There is a storm coming but preparing for it is a challenge of timing as much as it is of vision.
Storm Coming; Source: NASA
Some point soon, the market is going to have to fully reflect some of the obvious realities that are these:
- Europe putting off deciding to become a full-blown money printer like the USA
- Japanese money printing hitting warp speed
- Corporate earnings tiring and flattening out
- Demographic challenges in Western nations
- Slowing emerging markets (but still growing)
Europe
Here’s the skinny – there’s no way these people are paying off this debt. This is the result of people wanting excessive social services beyond what an economy can afford. These fools should have more children because like social security, the social services that everyone in Europe relies on requiring a growing population of young people to participate in the economy to pay for the old. Unless the government owns a national oil company (like Pemex in Mexico – but even that can be an eventual disaster), zero hour will hit when the system collapses. Europe is there now – either they print money which is a temporary fix (and another government disaster in the making) or implode.
Likely outcome – the European Central bank is given authority to print, one or two member countries back out of closer fiscal union, and the problem is “solved” for a short time.
Japan
Here they’ve been running up huge deficits forever (now at 200%+ of GDP) and Japan’s central bank has been swallowing up the debt with printed Yen. Interestingly, the Japanese currency has been very strong over the recent past. Typically, debasing the currency with monetary expansion (the classic definition of inflation – prices rising is not inflation) weakens a currency. But Japan is a unique case. In time, historical precedent will rule and Japan will suffer for this. Generally, a currency weakens due to increased supply (money printing) or lack of demand for that currency. And since fewer people demand the currency, the demand for Japanese government bonds decreases. When that happens, rates rise (bonds have an inverse relationship between price and rate explained here) and the cost to the people of Japan of higher interest costs on massive government debt is “Atlasian” in terms of the burden on the budget. The worst part is when foreigners lose faith in the currency then they will demand many more yen to trade than they do now – which means the cost of living in Japan increases significantly.
Likely Outcome – demographic troubles and the monetary story outlined above come to pass – winners will be Japanese equities as their products will be cheaper for foreigners. Losers will be Japanese consumers/citizens with higher cost of living and higher taxes.
Corporate Earnings
I think large companies have cost cut as much as possible (though they are still trying with more layoffs). Low rates have motivated housing related businesses like construction and home improvement (think Home Depot) but will rates go lower? They’ve resisted the most recent Fed stimulus. Global tech companies rely on Europe for a big part of their earnings (see above for their financial condition) and materials companies are seeing slowing demand in China for raw materials. Oil consumption in the US has fallen recently and it’s not because everyone drives a Prius.
The Toyota Prius
US economic activity is a bit slower in places. And depending on the region, many people are not working, or at least not working a job that pays the bills. In the Boston area, we are a bit blinded to some parts of the country where the local economy is much weaker. Layoffs have helped companies’ profits as software, engineering, and logistics improvement have all helped to eliminate jobs – think legal historian replaced by good legal software. But there’s only so much a company can cut – growth hasn’t been so hot on the revenue side and this will catch up.
Likely Outcome – more earnings “disappointments” but stocks may go either way due to Fed involvement. And even though some call for the end of it, the race into income paying stocks, REITs, MLPs and preferred stocks may continue as desperate investors look for places to put their savings – even if those same companies are not growing.
Demographics
This is simple – there are too many old people. said another way, there are too few young people in western nations. Basically if you don’t have 2.1 kids, you’re not replacing yourself and have no right to complain about social security cuts or such. Rick Perry was right in calling social security a Ponzi scheme – because it is. Here’ the definition for you doubters. Who cares if the government runs it – the basic premise that newer people pay for older people, can only continue if there are more young people. Even a surplus will eventually run out IF THE NUMBERS DON’T ADD UP. So get over it – or have more kids but don’t ignore the math on this. And for those of you that demand higher taxes, I present to you, THE EUROPEAN PRECEDENT for an example of social services based on fraudulent assumptions (yes the politicians who put these schemes in place decades ago were likely shown the bad math or the assumptions were terrible) that need ever higher tax rates of fewer on fewer workers to cover the costs. A big HELLO for you.
Likely Outcome – US follows Europe because you just can’t say no to the people. I don’t blame politicians so much anymore, just the unrealistic fools that vote for them (file under “cake,” “eat it too”). we need a currency crisis in Western nations to discipline everyone involved. Bernanke is one who thinks he can skate around this problem (you need an Econ PhD to think like that) but we won’t. It just may not happen that quickly – see discussion on that below.
Emerging Markets
I for one see great possibilities for emerging markets. Simply because what it takes to see impressive growth in some of these countries can be easy as they need the basics. For example growing the US economy requires (IMO) population growth, high technology growth and overall productivity growth. A combination would provide strong growth. However, in emerging markets, if people just started buying a fridge they’d have amazing growth. And infrastructure adds huge as countries like Myanmar would see huge growth once roads, internet, phone and energy are democratized.
Growth does not happen in a straight line however and it may be the case that countries that have come a ways, like China, have spent enough on materials and construction and turn their focus internally on social services. This is not good for materials providers like Australia, Canada, Brazil and other material exporters like some African nations. The risk are there that this slow down coincides with Western risks and cause a major dislocation. However, it is also possible that former emerging economies are ready to take the reigns on the global economy.
Likely Outcome – cloudy in my eyes, but I can see EM’s pick up the slack and continue to grow even with moderation to slight decline in Western nations. as mentioned above, simply focusing on domestic development of services (for example health care availability) will go a long way as consumers have more certainty in their budget for life’s necessities and can spend money on DISCRETIONARY items.
The Problem As You See It Doesn’t Arrive As Quickly As You Think & the Challenge of It Happens When It Happens
There is a problem with seeing these problems develop and trying to invest in them – one way or the other. These problems can take years to manifest. For example, investors have tried for years to short (be against) Japanese bonds. It seems so obvious – with rates below 1% on long term bonds, and endless Japanese money printing, they’d have to go down in value reaping rich profits for short sellers. Unfortunately for them, this has been a losing trade for years. investors have tried that here in the US a few times too. That hasn’t worked out too well yet either. And how about those who felt that emerging economies would keep growing? Look at the chart of the Chinese ETF:
Monthly Chart FXI October 2005 to Present Source: Finviz)
It’s been DEAD MONEY for FOUR YEARS! (this may actually be a positive). Those who invested in China the last 5 years have not come close to the performance of US stocks. It’s taken them a number of years perhaps to digest the overdevelopment and their new focus on internal services may be seen as bullish for Chinese stocks. Actually, it may NOW be time to invest in companies that focus on water quality and pollution control in China.
Chongqing has developed quite rapidly – it’s one of China’s special economic zones and has grown rapidly. The problem as you can clearly see from this video is the horrible pollution. Makes LA look clean. But again, this is timing – water companies did OK in anticipation of this but in the past few years, they have not been the leading market performers.
Hyflux – a Singaporean Based Water Treatment Company with an Excellent China (and Middle East) Presence. Stock performance hasn’t been good.
Hyflux is a good example of a leading company in an industry that people would have thought would have led in China but they haven’t done well. Health care is another idea that may now become a focus in Asia. But again, it wasn’t easily investible as ideas don’t develop as fast as we think they will.
The crux of all of this is that there are problems and opportunities. And we see them develop -however, making those ideas economical to your net worth is a studious task. Your investing plan has to reflect this challenge. And there are ways to approach this but having an idea and simply jumping in and waiting could be tedious if not costly.
Yes these storms are coming:
- “Zero Fiscal & Monetary Hour” for Europe, Japan and the US
- Growth slowing globally affecting profits of US companies (one of the best market performers globally this year)
- Economic growth resumption in the developing world (along with strengthening currencies exacerbating weak western currencies) – can you say higher cost of living for Americans?
- Demographic issues are straining tax revenue and required government expenditures
What is your plan? Are you prepared for contingencies or are you firm on an expected outcome? Do you know for certain the time frame of your expected outcomes? Share those thoughts below…
