Economic Outlook
Today, we have bad news and good news.
The good news is that there will be no 25-year recession. Nor will there be a depression that will last the rest of our lifetimes.
The bad news: It will be much worse than that.
Yesterday, the Dow rose another 43 points. Gold seems to be working its way back to the $1,200 level, where it feels most comfortable.
“A long depression” has been much discussed in the financial press. Several economists are predicting many years of sluggish or negative growth. It is the obvious consequence of several overlapping trends and existing conditions.
Old People Are Dead Wood
First, people are getting older. Especially in Europe and Japan, but also in China, Russia and the US.
As we’ve described many times, as people get older, they change. They stop producing and begin consuming. They are no longer the dynamic innovators and eager early adopters of their youth; they become the old dogs who won’t learn new tricks.
Nor are they the green and growing timber of a healthy economy; instead, they become dead wood.
There’s nothing wrong with growing old. There’s nothing wrong with dying either, at least from a philosophical point of view. But it’s not going to increase auto sales or boost incomes – except for the undertakers.
The Cure for Debt? More Debt!
Second, most large economies are deeply in debt. The increase in debt levels began after World War II and sped up after the money system changed in 1968-71.
By 2007, US consumers reached what was probably “peak debt.” That is, they couldn’t continue to borrow and spend as they had for the previous half a century. Most of their debt was mortgage debt, and the price of housing was falling.
The feds reacted, as they always do… inappropriately. They tried to cure a debt problem with more debt. But consumers were both unwilling and unable to borrow. Their incomes and their collateral were going down. This left corporations and government to aim only for their own toes.
Central banks created more money and credit – trillions of dollars of it. But since the household sector wasn’t borrowing, the money went into financial assets and zombie government spending. Neither provided any significant support for wages or output. So, the real economy went soft, even as the cost of credit fell to its lowest levels in history.
The Cronies Are in Control
Third, the developed economies have been zombified. The US, for example, is way down at No. 46 on the World Bank’s list of places where it is easiest to start a new business. And only one G8 country – Canada – even makes the top 10.
Paperwork. Expenses. Regulation. High taxes. High labor rates. Entrenched competition with aging, loyal customers. All are endemic from Boston to Berlin to Beijing.
Leading industries – heavily controlled and regulated, including defense, education, health and finance – are practically arms of the government. All are protected with high barriers to entry and low expectations. Competition is barely tolerated. Innovation is discouraged. Mistakes are forgiven and reimbursed.
Meanwhile, the masses are encouraged to become zombies too, with generous rewards for those who 1) do nothing, 2) pretend to work or 3) prevent other people from doing anything. After all the zombies, cronies and connivers get their money, there is little left for the productive economy.
The Solution Begins When Markets Crack
Typically, these problems – too much debt, too many zombies, and too many old people – lead to financial crises. Then, they are “solved” by either inflation or depression. And the solution begins when markets crack.
Markets never go up forever. Instead, they go up, down and even sideways. They breathe in and out. And after sucking in air for the last 30 years, US financial assets are ready to exhale. Legendary asset manager Bill Gross comments:
When does our credit-based financial system sputter/break down?
When investable assets pose too much risk for too little return.
Not immediately, but at the margin, credit and stocks begin to be exchanged for figurative and sometimes literal money in a mattress.
When that happens, problems begin to take care of themselves, in one of two ways…
A quick, sharp depression wipes out the value of credit claims. Borrowers go broke. Bonds expire worthless. Companies declare bankruptcy. The whole capital structure tends to get marked down as debts are written off and financial assets of all kinds lose their value.
Or, under pressure, the feds print money. Debts are diminished as the currency loses its value. The zombies still get money, but it is worth less. Inflation adjustments cannot keep up with high rates of inflation. Pensions, prices and promises fade.
Either way, the slate is wiped clean and a new cycle can begin.
But what rag will clean the slate now?
More tomorrow…
Regards,
Bill
Market Insight:
Invest in What the Fed Can’t Destroy
by Chris Hunter, Editor-in-Chief, Bonner & Partners
Publisher’s Note: Market Insight editor Chris Hunter is away on holiday this week. In the meantime, we thought you might enjoy an excerpt from the March issue of Bonner & Partners Investor Network. In it, Chris speaks with financial iconoclast and truth-teller David Alan Stockman about how to invest in a stimulus-drunk market such as this.
CH: You once said, “I invest in anything that Bernanke can’t destroy, including gold, canned beans, bottled water and flashlight batteries.”
How can our readers protect themselves from the dangers ahead? What one piece of advice would you give somebody who’s worried about another major credit collapse?
DAS: Three big points on this.
First, capital preservation – that is, not losing money – is more important for your readers than capital gains when government and central banks have gone rogue and have chronically violated every known rule of fiscal rectitude and sound money.
That means getting out of harm’s way in all the financial markets – debt, equity, commodities and derivatives – because when the big correction comes they will all experience a thundering collapse.
Second, short-term liquid investments and cash are not as bad as their microscopic yields imply.
The 20-year worldwide central bank credit boom has generated vast overinvestment in mining, manufacturing, transportation and distribution capacity worldwide. But now that the credit inflation is reaching its outer limits, and we are entering what I described as the “crack-up” phase, the forces of global deflation will drive down the price of goods and many consumer services as well.
When the next crisis fully materializes, cash will be king. It will buy more everyday goods and services and will have command over drastically marked-down financial and real estate assets of every kind.
Third, the impending collapse of the global central bank credit bubble will generate unprecedented volatility and drastic movements in asset prices of all kinds.
The rapid assessment of a business situation, combined with the courage of its leader to take bold action, is key to accelerating the growth of a company. This should be done with some structure, so that you are not breaking the things that are fixed, while fixing the things that are broken. In addition, a quantitative approach reassures the employees that decisions are being made by leaders in a thoughtful and measured manner, with all interests taken into consideration.
The following is an excerpt from an assessment tool I use when reviewing a company, and I am posting it today for the benefit of my subscriber
Introduction
The following is a readiness self-assessment based on the top ten factors that drive business growth. Assess each factor on how closely your company currently fulfils the definition, and apply a score on a scale from 0 to 4. Total the score and review your results below.
Scoring:
Never (0), Rarely (1), Sometimes (2), Mostly (3), Always (4)
_____ Team is experienced, capable, with complementary expertise and a track record of results.
_____ Product solves a significant customer pain in a unique, compelling and protected way.
_____ Finances have positive cash flow, good margins, with growing revenue and access to capital.
_____ Business Model is simple, scalable, and creates value with multiple market channels.
_____ Business Systems are lean, customer focused, repeatable and resilient.
_____ Customers Market segment is clearly defined, pain point understood, growing and global.
_____ Core Competency is known, clear, invested in, unique and leveraged across the company.
_____ Competition is low or fragmented, with high barriers to entry.
_____ Strategy is known, documented, communicated and supported by culture and actions.
_____ Key Metrics are closely monitored, customer oriented and drive decisions.
_____ Total Score (Maximum is 40)
Results and Assessment
Score (0 – 10)
Poor: Weak competitive position, with a no or low foundation for growth. Significant risk of financial or market deterioration. Long term viability of the business, without significant intervention, is doubtful.
Score (11 – 29)
Average: Several key elements for growth are in place, providing a foundation and resources to potentially expand the business. Review of the lowest scoring factors is necessary, and begin immediately to address deficiencies in order to improve long term performance and viability.
Score (30 – 40)
Good: Strong competitive position, with most of the necessary factors for growth in place. Well positioned to become a significant competitor in an attractive market, generating above average returns. Superior returns and a dominant market position can be attained through strategic review and the implementation of sustained and aggressive growth initiatives.
For more information on how to accelerate the growth of your business, visit Percygroup.ca. For the Percy Group Blog go HERE
This material is the property of The Percy Group, Vancouver, BC, Canada. All rights reserved. Copyright 2015.
USDCAD Overnight Range 1.2035 -1.2128
USDCAD shrugged off the worst Canadian Trade deficit on record (a $3.0 deficit) and moved lower in tandem with rising WTI prices that broke strong resistance at $60.00/bbl. The oil price rally is occurring despite no evidence of a respite in the glut that precipitated the November collapse. It remains to be seen if the current USDCAD weakness will be maintained in the face of a potentially poor Canadian employment report on Friday, especially if NFP is strong.
Greece was the focus in Europe and is still the focus now. A Reuters report quotes the Greek PM as stating that the May 11 deadline may not be met. The Financial Times says that the IMF may bail on providing more bail-out funds unless European lenders write off a significant chunk of Greece debt. The EU cut its forecast for Greek growth to 0.5% from 2.5% for 2015. EURUSD was sold but it has since bounced.
USDCAD technical outlook
The intraday technicals are bearish. The break of the minor uptrend line at 1.2090, stemming from the April 29th low has shifted the focus to a retest of 1.1960-80. There will be minor support seen at 1.2015. A move above 1.2130 argues for additional 1.2000-1.2200 consolidation
Today’s Range 1.2010-1.2090
Chart: USDCAD 1 hour-Intraday uptrend broken
While there is often some reference to the challenging nature of Emerging Markets, they have become an established part of the asset management landscape. In the past they have offered opportunities wrapped up in high levels of economic growth, positive demographics including young populations and aspiring middle classes, and expanding outlets for multinational corporations confronting aging populations and flaccid growth prospects in advanced economies. Challenges do remain, but acceptance of Emerging Markets for a wide range of investors is there – even with the recent volatility related to the collapse in commodity prices since 2014.
The word “challenging” however is more apt with Frontier Markets, the sizable swath of countries in Africa, Asia, the Middle East, and Latin America and the Caribbean. Lesser developed, less regulated and more prone to the whims of political risk, Frontier Markets are indeed challenging. The names in this group include Bangladesh, Egypt, Jamaica, Myanmar, Mongolia, Nigeria, Pakistan and Vietnam. Not in the Frontier Market group are Brazil, China, Colombia, Mexico, India or Indonesia, which are classified as Emerging Markets.
Frontier Markets are in the realm of the more adventurous, who are willing to stomach a fair share of ups and downs and certainly are not something that would be recommended for conservative investors. However, Frontier Markets are going to remain attractive for the very basic reason that they offer yield, which is in very short supply in more traditional markets. Interest rates in North America, Europe and Japan are historically low. Additionally, many Frontier Markets are not as closely linked to international markets as are Emerging Markets, which provide some degree of a buffer to potential crises – which there are more likely to be forthcoming in the next few years.
The macroeconomic and investment picture has improved for such countries as Egypt, Myanmar and Jamaica, while Mongolia is wrapped up in disputes with mining companies, Vietnam has lapsed on its privatization program and it is questionable whether it will privatize its target of 289 state-owned enterprises in 2015, and Libya has fallen apart (underscoring the dangers of investing in this sector).
Egypt has probably undergone one of the most significant shifts. The Middle Eastern/African country transited from being a politically unstable country, with a shell-shocked economy to a country that appears to have regained some of its footing as a regional leader. In 2014, real GDP growth was a meager 2.2%. The International Monetary Fund (IMF) is now forecasting real GDP expanding at 4.0% in 2015 and 4.4% in 2016 and is looking for unemployment to fall from 13.4% in 2014 to 12.5% in 2016. Egypt’s progress was noted by the IMF’s Managing Director Christine Legarde, who in early April 2015 sent President Abdel Fattah al-Saisi praising the Egyptian government’s economic reform measures.
Egypt’s progress on the economic front is also expected to increase investment in the economy. The country also benefits from $12.5 billion in aid collectively from Saudi Arabia, the United Arab Emirates, Kuwait and Oman. Even the rating agencies have acknowledged Egypt’s improvement, with Moody’s in April 2015 joining Fitch and Standard & Poor’s in upgrading the sovereign (from Caa1 to B3 with a stable outlook).
Myanmar is probably one of the most exciting of Frontier Markets stories. What was once an isolated economy, dominated by Chinese investment, has opened up its political and economic system to a degree and economy. Both Western and other Asian investment has flowed into the country. According to the Myanmar Investment Commission, FDI in the first five months of the fiscal year stood at $3.32 billion, a 113 percent year-over-year rise and is expected to cross $5 billion in 2015. The key areas for FDI are telecommunications, oil and gas, real estate and hotels. Although challenges remain, Myanmar will probably maintain itself as a strong candidate for Frontier Market investors. As of now, however, there are few pure-play securities offering exposure to Myanmar for the foreign investor, including Yoma Strategic Holdings Ltd. and Interra Resources, Ltd, which are listed in Singapore, though that will likely change as the economy continues to open and the Myanmar Stock Exchange launches later this year. Nigeria is another country with tremendous potential, with attractive demographics and an aspiring middle class. It needs a massive amount of infrastructure upgrades, especially in areas of transportation and communications. The country is Africa’s largest economy, has a population of 177 million, with more than 50% living in cities and being below the age of 15 years of age. Elections were just held, in which the winner was the opposition leader. The challenge is that Nigeria’s new government must contend with the collapse in oil prices and revenues (not to mention foreign exchange reserves), endemic corruption, and the Boko Haram insurgency in the north. Investors should be watching Nigeria closely as it is likely to regain momentum, probably after further policy adjustments. One way that has been suggested to play Nigeria as well as South Africa and a number of other Middle Eastern countries is the telecom company MTN Group Limited.
Two other countries loom as Frontier Markets – Cuba and Iran. Both countries have considerable political issues surrounding them, are currently off the investment menu, and could see some type of internal upheaval. However, they have relatively youthful populations, Iran in particular. While we are not advocating either country as an investment, Cuba and Iran are very much part of the discussion on what is the next frontier. Indeed, the Herzfield Caribbean Fund Inc (CUBA) has long offered U.S. investors an option on the Caribbean, with the premise that Cuba will eventually be on the investment list and will offer opportunity. Because of current U.S. laws, CUBA does not own anything in Cuba, with its largest exposure to U.S., Panamanian and Mexican companies. Iran’s prospects are conditioned by political factors, namely whether Tehran and Washington can reach a final agreement on the Middle Eastern country’s nuclear program, which would trigger an end to sanctions. While Iran’s geopolitical policies complicate matters, the end of sanctions is seen as a lynchpin for strong economic growth, driven by better prospects for exports, pent up demand for imported goods, and the need for foreign direct investment. Part of the backdrop to this is that Iran has a large urbanized population of 81 million people, most of whom were born well after the 1979 revolution. Normalization of relations with the West could have a major benefit for the Iranian economy and could open up investment opportunities for foreign companies. That said, there remain considerable work before a final deal is concluded, if at all.
International markets will continue to be a challenge in 2015. There are a wide range of risk factors – Greece’s problems (we increasingly believe that a Greek exit from the Eurozone is likely), a Chinese economic hard landing (not likely but always seeming to threaten), and missteps at the Federal Reserve that could lead to what the IMF recently referred to as the threat of a “Super Taper Tantrum” when it raises rates (which we expect in September 2015). All of this has an impact on investment, as any of the risk events singularly would inject volatility into markets and occurring together could be a systemic threat. Nonetheless, looking over the medium and long term, Frontier Markets are for the hardy investors willing to assume the needed due diligence to reap the benefits of higher yields.
Scott B. MacDonald is the Head of Research at MC Asset Management Holdings LLC, a wholly-owned subsidiary of Mitsubishi Corporation. The views expressed here represent only the views of Dr. MacDonald and do not in any capacity reflect those of Mitsubishi Corporation.
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