $109.66/bbl. The price for delivery in August 2015 was actually lower at $105.86/bbl.
In addition, the investment banks are now busy exiting the business, as their costs of capital are rising. Many have either closed down their commodity trading businesses, or are reducing them in size.
THE PRODUCER VIEWPOINT
Producers have been laughing all the way to the bank. They have kept a very careful eye on the broken Brent pricing mechanism, and have ensured that it has remained steady at around today’s levels. That was not very difficult to achieve in the over-heated conditions of the past 5 years. There are, after all, no laws to stop producers buying in distressed cargoes to avoid disturbing the market.
But whilst the influx of financial players added excess speculative demand, it also encouraged new production – most obviously in the US, but also around the world. It takes time to finance and find new sources of supply. But 5 years has proved more than long enough to create supply gluts in many major markets.
THE CONSUMER VIEWPOINT
High oil prices above $50/bbl have always led to recessions in the past. The impact has been mitigated this time by the easy money policies and giant stimulus programmes. But real incomes, adjusted for inflation, have mostly been falling in the West in recent years, causing higher oil prices to crowd out other more discretionary spending.
Equally, consumers have been looking to use more fuel-efficient vehicles, or to otherwise cut back on energy usage. Again, as with exploration, these developments take some time to impact the market. But they are now having an increasing effect in virtually every major market.
H2 may therefore prove to be the end-game for the post-2008 oil price market rally. What happens next may not be pleasant, as the blog will discuss tomorrow.
Oil markets have been driven by speculative excess since 2009. None of the factors that were supposed to create supply shortages have ever occurred. Markets have never even been close to scrambling for product. And the rallies are getting shorter and shorter, as this simple fact is finally being better understood.
Thus traders’ most recent efforts to create volatility over supposed Iraq interruptions have already fallen flat. The rally that began on 12 June has not only collapsed, but prices have actually gone lower again.
This raises the question of what might happen now we are in the seasonally weaker Q3 period, with the prospect of refinery maintenance looming in September, to further reduce oil demand?
The blog plans to look at this super-critical issue in more detail over the next few days.
WHERE ARE WE TODAY?
Key to this question is understanding where we are today.
As the chart based on data from the latest BP Energy reports shows, oil prices are now at levels which have always led to recessions in the past. The reason is simple, namely that today’s cost of oil is close to being 5% of global GDP – around twice historical levels:
- Consumers have little choice over their energy spending if they have to drive to get to work, or heat their homes when it gets cold. In hot countries, they also want air-conditioning during summer months
- But every extra dollar they spend on energy means a dollar less to spend on the discretionary items to drive the rest of the economy.
Of course, ‘this time has been different’ so far, in that central banks and governments have developed multi-trillion dollar stimulus packages and printed trillions of dollars of low-cost cash. This easy money has mitigated the impact of higher oil prices – but only at the cost of building up more debt for the future.
THE PENSION FUND VIEWPOINT
Critically, more and more pension funds are now realising that they were effectively ‘suckered into’ the oil price rally from 2009 onwards.
They had thought they needed to find a ‘store of value’, to overcome the downsides of the ’easy money’ policies being pursued by the central banks. Oil seemed the perfect hedge, as it is essential to the modern economy, and is priced in dollars – thus combating the US Federal Reserve’s aim to drive down the dollar’s value.
But it really hasn’t been a very successful investment. Much of the profit was taken by traders and the investment banks. Most of the rest was taken by hedge funds. Being faster-moving, they could jump into the market ahead of the pension funds and build positions early.
Equally important today is that a number of senior pension fund investors now recognise that higher commodity prices actually reduce the long-term spending power of their members. They worry that their funds’ short-term gain on higher oil prices then forces their pensioners to pay higher prices for the essentials of life.
Thus there is a growing body of opinion in the commodity markets that prices have been too high, for too long, as the blog will discuss in more detail tomorrow.
As promised yesterday, the blog looks today at the impact of today’s rapidly ageing populations. The key point is that global life expectancy been rising for over 40 years, whilst fertility rates have been falling. A paradigm shift is thus inevitable, where future demand will be very different:
- 1970 Onwards. Growth accelerated, as the population became concentrated in the wealth creating 25 – 54 age group, and the need to spend money on dependent children reduced. It then moved into SuperCycle mode as large numbers of women became able to re-enter the workforce after childbirth, and also won major increases in their earnings relative to men
- 2001 Onwards. Growth began to slow, as the number of wealth creators reduced due to more and more BabyBoomer men and women joining the New Old 55+ group. This slowdown is now accelerating, as the New Old represent a replacement economy. They already own most of what they need, and their incomes are reducing as they enter retirement
It also doesn’t take a rocket scientist to work out that this combination of increasing numbers of New Old, when combined with decreasing numbers of Wealth Creators, means that pension promises are unlikely to be honoured.
Or as the chairman of one of the world’s Top 5 banks told the blog privately, “everyone knows pensions will never be paid on the basis currently assumed“. To which the blog replied, “everyone seems to know – except the ordinary people who still expecting their pensions to be paid on the basis now promised.”
Italy is the world’s 8th wealthiest country, and offers a good example of what the future has in store, as the chart shows:
- As in the rest of the West, its fertility rates have been below replacement level for 40 years
- Meanwhile its life expectancy has already risen from 65 to 80+, and is still rising
- As a result, it now has 50% more adults over 65 than children under 10
This is potentially a double blow for companies, as it means future sales and profits will be much lower than expected:
- There will be 370m people aged over 60 by 2030 in the world’s wealthy regions, 4 times the 1950 level
- They will be 29% of the total population, versus just 12% in 1950
- There will also be 1bn aged over 60 by 2030 in the world’s poorer regions, 10 times the 1950 level
- They will be 14% of this population, compared to 6% in 1950
The crisis facing the world’s toy industry today is just one example of the massive disruption that will impact almost every company over the next few years. Demographic shifts take a while to be noticed, because they take place year after year. But their cumulative impact is enormous and irreversible.
Even if women suddenly decided to have more babies today, it would take 25 years for this to change the economic picture. And during the period, the balance would actually become worse, not better. Children, wonderful though they are, are dependents and not wealth creators.
If the blog had one wish, it is that companies would wake up to the fact that these major demographic changes will have an enormous impact on their future sales and profits. Tomorrow’s winning companies will be those focused on providing affordable goods and services for cash-strapped older and younger people.
So, here we are again. Each year it seems to take less and less time for the US Federal Reserve to give up on its confident New Year forecasts of economic recovery.
New Fed Chair, Janet Yellen, argued in February that the weather was responsible for the economy’s poor performance. But now she seems to have decided the problems go beyond the ‘polar vortex’ that saw record snowfalls in many parts of the USA. This, of course, will be no surprise to blog readers. Its view at the time was that the weather excuse was equivalent to a school student claiming that ‘the dog ate my homework’.
Yellen is of course right when she noted in her Monday speech that:
“While there has been steady progress, there is also no doubt that the economy and the job market are not back to normal health. The recovery still feels like a recession to many Americans, and it also looks that way in some economic statistics.”
But worryingly, she is still a long way from understanding that the Fed is making the situation worse, not better, by ignoring the demographic causes of today’s slowing economy.
Instead she made it clear on Monday that the end of her hopes for a quick recovery would lead to yet more stimulus support for financial markets. Yet as Barron’s, the US investment magazine notes, the main impact of the Fed’s policies has been to boost company hand-outs to shareholders to near-record levels:
“Combined, share repurchases plus dividends reached $214.4 billion in the fourth quarter, the second-highest total on record after $233.2 billion in 2007′s fourth quarter. For all of last year, buybacks increased 19.2%, to $475.6 billion, equalling the average stock-price rise, which means it took that many more bucks to buy pricier shares”
Unsurprisingly, therefore, the IeC Boom/Gloom Index has soared as Yellen’s about-face has taken place. It is the best measure of financial market sentiment and as the chart shows:
- It had fallen to 7 in February, as traders worried the Fed’s supply of easy money might stop (blue column)
- But it has since come roaring back, doubling to 14 in March
- The S&P 500 Index has similarly reached a new record level (red line)
So it looks as though we are now back in the familiar pattern of the past 5 years. The Fed encourages companies to focus on boosting profits in the short-term, and on handing back money to their wealthy shareholders. This does little for the real economy, as most Americans don’t have 401(k)-type stock market investments, but instead depend on Social Security for retirement income.
Then next winter, the Fed will again come out with confident predictions that ‘this time, recovery really is underway’.