The results of the central bankers’ great experiment with money printing are now in, and they are fairly depressing, as the charts above confirm:
- On the left are the IMF’s annual forecasts from 2010 – 2018 (dotted lines) and the actual result (black)
- Until recently, the Fund was convinced the world would soon see 5% GDP growth, or at least 4% growth
- The actual outcome has been a steady decline until 2017 and this month’s forecast sees slowing growth by 2020
As the IMF headlined last week, “current favorable growth rates will not last”.
- On the right, is the amount of money the bankers have spent on money printing to achieve this result
- China, the US, Japan, the Eurozone and the Bank of England printed over $30tn between 2009-2017
- So far, only China – which did 2/3rds of the printing, has admitted its mistake, and changed the policy
The chart above shows what happens if you spend a lot of money without getting much return in terms of growth. Again from the IMF, it shows that total global debt has risen to $164tn. This is more than twice the size of global GDP – 225%, to be exact, based on latest 2016 data. The IMF analysis also highlights the result of the money printing:
“Debt-to-GDP ratios in advanced economies are at levels not seen since World War II….In the last ten years, emerging market economies have been responsible for most of the increase. China alone contributed 43% to the increase in global debt since 2007. In contrast, the contribution from low income developing countries is barely noticeable.”
It doesn’t take a rocket scientist to work out the result of this failed policy, which is shown in the above IMF charts:
- Global debt to GDP levels are higher than in 2008 and in the financial crisis; only World War 2 was higher
- Debt ratios in the advanced economies are at their highest since the 1980s debt crisis
- Emerging market ratios are lower (apart from China), but this is because of debt forgiveness at the Millennium
CAN ALL THIS DEBT EVER BE PAID PACK? AND IF NOT, WHAT HAPPENS?
As everyone knows, borrowing is easy. Almost all governments and commentators have lined up since 2009 to support the money-printing policy. But the hard bit happens now as it starts to become obvious that the policy has failed.
We now have all the debt, but we don’t have the growth that would enable it to be paid off.
It would be easy to simply end here, and point out that John Richardson and I set out the reasons why money-printing could never work in 2011, when we published Boom, Gloom and the New Normal: How the Ageing of the BabyBoomers is Changing Demand Patterns, Again. Our conclusion then was essentially based on common sense:
Central bankers simply confused cause and effect: demographics drive the economy, not monetary policy.
Common sense tells us that young populations create a demographic dividend as their spending grows with their incomes. But today’s ageing Western populations have a demographic deficit: older people already own most of what they need,and their incomes decline as they enter retirement.
But having been right in the past doesn’t help to solve today’s problem of excess debt and leverage:
- Common sense also tells us that leverage equals risk – if it works out, everything is fine; if not…..
- If you have a lot of debt and the world moves into recession, it becomes very hard to repay the debt
Financial markets are doing their best to warn us that the problems are growing. Longer-term interest rates, which are not controlled by the central banks, have been rising for some time. They are telling us that some investors are no longer simply chasing yield. They are instead worrying about risk – and whether their loan will actually be repaid.
Essentially, we are now in the and-game for stimulus policies. Major debt restructuring is now inevitable – either on an organised basis, as set out by Bill White, the only central banker to warn of the 2008 Crisis – or more chaotically.
This restructuring is going to be painful, as the chart above on the impact of leverage confirms. I originally highlighted it in August 2007, as the Crisis began to unfold – unfortunately, it now seems to have become relevant again..
PLEASE DON’T FIND YOURSELF SWIMMING NAKED WHEN THE TIDE OF DEBT GOES OUT
Leverage makes people appear to be geniuses on the way up. But on the way down, Warren Buffett’s famous warning is worth remembering: “Only when the tide goes out do you discover who’s been swimming naked”.
*Return on Equity is the fundamental measure of a company’s profitability, and is defined as the amount of profit or net income a company earns per investment dollar.
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President Trump no longer tweets regularly about new record highs for US financial markets.
The tweets were a core activity in the first year of his Presidency, when he was still feeling his way into the job.
But now, as last week’s sackings of his Secretary of State and National Security Advisor confirm, his focus has returned to the promises made in his Gettysburg speech, before the election:
“I will begin taking the following 7 actions to protect American workers (my emphasis and status unpdate):
FIRST, I will announce my intention to renegotiate NAFTA or withdraw from the deal under Article 2205 – UNDERWAY
SECOND, I will announce our withdrawal from the Trans-Pacific Partnership – DONE
THIRD, I will direct my Secretary of the Treasury to label China a currency manipulator – TRADE WAR NOW BEGUN
FOURTH, I will direct the Secretary of Commerce and U.S. Trade Representative to identify all foreign trading abuses that unfairly impact American workers and direct them to use every tool under American and international law to end those abuses immediately – UNDERWAY
FIFTH, I will lift the restrictions on the production of $50 trillion dollars’ worth of job-producing American energy reserves, including shale, oil, natural gas and clean coal– UNDERWAY
SIXTH, lift the Obama-Clinton roadblocks and allow vital energy infrastructure projects, like the Keystone Pipeline, to move forward – UNDERWAY
SEVENTH, cancel billions in payments to U.N. climate change programs and use the money to fix America’s water and environmental infrastructure – WITHDRAWN FROM UN CLIMATE CHANGE PROGRAMME”
Trump knows he faces a tough fight in November’s mid-term elections, when the Democrats could win control of Congress. So he is refocusing on the issues that won him the White House in 2016. As I noted before his Inauguration:
“If President Trump pursues the policy program on which he was elected, we are therefore about to live through a paradigm shift in America’s role in the world. This is his right as President, and America’s right as a free country. But it is critical that all of us recognise the change about to take place.”
This programme is quite different from the historical Republican platform focused on free trade and sound money.
The comparison between President Reagan’s 1986 tax reform and Trump’s tax cut last year highlights the different agenda. Reagan built consensus over 3 years, and ensured his reform was revenue neutral. Trump simply used the Republican majority to force through the tax cut, and ignored warnings that it could add $1tn+ to the deficit.
FINANCIAL MARKETS HAVE BEGUN TO TUMBLE AS THE FAANGS’ MARKETS MATURE
Wall Street has had a great run, as the chart of Prof Robert Shiller’s CAPE Index confirms.
Its Price/Earnings ratio peaked in January at 33.6 – even higher than 1929’s top of 32.6. Only the dot-com bubble at the end of the Boomer SuperCycle was higher, at 44.2.
Essentially, markets have been operating on the “5 Everyone concept”© . There are 3 core “Everyones”:
- “Everyone knows” stocks are over-valued, but believes they are clever enough to spot when it is time to exit
- “Everyone believes” the Federal Reserve will always rescue them, if markets did happen to tumble
- “Everyone assumes” that every correction is therefore a buying opportunity, as markets can never fall
But since January, the benchmark S&P 500 Index has seen these “3 Everyones” start to be questioned:
- It peaked at 2839 in January, and by February “Everyone assumed” its 2581 level was a “buying opportunity”
- But the March peak was just 2783, and prices then tumbled to 2588 on Friday
- If prices now go below 2581, then they risk trending much lower, with “lower highs and lower lows”
The key issue is the growing doubt over the outlook for the super-hot tech sector, and the FAANG tech stocks. This challenges the 4th “Everyone” – that “Everyone agrees” Facebook, Apple, Amazon, Netflix, Google (and Chinese companies such as Alibaba and Tencent), will dominate the global economy for decades ahead.
Last year, as the Financial Times chart confirms, the world’s Top 7 companies by market value were all tech-based.
But what if this idea is wrong? Can tech really continue to grow to the sky, or are its markets starting to mature?
- We know, for example, that the smartphone market has peaked, as I discussed last month
- Price competition is also intensifying as companies focus on market share, not profit
- Apple CEO Tim Cook is also very worried by the potential impact of trade wars
- Can Apple and its rivals continue to increase their earnings, given these challenges?
Similarly, the growing political storm over Facebook suggests its days of stellar revenue and profit growth are ending.
Questions are also being raised about the viability of tech’s business model, which depends on users giving up their personal information for free.
After all, history shows that even the highest-flying companies and markets eventually mature. At that point, Price/ Earnings ratios begin to drop, and investors start to refocus on dividend payments instead.
Unfortunately for Wall Street, it seems that Trump’s attack on free trade may turn out to be the catalyst for their discovery that tech’s days of exponential growth are over.
INVESTORS FACE 5TH “EVERYONE” CHALLENGE, AS “EVERYONE REALISES” MARKETS HAVE PEAKED
Trade wars are not normally good for business. Nor is political uncertainty – which is certain to rise as President Trump energises core voters ahead of the mid-terms. His Gettysburg policies set out, after all, “to protect American workers“.
If Trump’s initial focus on financial markets was indeed purely tactical, markets now have a bumpy ride ahead. The risk is that gradually, a 5th “Everyone” will become apparent – that “Everyone realises” markets have peaked.
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As promised last week, today’s post looks at the impact of the ageing of the BabyBoomers on the prospects for economic growth.
The fact that people are living up to a third longer than in 1950 should be something to celebrate. But as I noted in my Financial Times letter, policymakers are in denial about the importance of demographic changes for the economy.
Instead, their thinking remains stuck in the past, with the focus on economists such as Franco Modigliani, who won a Nobel Prize for “The Life Cycle Hypothesis of Savings”, published in 1966. This argued there was no real difference in spending patterns at different age groups.
Today, it is clear that his Hypothesis was wrong. He can’t be blamed for this, as he could only work with the data that was available in the post-War period. But policymakers should certainly have released his theories were out of date.
The chart highlights the key issue, by comparing average US and UK household spending in 2000 v 2017:
- In 2000, there were 65m US households headed by someone in the Wealth Creator 25-54 cohort, and 12.5m in the UK. They spent an average of $62k and £33.5k each ($2017/£2017)
- There were 36m US households headed by someone in the 55-plus New Older cohort, and 12.4m in the UK, who spent an average of $45k and £22.8k each
- In 2017, the number of Wealth Creator households was almost unchanged at 66m in the US and 11.9m in the UK. Their average spend was also very similar at $64k and £31.9k each
- But the number of New Older householders had risen by 55% in the US, and by 24% in the UK, and their average spend was still well below that of the Wealth Creators at $51k and £26.4k respectively
Amazingly, despite this data, many policymakers still only see the impact of today’s ageing Western populations in terms of likely increases in pension and health spending. They appear unaware of the fact that ageing populations also impact economic growth, and that they need to abandon Modigliani’s Hypothesis.
As a result, they have spent trillions of dollars on stimulus policies in the belief that Modigliani was right. Effectively, of course, this means they have been trying to “print babies” to return to SuperCycle levels of growth. The policy could never work, and did not work. Sadly, therefore, for all of us, the debt they have created can never be repaid.
This will likely have major consequences for financial markets.
As the chart from Ed Yardeni shows, company earnings estimates by financial analysts have become absurdly optimistic since the US tax cut was passed.
The analysts have also completely ignored the likely impact of China’s deleveraging, discussed last month.
And they have been blind to potential for a global trade war, once President Trump began to introduce the populist trade policies he had promised in the election. Last week’s moves on steel and aluminium are likely only the start.
Policymakers’ misguided faith in Modigliani’s Hypothesis and stimulus has instead fed the growth of populism, as the middle classes worry their interests are being ignored. This is why the return of volatility is the key market risk for 2018.
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Rising life expectancy, and falling fertility rates, mean that a third of the Western population is now in the low spending 55-plus age group. Given that consumer spending is around two-thirds of the economy in developed countries, the above charts provide critically important information on the prospects for economic growth.
They show official data for household spending in 3 of the major G7 economies in 2017 – the USA, Japan and the UK:
- Each country reports on a slightly different basis in terms of age range and headings, but the basics are similar
- US spending peaks in the 45 – 54 age group: Japanese spending peaks at age 55; UK spending peaks at age 50
- After the age of 75, US spending falls 46% from its peak and UK spend falls 53%: after the age of 70, Japanese spending falls 34%
The data confirms the common sense conclusion that youthful populations create a potential demographic dividend in terms of economic growth. Conversely, ageing populations have a demographic deficit and will see lower growth, as.older people already own most of what they need, and their incomes go down as they enter retirement.
The Western world has been, and still is, a classic case study for this demographic effect in action, as the second chart shows:
- In 1950, only 16% of Westerners were in the New Old 55-plus age group; 39% were in the 25-54 age group that drives economic growth and wealth creation; and 45% were under 25 as the BabyBoom got underway
- But by 2015, the percentage of New Olders had doubled to 31%, whilst the percentage of Wealth Creators was virtually unchanged at 41% and only 28% were under 25 (as fertility rates collapsed after 1970)
The Boomers were the largest and wealthiest generation that the world has ever seen, and as they joined the workforce they created an economic Super-Cycle. This was turbo-charged by the fact that, for the first time in history, Western women began to re-enter the workforce after childbirth:
- In the US, for example, women’s participation rate nearly doubled from 34% in 1950 to a peak of 60% in 1999
- And after the Equal Pay Act of 1963, their earnings rose to 62% of men’s by 1979 and to 81% by 2005 (since when it has flatlined)
But since 2001, the oldest Boomer, born in 1946, has been leaving the Wealth Creator age group. By 2013, the average Boomer had left it. And since 1970, Western fertility rates have been below replacement levels (2.1 babies/woman). So the Western economy now faces a double squeeze:
- The Boomers who created the SuperCycle are no longer making a major contribution to economic growth
- The number of new Wealth Creators is now relatively smaller, due to the collapse of fertility rates
In the past, very few Boomers would have lived beyond retirement age, as the 3rd chart confirms based on UN Population Division data. So, sadly, they would have been irrelevant in terms of economic growth. But, wonderfully, this is no longer true today:
- In 1950, average US life expectancy for men was just 66 years and 72 years for women. UK men died at age 67, and women at age 72. Japanese men died at age 61, and women at age 65
- Today, US men are living an extra 11 years and women 9 years more. UK men are living an extra 12 years and women 11 years more. Japanese men are living an extra 19 years and women 22 years more
- By 2030, the UN forecasts suggest US men will be living 20% longer than in 1950, and women 16% longer. In the UK, men will be living 23% longer and women 18% longer. In Japan, men will be living 35% longer, and women 37% longer
By 2030, 36% of the Western population will be New Olders, almost equal to the 37% who are Wealth Creators.
Clearly there is no going back to SuperCycle growth levels. I will look at this critical issue in more detail next week.
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Commentators have confused cause with effect when analysing this month’s sudden downturn in financial markets, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog
Surprise and confusion seem to have been the main reactions to this month’s sudden downturn in western financial markets. Yet across the world in China, warning signs of a potential downturn have been building for some months, as discussed here in June.
As the chart below shows, President Xi Jinping’s decision to move away from stimulus policy will have a direct impact on the global economy, as this has been the main source of the liquidity that has boosted financial markets over the past decade.
China’s official and shadow bank lending totalled more than $20tn between 2009 and 2017. By comparison, the US Federal Reserve, Bank of Japan, European Central Bank and Bank of England added “only” $13tn between them.
The critical importance of China’s policy shift was highlighted in December by the state-owned Xinhua news service when it announced Mr Xi’s priorities for 2018 as being to fight “three tough battles” to secure China’s goal of “becoming a moderately prosperous society” by 2020.
“Financial deleveraging” was described as the first battle, and it seems the opening salvos have already been fired, given that China’s capital outflows collapsed from $640bn in 2016 to just $60bn in 2017.
The People’s Bank of China then reinforced this priority in January with a statement emphasising that “slower M2 growth than before will become the ‘new normal’, as the country’s deleveraging process deepens and the financial sector gets back to the function of serving the economy”.
Western financial markets, however, seemed to adopt the “Road Runner approach” to this major paradigm shift in economic policy. Like the cartoon character Wile E Coyote, the new year saw them continuing to hang in mid-air before finally realising they were about to plummet into the chasm.
Even more worrying, now calm has been temporarily restored, is their failure to learn from the experience. Instead, commentators have mostly gone back to their comfort zone and are again focusing on the minutiae of policy statements from the major western central banks.
This could prove a costly mistake for investors and companies. As the FT reported in December, Mr Xi has already “made controlling debt at state-owned enterprises a top policy priority”, and it seems likely he will follow the IMF’s advice by increasing budget constraints for China’s zombie companies and allowing more corporate defaults. January’s shadow bank lending was the lowest January level since 2009 at just $25bn, and it was 90 per cent lower than in January 2017.
The recent rush of asset sales by major Chinese corporates such as HNA and Dalian Wanda is another clear sign of the new discipline being imposed. Foreign investors must hope the companies realise a good return from these disposals, given that they provided $221bn in dollar-denominated loans to Chinese borrowers last year.
Deleveraging is only one of Mr Xi’s “three battles”, however. And while his second battle on poverty reduction is unlikely to impact the global economy, his third battle, the “War on Pollution”, has a number of potentially critical implications.
It has already led to thousands of company closures and forcible relocations, and has severely disrupted major parts of China’s economy — causing China’s producer price index to peak at 6.9 per cent in the fourth quarter. In turn (as we had forecast here in November), this surge has created today’s “inflation surprise” as its impact rippled round the world.
One key component of the “surprise” was the disruption caused by the unexpected loss of production in key commodity markets. Oil prices have surged, for example, as China’s move away from coal has powered a short-term increase in oil demand. And, as always, the surge has been boosted by the inventory build typically associated with such unexpected and sudden price hikes. This can be seen in the second chart, which focuses on volume changes in the chemicals market, normally an excellent leading indicator for the global economy.
It confirms that consumers put aside their initial scepticism over Opec’s ability to support the oil market, as China’s excess demand helped prices to rise 60 per cent from June’s $44 a barrel to January’s $71 peak. Purchasers scrambled to build stock ahead of likely price rises for their own raw materials.
This time round, it even led buyers to abandon their normal tactic of reducing stock at year-end to flatter working capital data. Instead, inventories rose quite sharply all down the value chains, creating the illusion that demand was suddenly increasing in a co-ordinated fashion around the world.
The world has seen many similar increases in such “apparent demand” over the years, and these can temporarily add up to an extra month’s demand to underlying levels. This increase is, of course, only a temporary effect, as it is quickly unwound again once prices start to stabilise. The chart also shows that this was already starting to happen in January, with the normal seasonal stock-build being replaced by destocking.
In turn, of course, these developments raise a major question mark over the current assumption that the world is now seeing a synchronised global recovery. We suspect that by the summer, policymakers may well find themselves repeating the famous lament of Stanley Fischer in August 2014, when the Fed’s vice-chairman sadly noted that “year after year we have had to explain from midyear on why the global growth rate has been lower than predicted as little as two quarters back”.
Paul Hodges, Daniël de Blocq van Scheltinga and Paul Satchell publish The pH Report.
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Oil and commodity markets long ago lost contact with the real world of supply and demand. Instead, they have been dominated by financial speculation, fuelled by the vast amounts of liquidity pumped out by the central banks. The chart above from John Kemp at Reuters gives the speculative positioning in the oil complex as published last Monday:
- It shows hedge fund positioning in terms of the ratio of long to short positions across the complex
- The ratio had been at a near-record low of 1.55x back in June last year, before the rally took off
- On 30 January it had risen to a record 11.9x – far above even the 2014 and 2017 peaks
The size of the rally has also been extraordinary, as I noted 2 weeks ago. At its peak, the funds owned 1.5bn barrels of oil and products – equivalent to an astonishing 16 days of global oil demand. They had bought 1.2bn barrels since June, creating the illusion of very strong demand. But, of course, hedge funds don’t actually use oil, they only trade it.
The funds also don’t normally hang around when the selling starts. And so last week, as the second chart shows, they began to sell their positions and take profits. The rally peaked at $71/bbl at the end of January, and then topped out on 2 February at $70/bbl. By last Friday, only a week later, Brent was at $63/bbl, having fallen 11% in just one week.
Of course, nothing had changed in the outlook for supply/demand, or for the global economy, during the week. And this simple fact confirms how the speculative cash has come to dominate real-world markets. The selling was due to nervous traders, who could see prices were challenging a critical “technical” point on the chart:
- Most commodity trading is done in relation to charts, as it is momentum-based
- The 200 day exponential moving average (EMA) is used to chart the trend’s strength
- When the oil price reached the 200-day EMA (red line), many traders got nervous
- And as they began to sell, so others began to follow them as momentum switched
The main sellers were the legal highwaymen, otherwise known as the high-frequency traders. Their algorithm-based machines do more than half of all daily trading, and simply want a trend to follow, milli-second by milli-second. As the Financial Times warned in June:
“The stock market has become a battlefield of algorithms, ranging from the simple – ETFs bought by retirees that may invest in the entire market, an industry, a specific factor or even themes like obesity – to the complex, commanded by multi-billion dollar “quantitative” hedge funds staffed by mathematicians, coders and data scientists.”
JP Morgan even estimates that only 10% of all trading is done by “real investors”:
“Passive and quantitative investors now account for about 60% of the US equity asset management industry, up from under 30% a decade ago, and reckons that only roughly 10% of trading is done by traditional, “discretionary” traders, as opposed to systematic rules-based ones.”
Probably prices will now attempt to stabilise again before resuming their downward movement. But clearly the upward trend, which took prices up by 60% since June, has been broken. Similar collapses have occurred across the commodity complex, with the CRB Index showing a 6% price fall across major commodities:
- Typically, inventory build ahead of price rises can add an extra month of “apparent demand” to real demand
- This inventory will now have to be run down as buyers destock to more normal levels again
- This means we can expect demand to slow along all the major value chains
- Western companies will now see slow demand through Easter: Asia will see slow demand after Lunar New Year
This disappointment will end the myth that the world is in the middle of a synchronised global recovery. In turn, it will cause estimates of oil demand growth to be reduced, further weakening prices. It will also cause markets to re-examine current myths about the costs of US shale oil production:
- As the charts from Pioneer Natural Resources confirm, most shale oil breakeven costs are below $30/bbl
- Pioneer’s own operating costs, typical of most of the major players, are below $10/bbl
- So the belief that shale oil needs a price of $50/bbl to support future production is simply wrong
PREPARE FOR PROFIT WARNINGS AND POTENTIAL BANKRUPTCIES BY THE SUMMER
Over the summer, therefore, many industrial companies will likely need to start issuing profit warnings, as it becomes clear that demand has failed meet expectations. This will put stock markets under major pressure, especially if interest rates keep rising as I discussed last month.
Smart CEOs will now start to prepare contingency plans, in case this should happen. We can all hope the recent downturn in global financial markets is just a blip. But hope is not a strategy. And the risk of profit warnings turning into major bankruptcies is extremely high, given that global debt now totals $233tn, more than 3x global GDP.
I strongly believe that forecasts should be monitored, which is why I always review the previous Annual Budget forecast before issuing the next Outlook, and always publish the complete list of Annual Budget Outlooks.
Since January, I have also been monitoring my blog forecasts, using the percentage mechanism highlighted in Philip Tetlock’s masterly “Superforecasting” book. Today’s forecast for oil prices to fall initially to $50/bbl is therefore now added to those on ethylene/polyethylene and the US 10-year interest rate. I am also increasing the confidence level for the interest rate forecast to 70%, and will continue to update these levels when circumstances change.
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