Saturday, April 11, 2015

Global growth stirring!

While I haven't posted a commentary in over six weeks the stock market has experienced volatility not seen in a few years as investors remain fretful of the Fed normalizing interest rate policy, a volatile crude oil market, a "Grexit" or Greek exit from the Eurozone (a farcical drama) and concerns that the US economy might be actually slowing.  My post this weekend will be brief but I intend to present a thesis on why we are in the midst of a turn in world economic growth and that global equities will move significantly higher in 2015; perhaps higher than many consensus forecasts on Wall Street.

To say I have long term concerns is both true and, in a sense, self serving.  No one with the potential readership I have does not try to "hedge his bets".  And in the case of the global economy, there are genuine issues that must give long term investors reason for pause:

  • Structural issues in the Eurozone which won't go away simply because the European Central Bank (ECB) is pumping 60 billion euros a month into the system
  • The fact that the ECB QE program may run out of "debt paper" to buy as they are constrained in buying bonds with negative yields.  The Eurozone is quickly becoming a negative yield bond market.
  • Runaway Japanese money printing in their attempt to finally turn the tide against two decades of deflation which is inflating their equity market (ditto China)
  • The "hiccup" in US economic growth which, with every passing day, is looking more and more solely weather related
  • The impact of falling oil prices on leveraged debt in and around the oil and NATGAS industry
And this is all good!  Because when everyone has concerns the market "climbs the wall of worry" and moves higher.  It's when investors get complacent that it's time to watch out.  And I will be giving an example of this complacency relating to another matter toward the end of my commentary.

The first three concerns I mentioned are actually a double edged sword.  Although they are distortions that have been created by central bank manipulation they are also the reason why global growth and equities are preparing to move another significant leg higher in the coming months.

In the wake of the 2008 debacle, central banks have inflated risk assets in the hopes that eventually asset prices would spur broader economic growth thru capital investment, thereby generating employment and overall prosperity.  Papering over trillions of dollars in lost wealth and debt was an experiment that was forced on central banks.  To do nothing would have been to invite a deflationary depression which would have made the early 1930's seem mild.  In a post 2008 world the central bank experiment has generated up to this point, only tepid and uneven growth.  There are many factors that have contributed to this fact which are outside the scope of this commentary but which I've touched upon is past writings.

In my last commentary I stated that, at a macro level, the consuming economies in the West would have to lead us out of this global economic malaise we find ourselves in before we could start to see a significant pick up in economic activity in the developing nations of Asia and the Mid East.  Simply, until Emerging Markets and China transitioned into true consuming economies, it was dependent on the West (US & Europe) to pull us out of this low growth, disinflationary to deflationary mire we find ourselves in.  I've also specified that with ECB QE being implemented, we would start to see global growth accelerate around mid year.  Well the Emerging Market complex seems to be giving us that signal already.  Let me explain.

  Many folks on the street have been concerned that as the US Dollar continues to rise, US Dollar denominated debt gets more expensive to pay off and emerging market countries, as a whole, are over exposed to US Dollar denominated debt.  The following chart illustrates the problem:


(click on chart for larger image)

This has been a major concern of mine since the Dollar started its rise last year and, at first, emerging market stocks did not respond well to the Dollar's rise.  And that made sense given the predominant inter market relationships prevalent in the financial markets.  However, in the past few weeks Emerging Market stocks have made a huge move to the upside.  Most analysts attribute the move to the spillover from the ongoing parabolic rally in Chinese mainland stocks.  But that's nonsense in my opinion.  China has singular issues that, at a macro level, have to do with excess capacity and demographic skew due to their decades long "one child" policy.  The rally in China has everything to do with government stimulus, a change in trading regulations allowing many more investors to enter the market, and a shift way from real estate as the investment "du jour" to equities.  However, I believe EM stocks, rallying in the face of a strong US Dollar, are signaling a return to normalcy that we have not seen since the 1990's.  Here's a weekly chart of the MSCI iShares Emerging Market ETF (EEM):

(click on chart for larger image)

I want my readers to notice the correlation coefficient in the panel above the chart.  EEM is in the midst of a strong rally while facing a strengthening US Dollar!  So much for US Dollar denominated debt being an anchor around emerging market economies!  

In the chart above, the previous rise in 2014 in which emerging markets rallied with a positive correlation to the Dollar ceased when the Fed officially ended their QE program.  Emerging Markets reacted as they had in the past to a strengthening dollar.  But now the rise is accompanied by global expectations that the Fed will raise short term rates this year.

If this signal persists it can only mean that the market is pricing in true and sustained global economic growth.  In a post 2008-2009 world, there is no way that a sustained strengthening US Dollar could coexist with strong Emerging Market growth.  The only way this can be occurring is by the economic paradigm changing.

Here's another curve ball I'd like to throw my readers.  I made a statement above about investor complacency that I'd like to tie in with another situation that I believe may be brewing.

My "mantra" since I've been writing these commentaries (2010) is that the global economy was being held captive to gargantuan deflationary forces and that this was the battle that central banks and governments had to fight.  In a world who's population had been steeped in an inflationary mindset, this view was often met with a quizzical glance or outright objections.  However, in the past few months, in my capacity as an investment and financial advisor, almost everyone I meet is willing to admit that deflation is the real battle and that inflation is not the present enemy.  Interestingly, the change in attitudes has coincided with a stirring.  Here's a weekly chart of the SPDR Gold Trust Shares (GLD):

(click on chart for larger image)

Admittedly, I have to embrace the fact that technically Gold is in a down trend and with the prospect of higher interest rates (even if incremental) there should be more downside pressure on the yellow metal.  And the price action in mining stocks do not support a move higher either.  However, if the move in Emerging Markets is more than the anomaly I think it is, then in the same technical environment, would Gold not rally in tandem with a strengthening dollar?  Some of my friends may giggle that I am even suggesting that a strong Dollar and Gold could be positively correlated but if the move in EM is sustained then inflationary pressures could mount globally as economies in both the developed and developing world start to fire on all pistons.

To sum up, with a Federal Reserve tentative about raising short term rates, the ECB and BoJ (Bank of Japan) flooding the global system with liquidity, muted inflationary pressures and expectations and an interest rate environment very conducive to borrowing for capital growth, equities have nowhere to go but higher.  A twenty five or even fifty basis point rise in short term rates is not going to ruin the party.  Yellen predicates any move on interest rates as data dependent.  So, as it stands right now, if the Fed goes this year it will be in September and with only one bump of twenty five basis points.

Have a great week!

The statements, opinions and projections made in this writing are for informational purposes and are my own.  They do not represent the views of my broker/dealer.  Additionally, this writing does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by me or my broker/dealer in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction

The information contained in this writing should not be construed as financial or investment advice on any subject matter. This writing is not published for the purpose of utilizing the information for short term trading or long term investing in stocks, bonds, ETFs, mutual funds,currencies, indexes, index or stock options, LEAPS, and stock or commodity futures. I expressly disclaim all liability in respect to actions taken based on any or all of the information on this writing.  Seek the personal, face to face guidance of a registered investment advisor before entering any trade or investment.  Anyone who trades or invests based on the information in this commentary does so at his/her own risk.  

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