Could the stock market be headed for a huge fall now that central banks are removing stimulus measures?

Jerome Powell
Fed Chair Jerome Powell speaks in the Rose Garden shortly after his nomination in November, 2017

In the wake of the financial crisis over 10 years ago, the world’s largest economies were left in a precarious situation. Low growth, hampered investor sentiment, lower spending and high unemployment all combined to create an economic malaise which forced central banks to act, in an effort to stimulate the ailing economies which they served.

In the years that followed, the Federal ReserveBank of JapanEuropean Central Bank and Bank of England all took measures to deal with a major economic downturn, which had spread globally.

One way they did this was through quantitative easing, where they bought large amounts of assets from commercial banks and institutions (including government bonds) while raising the supply of money in the economy.

The overall goal was to encourage lending, borrowing and consumer spending and to improve business sentiment, but there was another side effect they were hoping for — an increase in asset prices (including stocks). This side effect was realized, though not only through QE, but also because banks slashed interest rates to historic lows, which meant that bonds became less attractive for investors (due to lower returns). Because of this, investors sought riskier assets like stocks to generate higher returns. With more money being pumped into the stock market, the price of those securities increased. Central banks also hoped that by improving returns from stocks, they could also create a ‘wealth effect’, that would lead to higher spending too.

But that was the past and now all of this is changing.

The Fed in the US and the ECB in Europe are reversing their ‘easy money’ policies, because they think that the US and Eurozone economies are strong enough to stand on their own. It has taken 10 years, but economic markers are now being dubbed healthy enough to begin a long period of ‘unwinding’. The ECB confirmed in a statement on June 14th it would end QE bond purchases by December, while the Fed has already started unwinding its massive balance sheet after ending QE and is raising interest rates as both banks move to ‘normalise’ monetary policy.

What does this mean for investors?

Could things get bad for stock prices now that central banks are removing some support for the economy? Did QE really make that much of a difference to stock market valuations and is broader policy normalisation definitely going to hurt your portfolio? Opinions differ wildly on the matter, which makes things all the more confusing!

Writer Thomas H. Kee Jr. at investment publication MarketWatch said: “We believe that bonds, stocks and real estate will experience significant repricing in the years ahead, with the stock market at greatest risk. A 40% correction in the S&P 500 is possible.” Given the fact that many stocks in that index (particularly big names in the tech sector) look overpriced relative to their peers in other markets around the world, the earlier part of the argument seems like a fair assertion.

Then we have the counter-arguments. A report from Deutsche Bank in late 2017 said that QE may have impacted stock market movements by artificially boosting corporate profitability and by raising investors’ animal spirits, but the overall message was that strong earnings potential for US corporations indicated that corporate America is strong enough to withstand the withdrawal of QE and higher interest rates, and that fears that a withdrawal of stimulus could trigger an equity market meltdown appeared overblown.

Invstr CEO and former Deutsche Bank Director Kerim Derhalli is not so optimistic. He explained: “QE worked by boosting liquidity in the economy as the central banks bought bonds and gave the sellers of those bonds dollars or other cash in return. Many people agree that the liquidity that was generated contributed to the phenomenal rise in financial asset prices. As the Fed continues to unwind its $4.3trn balance sheet, the opposite will be true. The Fed will sell bonds on its balance sheet and drain US dollars out of the economy. This will reduce the liquidity available to purchase equities.”

He added: “Four other factors also bear watching: 1) Interest rates will rise making equities relatively less attractive than bonds. 2) Companies, especially emerging market companies who have added $40trn of debt since the debt crisis (!) will find it much harder to re-finance their bonds and loans in the capital markets. They will be competing for US dollar liquidity with the Federal Reserve. That will lead to more corporate insolvency and create pressure in the equity markets. 3) The US government has massively increased its budget deficit following President Trump’s tax cuts. That means that companies will be competing against both the Fed and the Treasury for liquidity. 4) The consequence of greater competition for dollar liquidity will mean a sharp rise in the value of the US dollar. This will have negative implications for US exporters and commodity producers creating further negative feedback for equity markets.”

Stock markets in the US in particular saw a large correction back in February this year, but relative stability has remained since then. Even with the knowledge that the era of QE and ultra low interest rates is beginning to come to an end, the S&P500 index is still up over 14% since June last year, with a slew of strong corporate earnings for bluechip companies through 2018 thus far too. It seems for most of the year, investors were betting that Jerome Powell and his fellow central bankers across the world would not make any significant missteps and that stock prices could remain high in the face of gradual policy normalisation.

Overall though, as billionaire investor Howard Marks put it to The Irish Times late last year: “We are in uncharted territory with all these central bank policies. We can’t say what will happen.” He added, “Anyone who says ‘I am completely confident in my understanding of the situation’ is really not that smart.”

A smart move for investors would be to keep an eye on this narrative as it develops. Whether the outcome of the withdrawal of stimulus measures is a huge correction in the markets, or whether it’s relatively minor in comparison, the end of the ‘easy money’ era is definitely going to have some impact on global stock indices.

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India’s economy set to overtake UK – knocking it from The Commonwealth’s top spot

This week Britain is playing host to the leaders of The Commonwealth nations. As the event takes place, the UK will still hold the crown as the largest economy out of the 53 countries included in the lineup, but by the time of the next meeting in Malaysia in 2020, it’s almost guaranteed that India’s economy will have surpassed Britain’s in size. It will be a change that symbolises the tectonic shifts in the world economy, as Asia’s booming nations continue to challenge the economic dominance of the West.

Currently India stands at number 6 on the International Monetary Fund (IMF) world GDP rankings, with a GDP of over $2.26 trillion behind Britain’s $2.61 trillion, but bullish forecasts from both the World Bank (WB) and IMF suggest India will cruise comfortably into 5th place behind Germany in the next 2 years. The WB forecasts 7.3% growth this year for India’s booming economy, up from 6.7% last year, while IMF pegs it at a slightly more upbeat 7.4%. This will make India the world’s fastest growing economy in 2018, surpassing China.

But it’s not only India’s current shorter-term (1-2 year) growth prospects that should be cause for excitement, not least for investors in Indian equity markets. The longer-term equation looks equally lucrative. The Indian economy has plenty of room for future growth. Putting aside any external tailwinds from problems elsewhere in the world which could affect global trade and investment, India has the recipe for success including:

– A rising middle class which is spending and investing more.

– A young population (more than 65% below the age of 35) with more and more people entering the workforce, growing the pool of labor available for companies.

– A massive rural population that currently has low access to digital services and infrastructure, but with a government that is pushing to create a digital revolution in India, ecommerce companies like Amazon and Flipkart will be able to grow quickly as people who once never had access to internet start buying goods online.

– A stable government that has launched a flagship health insurance scheme to cover over 100 million families, while also pledging to invest large sums in the agricultural sector (the most important sector of the Indian economy accounting for 18% of India’s GDP which employs 50% of the nations workforce).

The IMF said today that India needs to address weaker aspects of its labour market and reform issues in its financial sector. With these issues solved, more jobs will be created and banks will feel more comfortable lending, both adding yet another stimulus to an already rapidly expanding economy.

Britain will now be looking to secure an even closer partnership with India, (which was referred to the ‘crown jewel’ of its empire in the colonial period), especially given the need it has to establish new trading relationships post-Brexit. It is likely that trade will be a key factor of discussion as representatives from both nations, and all other members of the Commonwealth community representing over a quarter of the world’s population, meet in London this week.

Trump puts world markets on edge – but relief for stocks may be at hand

Stock markets around the world took a large blow last week. The biggest factor at play was President Trump’s instigation of new tariffs on China over concerns of intellectual property theft – the second action on trade in as many weeks after the administration enacted steel and aluminium tariffs for the Chinese and other nations.

However the other reason concerned geopolitics, and perhaps the future of the world as we know it today. The sitting National Security Adviser at the White House H.R. McMaster was axed, and Trump replaced him with a former ambassador and mouthpiece for the military-industrial complex John Bolton. This appointment has palpably raised the prospect of an armed conflict between the United States and one of its adversaries, most likely to be Iran. Indeed, John Bolton called for Israel or the US to bomb Iranian nuclear facilities as recently as 2015, in an op-ed piece for the New York Times. Bolton was also a firm supporter of the war in Iraq, which many consider to be an illegal war driven purely for the benefits of American corporate interests, including oil companies.

Trump has seen more moderate and reflective members of his administration leave in recent months. Hope Hicks, who was known as having a calming influence on the President, left her post as White House Communications Director, shortly followed by Gary Cohn – Chief Economic Adviser. A former Goldman Sachs employee, Cohn had opposed Trump’s metal tariffs, and was one of the key players behind getting the popular tax reform bill passed last year. Soon after Rex Tillerson got the chop as Secretary of State, another moderate who favoured keeping the Iran nuclear deal and seeking a diplomatic resolution to tensions on the Korean peninsula. Trump replaced him with Mike Pompeo, the former CIA Director who holds a noted aggression towards Iran.

Jeremy Bash, a former Chief of Staff at both the CIA and Defense Department said on MSNBC that Trump was “assembling a war cabinet”. Given the direction of his team, this seems hard to argue with. With less mediating influences at his side, Trump will be less likely to hear opposing arguments from more dovish staff. Instead his views on Iran may be blindly accepted in an echo chamber where voices of dissent are minimal. Ironically, Trump ran on a platform based partly on withdrawing the US from expensive overseas wars, but he has constantly reaffirmed his commitment to increase military spending since he took office.

A war in Korea has been made less likely thanks to Kim Jong Un approaching South Korean leader Moon Jae In, but a question mark still hangs over the Middle East, not only because of the possibility Trump will scrap the Iranian nuclear deal, but also the prospect of a conflict erupting over Syria, where Russian forces are still propping up the Assad regime. Just last month, The Guardian reported that scores of Russian mercenaries had been killed by US airstrikes in the country as the US attacked pro-regime forces. If events like this continue to occur, the prospect of a confrontation between the US and Russia rises. Russia already resents the fact that NATO military buildup on its borders in Eastern Europe, and it goes without saying what a war between the two could mean for the global economy.

None of this is good news for the world as a whole, except those in the military-industrial complex who hold stock in military companies!

Today though things look brighter. US stock futures are up, on reports the US and China are trying to resolve the trade dispute behind the scenes. European markets are also driving higher led by the DAX (Germany 30). We have our fingers crossed that the worlds foremost superpowers can be pragmatic, adult and reasonable – though with Trump at the helm of one of them, this is not guaranteed.

The world economy is stronger but tensions are rising – a look at the OECD’s latest report

The OECD says the global economy will see its strongest growth in seven years in 2018 thanks to a rebound in trade and investment, though it also warned today that a trade war could threaten the recovery.

In its March 2018 interim economic outlook which used the subtitle ‘Getting stronger, but tensions are rising’, the organisation updated its outlook for G20 economies and raised its global growth forecast for 2018 and 2019 to 3.9 percent – the highest since 2011, from previous forecasts of 3.6 percent for both years.

The raised forecast is partly due to expectations that U.S. tax cuts will boost the American economy.

Here were the key positive takeaways from the report:

– Growth is improving or steady in most G20 economies

– Trade and private investment are bouncing back

– New fiscal stimulus in the United States and Germany will further boost short-term growth

– Inflation (a concern for Central Banks) is set to rise slowly

– Consumer confidence, particularly in BRIICS nations (Brazil, Russia, India, Indonesia, China and South Africa) has risen sharply

The key negatives and risks were as follows:

– Income gains, particularly for median and low income households have barely improved over the last decade

– Public and private debt in G20 nations is very high, with China leading the way at over 200 percent of GDP

– The pace of structural reform is slow, in emerging market countries especially

– An escalation of trade tensions would be damaging for growth and jobs

Regardless, the overall picture is healthier. Acting OECD Chief Economist Alvaro Pereira said: “We think that the stronger economy is here to stay for the next couple years,” He added, “We are getting back to more normal circumstances than what we’ve seen in the last 10 years.”

This is good news for investors the world over, as a more robust global economy will create a better environment in which companies can grow and expand more easily, boosting corporate results and shareholder returns.

China vows to retaliate to U.S. tariffs on steel and aluminium as prospect of trade war looms

The Chinese government in Beijing has confirmed it will retaliate if the Trump administration goes ahead with a plan to place tariffs on steel and aluminum imports from China and other nations including Brazil.

In the latest progression in tensions between the 2 countries, Wang Hejun, a senior official at China’s Commerce Ministry said: “If the final decision from the U.S. hurts China’s interests, we will definitely take necessary measures to protect our rights.”

He was of course referring to proposals drawn up by U.S. Commerce Secretary Wilbur Ross, who last week recommended Trump should impose tariffs on foreign suppliers of metals due to ‘national security’ issues, as well as unfair trade practices including steel ‘dumping’. Dumping is the process of keeping steel prices artificially low, which has the effect of pricing other producers out of the market. Republicans in Washington argue that this practice negatively impacts the ability of U.S. steel companies to compete, thus hitting communities in America which have depended strongly on manufacturing jobs, and have been decimated by the closure of factories, particularly across the rustbelt.

Trump’s more protectionist rhetoric on trade and his skepticism of globalisation resonated strongly with voters in these communities in 2016, yet this is an age-old problem that was a hot topic even under Obama. Even notoriously anti-Trump news outlet CNN formerly sympathized with his perspective. In a report in 2016, CNN said that the American steel industry was “being hurt by an unprecedented surge in unfairly traded imports, with record amounts of foreign-produced steel flooding into the United States. Cheap, subsidized foreign imports are taking steel jobs away.”

Whether these tariffs are good for the American worker is yet to be seen, because this is only the second salvo to be fired in what could become a full blown trade war, but it’s fair to say the ramifications of this action from the Trump administration will be significant, given that China produces around half the world’s steel. Trump has until mid-April to decide on whether to go ahead with the proposals, which would mark the second major action on trade after he imposed tariffs on solar panels and washing machines from the Asian superpower in January.

The move won’t be a surprise given the rhetoric Trump used during the campaign and in his first year in office. He’s set his sights on renegotiating everything from how much NATO members spend on their military budgets to coming down hard on Canada’s lumber industry, whereby the Department of Commerce set total import tariffs at above 20 per cent for most Canadian softwood lumber producers last November.

China’s Ministry of Commerce soon went on the defensive, and said the conclusions from a US departmental national security review of the steel and aluminium industries were incorrect, because China has proven its products did not threaten U.S. national security. Wang Hejun said: “The spectrum of national security is very broad. Without a clear definition, it could easily be abused. If every country followed the U.S. on this, it would have serious ramifications on the international trade order.”

Tesla Stock Turns Bearish as Model 3 Production Disappoints Investors

Shares in electric auto-maker Tesla slipped Thursday (4/1/2018) on American stock markets, after the company announced production targets of Tesla’s highly sought after Model 3 cars had been pushed back yet again!

In the latest disappointing news for Tesla investors, the company revealed they delivered 29,870 vehicles in Q4 2017, with only 1,550 of those being Model 3 cars. These numbers fell short of forecasts, while it pushed back production targets for the Model 3 as well. This puts the Model 3 at under 2,000 deliveries for its first six months, while the Chevy Bolt just announced its best month ever at more than 3,000 units delivered. A damning comparison.

In 2017 the company said it planned to reach a production rate of 5,000 Model 3 cars per week by the end of the year, but later revised back this target to the end of Q1 2018.

Now however it says it doesn’t expect to reach this target until Q2 this year (representing yet another delay). It said it had made “major progress” toward addressing production bottlenecks, but these words will ring hollow for investors who are growing increasingly frustrated.

Tesla figurehead Elon Musk said in October that the company had been “deep in production hell” making the Model 3. The car is its first attempt to create an appealing electric vehicle for the mass market and not just niche enthusiasts.

Some investors believe the issues in the production chain could be more easily resolved if Musk spent more time on Tesla instead of his other ventures (The Boring Company and SpaceX).

Here’s a 1 month chart for Tesla’s stock. It was a poor December for shareholders.

Telsaa

With all of this being said, I find Tesla to be a fascinating company and a stock to watch for the long term.

Setbacks in production, though frustrating, are not unusual for a business which is so focused on revolutionizing the auto-sector and the way humanity will travel in the future. I think investors understand that too.

Tesla’s tentacles keep spreading further across the auto-industry. Elon Musk announced the Tesla ‘Semi’ truck in November 2017, a fully electric alternative to traditional trucks, which seems as if it will genuinely be able to compete in the space with its regular diesel/petrol counterparts.

Then there is his side-line projects like The Boring Company, which aims to relieve congestion on American roads by creating huge underground tunnels for traffic to flow through, as well as his ambition to give people the chance to travel around the world at rapid speeds via spacecraft (London to New York in 29 minutes, anyone?)

Overall, those who are shorting Tesla stock at the first sign of issues (like this production problem) are probably not the sort of people who should have bought the stock in the first place. If you believe in Elon Musk and his aspirations, then this is a long-term buy and hold and you shouldn’t jump ship when hiccups occur along the way. You can see that by looking at just how far Tesla’s vehicles have already come since its inception in 2003. The stock price has also ballooned by nearly $300 in the past 5 years despite a chorus of criticism from naysayers who doubted its ability to enact change.

 

Former ECB head calls time on debt & highlights risks to investors

Trichet
Mario Draghi’s predecessor is concerned

Eurozone growth is up across the board, earnings season in the US was impressive, the UK’s FTSE100 has had a stellar year despite Brexit worries, and even Greece’s economic woes look far less terrifying.

Everything looks better, doesn’t it? Aren’t we through the worst of the post-crisis economic downturn, so now we have less to worry about? Jean-Claude Trichet, the former President of the ECB (pictured), doesn’t entirely think so.

Speaking to CNBC, Trichet said, “Despite the fact that real growth is active, I wouldn’t say buoyant, but very satisfactory, we have some indicators on global leverage that are not reassuring.” Referring to massive debt levels across the world, he added, “We are now at a level (of debt) which is higher than immediately before the financial crisis, so there’s no time for complacency.”

The International Monetary Fund has repeatedly warned about global debt levels. The IMF’s deputy managing director David Lipton said, “We are seeing some greater leverage in the corporate world, in some countries for households, so that rising indebtedness and that increase in market risk really is something policymakers should keep an eye on.” Last year, global debt hit a record high of $152 trillion, while the IMF warned it added major risks to recovery.

Even China, which has relied heavily on debt to boost their economy in the past, is slowing down borrowing in order to reduce risk. Yesterday they pulled a $4.6 billion subway project in Inner Mongolia.

Additionally, Jean-Claude Trichet pointed out that a very long period of ultra low interest rates, coupled with quantitative easing programmes carried out by central banks, has allowed for the prices of financial assets like stocks to rise rapidly. This presents the risk of major bubbles in financial markets, which some would argue are already present.

Indeed, surveys indicate that a large number of investors think stock markets are overvalued, though they are still choosing to take on high levels of risk. Bank of America Merill Lynch’s new fund-manager survey (which includes over 200 people who manage $610 billion) shows a record number of survey respondents are taking higher-than-normal risk, at a time when US stocks are close to their highest valuations in history. Overconfidence here could be dangerous. The data indicates investors are feeling emboldened at a time when they should be more cautious.

Regardless, US markets are likely to rise further, pushing up stock prices. UBS thinks tax cuts in the US could boost S&P500 earnings per share by at least 6.5% in 2018, with telecom and financials predicted to be the biggest winning sectors. They noted that the S&P500 rallied by over 40% after the 1986 corporate tax cut under Ronald Reagan, so this seems likely.

Patrick Jones