Don’t tie your fortune to a rising market – and I mean any kind of market anywhere on the globe. This is a time to think strategically, stay hedged and diversified, and avoid big directional bets. I think active and hedged management will be the place to be in the coming period. To quote the motto of House Stark in Game of Thrones, winter is coming…Below is my 2016 forecast.
By John Mauldin (MauldinEconomics.com) An edited & abbreviated version of the original.
In general, recent data has been trending down (with the obvious exception of the employment numbers). I am concerned that the U.S. will be much closer to 1% growth than 2% for 2016. I know plenty of folks who expect the U.S. to go into recession this year. They may be right, but, if so, that downturn will be due to some kind of external shock but at a 1% growth rate, which is close to economic stall speed, it wouldn’t take much of an external shock.
I can see three real possibilities that we will need to keep an eye on.
- The first is Europe. Longtime readers know that my base forecast is that the euro survives, but only if the eurozone nations mutualize their national debts. The euro is not an economic currency; it is a political currency and it will take the political solution of creating a fiscal union to maintain it. Given the level of debt of most of the major members of the eurozone, a fiscal union can occur only if every country – read Germany – agrees to mutualize debts…
Up until recently I believed that you could get a majority of eurozone voters to go along with the pro-euro elite politicians’ extraordinary intentions to actually mutualize debts under the balance sheet of the European Central Bank (or another organization that would be created in the midst of crisis). Now I think that a political solution is at serious risk because of the immigration crisis. You can almost feel whatever sense of political unity existed in Europe disintegrating right in front of us. The recent tragic events in France and Germany are exacerbating the problem. I think getting a majority of voters to go along with the idea of giving up national sovereignty over their own budgets (which is what a fiscal union and the mutualization of debt would require) is becoming increasingly unlikely. As more and more people begin to demand that their countries control their own borders, the entire Schengen agreement is in jeopardy and without that agreement, the next national debt crisis (beyond that of Greece – Italy? France? Spain?) will call into question the unity of Europe.
As country after country in Europe begins to close its borders, the flow of refugees will not slow but will actually increase. If you are in a failed state in the Middle East or North Africa and you think the doors to Europe are closing, you’re going to go now rather than wait. The refugees will find ways into Europe through those countries that don’t have the resources to control their borders (think Greece). Europe’s ad hoc approach to border control simply won’t work. It will only serve to demonstrate the true impotence and incompetence of Brussels and EU bureaucracy and it will provide political fodder to nationalist groups that are beginning to hold sway in a number of major European countries.
No matter what you think of economic austerity in Europe, that concept is going to come increasingly under political fire and will be discarded. European borders are becoming less transparent, and Europe is increasingly economically vulnerable. A recession in Europe will cause a recession in a U.S. economy stuck at stall speed.
- China: I have just been a speaker at a conference sponsored by Bank of America Merrill Lynch with some 60 major investment… executives representing multiple hundreds of billions of dollars of funds around that table…and the overall mood was decidedly bearish. Only a few people were actually talking hard landing, but the large majority of Chinese growth projections were decidedly lower than government forecasts.
Further, there seemed to be general agreement that the renminbi is headed down. I was particularly impressed by the Merrill Lynch Chinese analyst from Shanghai who pointed out that if the wealthiest 3% of Chinese moved just 7% of their money offshore, we would be talking close to $1.5 trillion. Money is literally flying out of China, in a variety of legal and questionable ways.
The Chinese government has been manipulating its currency higher for many years. That is now getting ready to change. Andy Xie, a well-regarded China analyst who sat next to me during my presentation, would not rule out a 30–40% devaluation over time. Admittedly, his is one of the more bearish forecasts, but few in the room were arguing that the renminbi would get stronger. Andy in particular was bearish about China over the next two years, though he remains an undaunted China optimist over the longer term. He truly believes China will rule the world within a few decades…
China’s slowing down more than forecasts anticipate – or, God forbid, a hard landing – would definitely deliver a shock to a still-weak U.S. economy. We will have to pay close attention to China this year.
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- While everybody thinks of the Middle East in terms of geopolitics and military conflicts, the economic consequences of low oil prices will have far more problematic effects on the stock markets of the world. We are talking about sovereign wealth funds holding multiple trillions of dollars having to liquidate a portion of their assets in order to maintain their governments. These vehicles were created as the ultimate rainy day fund, and it is raining hard right now. My personal view is that we will see oil in the $20s before we see it back in the $50s. By a kind of perverse logic, the cure for low prices is low prices. It won’t happen overnight, but oil will reverse. In the meantime, low oil prices mean that sovereign wealth funds have to liquidate.
Let’s examine that concept for a moment. Many sovereign wealth funds are invested in very long-term and illiquid projects. Rightly so – that is what you should be doing with that sort of money but that means when you have to liquidate, you sell what you can, not what you want and that means funds will be selling liquid stocks and bonds by the hundreds of billions of dollars’ worth. That is a lot of selling pressure, much of it in dollars and much of it in the U.S..
Unfortunately, this will happen just as more people realize the U.S. stock market is priced for a correction. The earnings expectations of many companies are far too optimistic, and they are running out of financial engineering tools to hide it. We have gone much too long without an extended correction. I believe we could see a 15–20% downturn if key companies miss their forecasts.
While multiple crises blanketing the entire Eurasian continent suggest that dollars will be flowing into the United States, the sovereign wealth fund need for liquidation will require the reverse. I defy anyone relying on anything other than an educated guess to tell me which will be the greater force. (Do Japanese pension funds continue to liquidate JGBs and buy US and European stocks? In what size? Do they wait for the markets to settle out? Inquiring minds want to know.)
Here is the real question: Can the U.S. have a recession without an inverted yield curve? This is an ongoing debate I am having with several prominent economists. I would say yes. Although we have not seen a recession without an inverted yield curve since World War II, I think we are now in different times, with different underlying conditions, as noted above. Zervos and Rosenberg would argue that the Fed will continue to raise rates until we get the potential for an inverted yield curve, albeit at a lower rate than we have ever seen. I am doubtful that the Fed will raise rates more than two or three times this year. We are going to enter the next recessionary period with interest rates the lowest they have ever been. I defy you to perform an historical analysis that sheds light on future conditions under those circumstances. Which is why I’m concerned about the Fed giving us negative interest rates.
I’m actually far more concerned about a real bear market in stocks creating the conditions for a recession. Any of the three potential shocks I listed above could create a bear market and a U.S. recession. Attention must be paid.
Jim Grant, who spoke at the same private conference in Hong Kong that I did, said he was worried that the U.S. is already slipping into recession. I am certainly not ready to agree with that analysis, but I am not confident enough to disagree with my friend Doug Kass, who expects that the U.S. will enter recession before the end of the year. My base case at the moment is that we will not enter a recession, but we will continually teeter on the brink. For all intents and purposes, the result may feel like a recession which suggests to me that the data the Fed looks at will keep them from raising rates the four times they currently predict. I still think we will once again see 0% interest rates before we see 2% rates or maybe even 1% rates – depending (I say with a dollop of sarcasm) on the data.
Looking beyond China and Europe, Latin America is a wild card. The strain of lower resource demand from China is beginning to show. Argentina has a new president, and Brazil may get rid of its current administration. I think we will see some dramatic swings in Latin American stock, bond, and currency valuations this year. Venezuela is on the edge of collapse.
Pulling all the evidence together into a strategy, my own plan is to avoid directional market exposure as much as possible. We should see plenty of volatility, and staying on the right side of it will be very difficult. I think certain targeted technologies will do well – mainly those that enhance productivity. Human workers will keep losing ground to artificial intelligence algorithms – a phenomenon that will continue to spread both vertically and horizontally in 2016…
Bottom line for 2016:
Don’t tie your fortune to a rising market – and I mean any kind of market anywhere on the globe. This is a time to think strategically, stay hedged and diversified, and avoid big directional bets. I think active and hedged management will be the place to be in the coming period. To quote the motto of House Stark in Game of Thrones, winter is coming…[The original post written by John Mauldin (MauldinEconomics.com) is presented here by the editorial team of munKNEE.com (Your Key to Making Money!) and the FREE Market Intelligence Report newsletter (see sample here – sign up in the top right corner) in a slightly edited ([ ]) and/or abridged (…) format to provide a fast and easy read.]
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