Rudi's View | Sep 02 2015
Is There A Recession On The Horizon?
By Rudi Filapek-Vandyck, Editor FNArena
It’s kinda funny. Markets land in turmoil and experts the world around start looking at the past to find any clues about what possibly might lay ahead.
At least those once popular references to the 1930s are proving a lot less popular this year.
Also remarkable: bears are looking at 2007, as that was the precursor to the last bear market, while bulls (much larger in numbers) are looking back at 2011 when global market turmoil proved temporary and but a blip in an ongoing uptrend.
Now that we are looking back at history, the late 1990s might be a much better precedent to take guidance and draw conclusions from. For multiple reasons.
Fed Looking To Raise
Back in the 1990s, the US Federal Reserve under Alan Greenspan (pretty much considered The Almighty & Divine Oracle at that time) was done with cutting interest rates at 5.50% by early 1996 and in March the following year the first 25bp hike was announced.
Three months later Thailand had to abandon its USD-peg and a currency crisis developed that gradually affected the whole region. Financial markets volatility spiked and Greenspan & Co sat on their hands for a while (despite being in “tightening mode”) and eventually delivered three rate cuts throughout 1998, before resuming their tightening in 1999.
What initially started as one country’s failed policy (Thailand) triggered riots in the streets throughout South-East Asia, ending the reign of president Suharto in Indonesia, forcing Russia into default and Long Term Capital Management on the wrong side with losses rapidly accumulating to US$4.6bn. That was when the Federal Reserve Bank of New York organised a bailout to the tune of US$3.625bn. And Greenspan and Co delivered three rate cuts.
Nowadays, we are all used to see trillions here and there, but those were big numbers back then. And one can just imagine the fears that gripped the global investment community. Contagion? A global recession?
While the Fed was busy fixing the mess at LTCM, the crisis spread to Brazil and Argentina with the latter ultimately defaulting on its debt, in 2001.
Those were “eventful” days, to say the least, but take a look at the chart below picturing the S&P500 throughout that period (I simply grabbed it off the internet).
There was a sizeable pull back in mid-1996 and two more closer to the Fed’s first rate hike (after which US equities rallied), followed by a a bigger correction in 1998 (when LTCM hit global headlines), but all merely punctuated, instead of killing off, the underlying uptrend.
US Economic Resilience The Key
While some overseas markets melted by 50% as scary events unfolded, US equities proved far more resilient and the reason, explains Glushkin Sheff’s chief economist and strategist David Rosenberg, is the US economy proved far more resilient than its detractors feared at the time.
If you’re looking for additional colour, and even more parallels with 2015, consider that:
– 30% of global growth was in crisis
– crude oil prices fell by 50%
– industrial commodities prices fell by 25%
– trade-weighted USD rose by 10%
– US real GDP growth averaged 4%
– US jobless rate fell to near 4%
– US inflation fell to 1.4%
– US corporate profits went flat, but investors responded by pushing up PEs
– The VIX index jumped from 18 to near 46 at the peak in October 1998
To be clear, Rosenberg does believe all of the above merely postponed the inevitable with the US economy awaiting recession in 2000, triggering a genuine bear market for global equities in March that year. By then the Federal Reserve had pushed up interest rates to 6.5%.
The message for US share market investors is clear: do not fear foreign turmoil unless it pushes the US economy into recession and the latter is far more likely to occur when the Federal Reserve is at the end of its tightening cycle, not at the beginning.
A De-coupling In The Making?
The situation is not quite the same for investors in the Australian share market, of course. If 30% of global economic growth melts down again, both the Australian economy and the local share market will prove far less resilient. As was the case in the 1990s.
I couldn’t find a nice looking chart for the All Ordinaries index for the period, but suffice to say, things were a lot more volatile on the ASX. As a typical commodities oriented economy, Australia also largely missed out on the euphoria followed by complete disaster that followed the global Y2K/technology boom-bust cycle that came next.
It was here, of course, but more on a micro scale. The All Ordinaries merely went sideways between 1999-2003 while the Nasdaq in the US, to name but one contrasting example, rose to an all-time high pinnacle and then crumbled all the way down again.
As NAB economists put it on Monday afternoon: Should the global/local growth outlook deteriorate significantly the RBA will not hesitate to cut again and they could cut aggressively. But with their hurdle to cut again quite high, it’s also unlikely they will pre-empt this possibility.
In contrast, NAB, and many others, expect the Federal Reserve to finally deliver that long-awaited first rate hike later this month. Because the US economy is in good shape and it looks like it can cope with such a minor change in monetary dynamics. And as the above example suggests, the Fed won’t hesitate to reverse course, if need be.
One of the lessons that can be drawn from the past is that in times of Asian troubles, US and Australian financial markets cease moving in lock-step. It happened in 1999 and it again makes a lot of sense this time around since US investors can fall back on what is likely to be a fairly resilient economy.
The RBA simply does not have the same clout.
China Is Slowing
Which brings us to the enigma that led to August’s sudden spike in global markets turmoil. There was no crisis in Thailand or anywhere else, so what was it all about?
In essence, ongoing downward trajectory for global growth forecasts and China sits at the centre of it. Not only because China has become the world’s second largest single-country economy, it also is the largest contributor to global annual growth. Plus a slow-down in China directly affects its neighbouring countries, so it has quite a profound impact on global growth and on growth in Asia in general.
This process is still ongoing.
On Monday, my Twitter feed told me Goldman Sachs has cut GDP growth projections for China to 6.4% from 6.7% prior for next year, and again lower for subsequent years. Do not believe the nonsense that is steadily repeated about 6% is still a high number and China’s economy is now larger in size.
Instead, ask yourself did BHP Billiton shares require a “hard landing” in China to fall below $23 or was a continued slowing in the pace of growth sufficient?
Economists at ANZ Bank keep a close watch on global growth indicators. Their latest update states: “The ANZ global lead index (GLI) fell in July and looks set to do so again in August. The slowdown is being led by China as activity in other major regions is stabilising. Our inventory pulse measure suggests that global momentum may weaken further in coming months, led down by China again“.
It is this ongoing deterioration in China’s economic momentum, coupled with significant loss in investors’ confidence on the back of share market incompetence, that is leading to a noticeable retreat in global risk appetite. And as history shows (see 1997-98 above), when put under pressure, sooner or later the weakest link will break and create the next confidence-shattering event.
Is there enough pressure already? Who’s going to be the next weak link to break? I note Indonesia is once again on many an Asia watcher’s list. Most times, trying to predict the next event is but a futile exercise.
Pared Back Expectations
What comes next is all about whether economies -locally, in the US or even globally- are facing recession or not. Thus far, there is little evidence we should expect negative growth in Australia, let alone elsewhere or in the US. Investors worried about a repeat of 2008-2009 or 2000-2003 should note in both cases the US economy landed in recession.
This doesn’t mean the events from August won’t have any impact on financial markets next. The Australian share market has lost 15% of its value over the past six months. On Monday, strategists at Deutsche Bank issued a report in which they identified 15 similar events over the past 55 years.
At face value, markets can fall a lot further still and they can rally all the way back. History shows plenty of examples for both scenarios. However, if we exclude the possibility of a recession, then a positive picture emerges with Deutsche Bank reporting only on one occasion did the share market not rise over the subsequent twelve months. On all other occasions markets ended higher on a twelve months horizon, with the average gain 10%.
The report also sees Deutsche Bank strategists, previously among the most optimistic bulls locally, pare back their projections for the ASX200. Instead of their earlier target of 6200, the strategists now see the ASX200 at 5600 by year-end, at 5800 by mid next year and -finally- at 6000 by late 2016.
Post a rather meek and disappointing local reporting season, these projections still require above average share market valuations so Deutsche Bank clearly is banking on investors keeping the faith in central bankers’ abilities and in central bankers further feeding this confidence. Lower bond yields shall play their part too. Governments probably not.
[With local reporting season now done and dusted, I shall publish a detailed analysis/assessment later in the week]
Rudi On TV
– on Wednesday, Sky Business, 5.30-6pm, Market Moves
– on Wednesday, Sky Business, 8-9.30pm, Your Money, Your Call Equities (host)
– on Thursday, Sky Business, midday-12.45pm, Lunch Money
(This story was written on Monday, 31 August 2015. It was published on the day in the form of an email to paying subscribers at FNArena).
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena’s – see disclaimer on the website.
In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via Editor Direct on the website).
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THE AUD AND THE AUSTRALIAN SHARE MARKET
This eBooklet published in July 2013 forms part of FNArena’s bonus package for a paid subscription (excluding one month subscriptions).
My previous eBooklet (see below) is also still included.
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MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS
Odd as it may seem, but today’s share market is NOT only about dividend yield. Post-2008, less risky, reliable performers among industrials have significantly outperformed and my market research over the past six years has been focused on identifying which stocks, and why, are part of the chosen few; the All-Weather Performers.
The original eBooklet was released in early 2013, followed by a more recent general update in December 2014.
Making Risk Your Friend. Finding All-Weather Performers, in both eBooklet versions, is included in FNArena’s free bonus package for a paid subscription (excluding one month subscription).
If you haven’t received your copy as yet, send an email to info@fnarena.com
For paying subscribers only: we have an excel sheet overview with share price as at the end of August available. Just send an email to the address above if you are interested.
