Avoiding the Japanese Financial Disease
The world has changed. Growth isn’t like what it used to be. And if growth isn’t readily available, that might be bad news for the investment world in general.
Japan may well represent the path of “change” we’re on globally. And that doesn’t look pretty.
Back in the 1970s and 1980s Japan was the home of innovative business models and progressive economic policies. These were seen as the cornerstone that propelled the country’s spectacular post-World War II growth story.
But now Japan only resonates long-term slump, economic mismanagement and huge government debt levels. After decades of unparalleled growth, Japan’s downturn took hold in the early 1990s when its asset price bubble burst and had a massive structural impact on the economy.
It wasn’t long before Japan became an economy where inflation, real interest rates and growth all sat close to or below the zero percent level. Efforts to resurrect the economy have so far failed.
Unfortunately, there are signs the negatives within the Japanese story may be spreading.
Where does that mean for the rest of us?
The worry is that the global economy has caught the “Japanese disease” – i.e. secular stagnation and efforts to stimulate growth failing to have an impact. The key to whether it takes hold is whether global governments and central banks have learned the lessons and take a more proactive approach
Relying on interest rate cuts alone wasn’t enough to inflate the Japanese economy. Instead, the slowdown triggered deflation, with households delaying or cancelling purchases, expecting prices to be lower in the future.
The global economy is slowly moving towards the Japanese way. Central banks have spent years slashing interest rates and injecting more cash into economies. The aim was to stimulate growth in the post-global financial crisis world. But the rebound hasn’t materialized and inflation remains too low and moving towards deflationary levels. The European Union is a particular worry, as consumer prices continue to fall.
The Organisation for Economic Co-operation and Development (OECD, which promotes economic growth, prosperity and sustainable development) recently warned that the world economy is slipping into a self-fulfilling “low-growth trap.” In such a scenario, slow growth would become a norm that would be hard to escape from.
How did we get here?
Demographics, the explosion of debt globally and the disparity in wealth between the rich and poor are all part of the story. Low interest rates are also a natural consequence of too much government borrowing after the financial crisis. Essentially, 2008-09 changed a lot of things that we haven’t been able to reset.
Nowhere to hide
One issue trouble now is that growth is slow everywhere and no one region is strong enough to bail the others out. For some context, before the global financial crisis, over the 1980 to 2008 period, world GDP growth averaged 3.5%, according to economist Stephen Roach. That compares with 2009’s mere 0.028% increase and its later weak rebound.
Global authorities have also been slow to act. For years Japan resisted the restructuring and structural changes that might have supported a rebound. Instead, the economy spiraled lower. Prime Minister Shinzo Abe’s recent three-pronged attack on reviving the economy looks set to only have a limited impact.
The problems are spreading
Symptoms of the Japanese disease are evident across the world. Bubbles in the real estate and credit markets inflated US consumer spending after years of cheap credit. When the markets burst, the heavily indebted, savings-short households were badly affected.
Between 2008 and 2015, growth in inflation-adjusted consumer expenditures averaged just 1.5%, according to Stephen Roach. This was less than half the 3.6% pace of the preceding 12 years. Like Japan, the US now finds itself struggling to move beyond a low interest rate position with little in the way of sustainable growth to show for it. When rates do rise soon, hold your breath…
Europe is mirroring Japan even more. The continent has limped from one crisis to the next. The policy response has been quantitative easing and, now, negative interest rates, which is a similar approach to Japan. But the efforts to stimulate growth in the region and generate inflation have failed so far. The European banking sector is starting to look a lot like Japan’s – struggling with poor quality balance sheets. Tough decisions need to take place in Europe, even if the general public is resistant.
Emerging markets aren’t much help at the moment either. The resource-rich economies of Russia, Brazil and the Middle East are feeling the impact of low commodity prices. China’s slowdown also isn’t helping.
This has huge implications for investors. The Japanese stock market is less than half the value of its 1989 market peak after its struggles. The fear is that if the disease does spread this could signal tough times ahead for global stock markets.
What can policymakers do to counter the threat?
How can these countries put themselves on a better footing?
For the US that may mean pushing the general public to reduce household debt and increase long-term savings. In Europe, banking industry reform and a coordinated government response look essential.
China needs to find ways to get its population to spend more as it reshapes itself into a consumer spending-led economy. The country also needs to address overcapacity in industries, such as the steel and cement sectors, which is driving deflationary pressure.
Japan needs to find ways to remain productive with a rapidly aging society and declining workforce.
Ultimately, a strong and coordinated policy approach to structural change could be the only answer. The OECD believes there has to be “collective action across economies to raise public investment in projects with a high growth impact would boost demand and improve fiscal sustainability.”
Left untreated, there’s a danger the Japanese disease becomes ingrained in our biggest economies and potentially infects everywhere. If that does happen, expect stock markets to struggle globally.
Shares like growth, not stagnation. In that environment, safe havens like gold will continue to be a popular home for cash.
With great risk comes great reward. The truly great investors understand the risk/reward ratio and aren't afraid to take a calculated chance. How do we mitigate that risk? We study. We research. We gather like squirrels collecting nuts for winter in the hopes we can weather the storm when everyone else panics and pull a decisive victory out of thin air.
So what interests me about GNE? I am by nature a risk taker. I am not, however without caution when I need it. Even an old paratrooper like me knows to clip on a reserve pack when I jump out of a C130 at low altitude. Some investments are exactly like that. Ask anyone who invested right before SIRI dropped back during the bankruptcy days. Lucky for many of us at that time, we formed a support group of sorts on several websites. I managed no fewer than three of those forums at one point starting with the old SW, Radio Wars, Stock Shock crowd. Several of those investors had iron constitutions and turned .06 shares into substantial profits on the rebound. I am not saying GNE will do exactly that, what I am saying is that conditions are primed for a surprise.
Let's look at the basics:
The Strategic Advisory Board for Genie is not a list you won't recognize. Do you think that's a coincidence? Do they know something you and I don't? Sometimes the best thing an investor can do is follow the money. Who has taken interest in an investment and who has already done the risk/reward calculation. Let's throw a few names out there. Let's see who you recognize within a millisecond of reading my next words.
Richard Cheney (yes THAT Richard Cheney) 46th Vice President of the United States
Rupert Murdoch - Founder and Executive Chairman of News Corporation, one of the world’s largest diversified media companies.
Mary Landrieu - Former U.S. Senator from Louisiana
Bill Richardson - Former Governor of New Mexico
Jacob Rothschild - Chairman of the J. Rothschild group of companies and of RIT Capital Partners plc. Chairman of Five Arrows Limited.
Michael Steinhardt - Wall Street investor and Principal Manager, Steinhardt Management LLC.
Dr. Lawrence Summers - Charles W. Eliot University Professor and President Emeritus at Harvard University.
R. James Woolsey - Former Director of the CIA
Do I have your attention yet? Imagine me knocking on your computer screen from the inside out. Pay attention.
Now that we have the ice breaker out of the way let's look at another thing we love here at kingofalltrades.com. A chart. Yes it's time for the charts. We love to dissect them, flip them upside down, study them, and in my particular case I love looking at the long-term charts while everyone is hypnotized by the short term and misses the bigger picture.
So at a quick glance a pattern seems imminent.
I don't want to say you are blind if you don't see it, but I will if necessary.
With potential energy reserves that could tip the scales in Israel's favor dramatically in the coming years, that list at the top of this article is likely playing the long game. They are titans. My own opinion is that there will be money made on the next pop. Barring a surprise crisis beyond the chaos now. In the long term? I would bet those you see above have already set themselves up to laugh all the way to the bank.
Disclosure: I own shares of GNE as part of a balanced portfolio. All investors should do their own due diligence before investing in anything including stocks. Please consult a professional investment advisor if you are uncertain or wish to gain a better sense of the risks should you choose to invest. As with any investment I recommend you have a plan and only invest once you have completely gained an understanding of the effects of your investment.
"Both from the standpoint of stocks and bonds, an investor wants to go where the growth is." Bill Gross
The trouble with buying into hot investment themes is that sometimes we find out too late that the idea isn’t so hot anymore. And that seems to be playing out with one of the more fashionable concepts over the last decade or so: BRICs.
Back in 2001, Goldman Sachs strategist Jim O’Neil wrote an investment piece entitled “Building Better Global Economic BRICs”, which championed the investment potential of Brazil, Russia, India and China (or “BRIC” for short). Despite the fact that the four countries from three different continents are shaped by very different political systems, growth dynamics and even national sports, they were viewed by many as one homogeneous story. In fact, O’Neill was trying to represent the broader fast-growing, heavily populated emerging markets space. It reflected what was seen as a shift in global economic power away from the established powers to a new bloc. Little did he know the true impact of his acronym.
Some commentators added South Africa to the party to form “BRICS” - and you could as easily have thrown in the likes of Indonesia and Vietnam into the mix – as it was really a reflection of the outlandish growth dynamism seen within the emerging market space in the new millennium, aided later by the cheap money of quantitative easing.
And the story seemed to play out. Investors jumped into BRIC funds, growth boomed and investment into these parts of the world soared. It was no coincidence that these countries were also invited to host some of the major global sporting events for the first time – the FIFA Soccer World Cup in South Africa in 2010, Brazil in 2014 and Russia in 2018; the Summer Olympics in China in 2008 and in Brazil later this year; the Winter Olympics in Russia in 2014 and China in 2022.
The whole thing’s been like a coming of age movie. And as with any of these things, you get to see the growing pains in full flow. 2015 and 2016 have reminded investors that these markets still have a lot of growing up to do. Last summer China’s stock market implosion came under the spotlight. Trying to sustain 7%+ per year GDP was always going to be a tall ask, particularly when your government is looking to develop a brand new growth model based on consumer spending rather than the investment and exports one that had served you so well in the past. Unfortunately, the fallout from this has left many investors questioning whether these kinds of markets deserve their attention.
And it hasn’t been a great time for these countries of late. While India has held up relatively well, the economic environment has significantly impacted many of the leading emerging markets countries. Collapsing commodity prices have had a severe impact on Russia, Brazil and South Africa. As much as these countries have grown their presences on the global stage, they still have classic emerging market sensitivities to counter – too heavy a reliance on natural resources in their cases.
And when growth slows, the spotlight falls back onto how well the country is being run. In 2016 we’ve already seen calls for the impeachment of the presidents of both Brazil and South Africa, as accusations of corruption, money laundering and the misappropriation of funds hang heavy over both heads of state. Russia is once again getting used to its status as an international pariah – whether that’s over the country’s involvement in Syria and the Baltics states, or allegations of state-sponsored doping of its athletes. None of this has been good for their stock markets or provided peace of mind for investors still buying into the BRICs concept.
What all of this shows is that emerging markets still have risks. Plenty of risks. But does that mean investors should run a mile and stick to developed markets? No. Just looking at Asia, some 60% of the world’s population live in the region, with China and India accounting for 37% of the world’s numbers. The fastest growing consumer markets for everything from champagne to Gucci bags can be found in emerging markets. People here are still building lifestyles. They are new consumers. They are still emerging. And while there is always the argument for investing in some of these regions through companies with heavy exposure to them, it’s never the most “honest” way to approach emerging market exposure. It always feels like you’re missing out on some of the ride, both up and down.
The risks are certainly there but so are the returns over the longer term. That’s why investors get excited about these types of places in the first place. Given the global growth concerns and where we are with the commodity cycle at the moment, today may not be the best time to jump into some of these markets. But that time will come and these markets will come again.
“We really can't forecast all that well, and yet we pretend that we can, but we really can't.” Alan Greenspan, former Chairman of the Federal Reserve Bank.
It wasn’t meant to be like that. A new year and a fresh new start was supposed to be the narrative. The Fed starts its rate rising cycle into an unassuming, benign environment. Well, it seems stock markets around the world simply haven’t been listening.
It was only months ago that we were celebrating multi-year highs across a number of global indices. Now all the talk is about guessing which stock market will next fall into bear-market territory. Whether it’s China, the UK, Japan or Australia, all regions have markets at least flirting with the 20% decline from their peaks that would define such a slump.
And the negative headlines continue: “India hits a 20-month low”, “The S&P 500 declines to a 21-month low”, “Hong Kong’s Hang Seng Index falls to its lowest since 2012.” It’s been a bit of a bloodbath, laced with a margin call/liquidation feel about it. VIX, the “fear index”, has jumped over 50% this year. Throw in the hits to high yield currencies and commodities, and a lot of investors are feeling a little nervous right now.
So what’s driving this? In a nutshell, wherever you live in the world and whatever your geographic market bias, it’s back to stressing how much we live in an interconnected world.
One of the biggest headline grabbers of late has been the collapse in the oil price. The West Texas Intermediate (WTI) grade has fallen more than 25% so far this year and now sits below $27 a barrel for the first time since 2003. 18 months ago we had $100 oil and all was right with the world.
The trouble with what's happened with oil of late is that it encapsulates a number of different concerns: economic growth, politics, geopolitics, and corporate debt.
On the global economic front we’ve got China’s slower growth story continuing to unnerve investors. Whether the data coming out of the country can be trusted remains open to debate. Critics only see exaggeration. Nonetheless, the 6.9% growth figure China released for 2015 did fall short of 7% government estimates, was below the 7.3% for 2014, and marked the slowest rate in 25 years. Analysts forecast 6.5% for 2016, which wouldn’t be much of a problem if the rest of the world hadn’t become so reliant on this economy to take up the global growth slack. And a slower-growth China also means lower demand for oil.
Not only is the oil space being hit by a weaker demand environment, it’s also facing a new wave of supply coming onto the market. In the US, Congress voted in December to lift a 40-year ban on crude oil exports as part of a broader spending bill that averted the possibility of a government shutdown. The legislation will finance the government through September 2016. The political compromise is proving to be unfortunate timing for the oil market. Who knows what the changing of the presidential guard in the US this year will do for future energy policy?
Events in the Middle East have also added to the oversupply dynamic. Diplomatic relations have become even more strained than normal between Iran and Saudi Arabia, the world’s largest oil producer. Unfortunately, this is also playing out messily when it comes to oil. US and European Union sanctions have recently been lifted on Iran, restoring the country’s access to world markets. With the country planning to immediately ramp up oil production by 500,000 barrels per day, it aims to boost output by as much as 1 million barrels within a year. Rather than trying to support oil prices by cutting output, Saudi Arabia seems set on maintaining levels and market share to nullify the Iran threat. So for expediency’s sake, Saudi Arabia appears happy to keep oil prices low to hurt Iran. That’s how it appears anyway.
And then there’s the issue of debt. In the post-financial crisis world, banks had to rebuild their loan books with safer, more reliable borrowers. It was time to step away from the consumer and target corporates. What could be safer in a low interest rate environment than energy companies looking to expand production into new growth markets with the oil price at $100? Well, it’s become a bit of a perfect storm – interest rates are rising, the strong dollar is impacting the value of overseas earnings, emerging markets aren't emerging so much and we all know what’s happening with the oil price. So this is could become an earnings concern for coming quarters – will banks struggle with escalating defaulting loans from energy companies?
So investors have plenty to think about. With the beauty of hindsight a number of commentators have come out to say that the Fed shouldn’t have raised rates at all in December. The counter to that view is that markets are telling a different story to the broader economics, which really aren’t that bad. Yes, China’s expansion has slowed but that’s not new news, while the US has been showing steady if unspectacular growth.
But this is very much a sentiment-driven market. And sometimes sentiment can make certain scenarios self-fulfilling. Understandably money is flocking to gold and other safe havens. There’s also plenty of cash sitting on the sidelines, waiting. Who knows whether in five years’ time we’ll even remember any of the current narratives. For now, though, it’s not a time to panic. Keep calm, carry on and make the most of the cheap flights the oil price should give us.
“Cheers to a new year and another chance for us to get it right.” Oprah Winfrey
It’s December already and the year seems to have gone by in a flash. It doesn’t seem that long ago that excessively bullish sentiment was front and center of our minds, even if a US recovery was still uncertain and the noises out of Europe were worrying. How quickly we move on.
Investors will be catching their breath after another uncertain year and the “will they, won’t they?” Fed deliberations. In September the VIX Index partied like it was 2011 all over again, the last time the volatility measure rose above the 40 level. That time we had the European sovereign debt crisis, this time we had China. We live in an interconnected world.
As 2015 comes to a close it’s time to look back on another memorable year for the markets - memorable in part because we have finally put to bed the “Great Equity Market Bull Run” that blossomed out of the ashes of 2009. Yes, the Dow Jones Industrial Average hit an 18,351 record high back in May, but the market swings experienced in the second half of the year suggest we shouldn’t expect the market to oblige with a straight line trajectory in 2016.
So what have we learned?
If you weren’t too familiar with the Chinese stock market before this year, you’re certainly more aware of it now. Never has a 7% annual growth rate (or there abouts) turned out so messily for a country. The global market rout seen in August tells us that. As Chinese authorities battled to prevent the boom-bust behavior spilling into the real economy, so much wealth was created and so much destroyed in so short a period of time. It’s the meeting of free market principles with a managed economy. The experiment remains a work in progress. China’s increasing presence on the world stage, though, means investors have no choice but to monitor events there.
And China’s slowdown and subsequent government interventions have had huge ramifications across the board: commodity prices have collapsed, hurting resourced-biased economies from Australia to Brazil to Chile. It postponed the Fed's rate hike decision in September. It sent emerging market currencies into panic mode. It even managed to take a bite out of Apple’s revenue as smartphone shipments in this key market for the company slowed. Shipments are forecast to grow about 1% in 2015, compared with a 20% increase in 2014 and 64% in 2013, according to market research firm IDC.
In case it escaped anyone’s attention, Europe remains a basket case. Even without the enormity of the migrant crisis – and 2016 doesn’t look like a year of resolution for this - we’re talking about a region with a central bank that began a $1.2 trillion quantitative easing program in March and is likely to do more. The Greek crisis is still, well, a crisis. Meanwhile, the shadow of terrorism once again loomed large though Islamic State-inspired atrocities. Add to that the unconvincing post-austerity recoveries that have fed voters frustration and lurches to the extremes of the political spectrum, and you can see why confidence is fragile. The region is set for a very different growth trajectory to that of the US and that’s playing out in interest rate expectations and euro weakness. The divergence in regional cycles isn’t great for investors.
Emerging markets were supposed to make up for the global growth where developed markets, and Europe in particular, were falling short. We were supposed to be embracing CIVETS (Columbia, Indonesia, Vietnam, Egypt and South Africa) as we tired of BRICs (Brazil, Russia, India and China) and milked the EM story further. Unfortunately, we've hit a pause button here. The EM space has showed signs of rolling over at a time that the US is showing signs of recovering. And having borrowed heavily in US dollars, a rising currency that will accompany rising US interest rates will continue to provide headwinds for EM. The threat of heavy fund flow out of these markets and into a US market of rising interest rates is a risk for 2016. Let the flight to quality begin.
Most of the smart money accepted the price of oil wouldn’t return any time soon to the heady days of above $100/barrel seen back in summer 2014. But while the setting for 2015 may have looked challenging with West Texas Intermediate grade oil at the $60 mark, who would have guessed we could end the year closer to the $35 level? The oil story is where the macro picture meets geopolitics, very little of which has been supportive.
The gold bugs have also gone quiet, for now at least. The commodity’s early-year peak of $1300/oz now looks a world away from $1066 now. The prospects of a rising interest rate environment ensured that plenty of institutional money departed stage left in recent months, leaving plenty of retail investors newer to the game with holdings significantly under cost price and effectively waiting on the next crisis.
Geopolitical tension and terrorism are now part of life. For good or for ill, the market doesn’t get so shocked by terrorist attacks any longer. The shooting down of a Russian passenger plane, the tragic November events in Paris, the San Bernardino attacks, and the Charlie Hebdo terror all shook us as individuals. But the market absorbed the events and moved on.
The consensus view for 2016 is broadly cautious so read that as expectations for another bumpy ride. The Fed’s rate normalization process, China’s growth narrative and Europe’s state of disrepair provide the backdrop. Let's also not forget the small matter of a US presidential election and that can polarize and impact market sentiment.
Suffice to say none of us have a crystal ball and most forecasts coming out now for 2016 will be proved wrong, at least in part. That’s not to say we shouldn’t listen to them but as investors we do very often have short memories. Before we know it we’ll be excessively bullish again. Let’s just see now how quickly we move on.