Tags: capex | growth | BIS | euro

Chasing Yields Is Like Skating on Thin Ice

Tuesday, 01 July 2014 01:29 PM Current | Bio | Archive

Speaking on Monday to the Utah and Montana Bankers Association, John Williams, president of the Federal Reserve Bank of San Francisco, said the Fed should "stop answering the question" about exactly when it will raise rates. He added he is a fan of the "dot" chart, which shows the range of individual Fed official views on when rates should rise because it captures the uncertainty over the outlook. Williams believes rates should probably rise sometime in the second half of 2015.

He also expects real U.S. GDP growth to run "above" 3 percent for the remainder of 2014 after having contracted by 2.9 percent in the first quarter. The personal consumption expenditures price index, which the Fed follows the most closely, is currently running at approximately 1.75 percent, and Williams expects it to move gradually up to 2 percent as the economy moves closer to full employment, which he said is 5.5 percent or lower, a number that could be reached by the end of 2015 or the first half of 2016.

"We're moving towards 'normalization,' and as the economy continues to improve, we'll take off the cast; when it's able to move on its own, we'll take away the walking stick," he concluded.

His time span that covers from the second half of 2015 to the first half of 2016 becomes really interesting when we look at it in the context of various observations made in Bank for International Settlements (BIS)'s 84th annual report wherein it stated: "Several early warning indicators signal that vulnerabilities have been building up in the financial systems of several countries. . . . To illustrate, assume that money market rates rise by 250 basis points (2.5 percent,) in line with the 2004 tightening episode. At constant credit-to-GDP ratios, this would push debt service ratios in most of the booming economies above critical thresholds."

I'd like to add here that the word "booming" might be better read as: 1) most of the stronger (booming) emerging economies, 2) the still-recovering euro area peripheral economies, which are surely not booming and 3) literally all "undertakings" that have been excessively leveraged up (carry) on "cheap" U.S. dollars.

I think long-term investors would do well not becoming overly complacent in case they have investments in or under these three aforementioned areas. I don't think this time will be different from what we have experienced before when complacency also "blinded," as it is doing now, a huge part of many investors all over the globe.

BIS Chief Economist Hyun Song Shin told Reuters, "Things look and feel great, but we are storing up a possibly more painful and more destructive reversal. . . . The one thing that is different between now and the 2006/2007 period is that the protagonists are no longer 'the banks' as it has been the case in the pre-crisis period in the U.S., but also in other places, but risk taking is now done by other market players that include long-term investors in their search for yield." Shin noted that this changing pattern of behavior carries "a potential source of danger. . . . We are going into somewhat unfamiliar territory."

Nevertheless, I think we are really living in a strange financial world where now on the one side the International Monetary Fund (IMF) warns central banks not to tighten too early and on the other side the BIS warns central banks not to tighten too late. As always, only time will tell who was right.

I think long-term investors should take notice of the Standard & Poor's Ratings Services Global Corporate Capital Expenditure (CAPEX) Survey 2014, wherein it states we'll still have to wait for some time (years) to see a recovery in global capex. Apparently the capex cycle remains in neutral and many key drivers are likely to continue constraining near-term prospects for recovery.

S&P estimates "global" capex growth, as measured in real dollar terms, to finally come in for 2014 at a rate of -0.5 percent and 2015 could see a decline of 3 percent. S&P also expects a sharp deterioration in emerging market capex.

I'd like to add that you don't have to be a rocket scientist to give yourself an idea of what could be the consequences for all these fragile economies once the Fed starts raising rates, which is in my opinion practically unavoidable if the U.S. economy continues to grow as it does for the moment.

The North America non-financial capex growth in real dollars is expected to grow 1 percent in 2014, which is the same as in 2013, and to contract 2 percent in 2015 and 1 percent in 2016. Western Europe's non-financial capex growth is expected to grow 1 percent in 2014 and to contract 2 percent in 2015 and 1 percent in 2016. Latin America non-financial corporate capex growth is expected to contract 3 percent in 2014, 1 percent in 2015 and 6 percent in 2016. Finally Asia-ex-Japan non-financial capex growth is expected to contract 3 percent in 2014, 6 percent in 2015 and 5 percent in 2016. Yes, it looks like non-financial capex growth is bound for the doldrums for quite some time.

Finally, the final Markit Eurozone Manufacturing PMI for June came in at 51.8, the slowest growth rate in seven months, from 52.2 in May, with France and Greece showing outright contractions.

In the meantime the unemployment rate in the euro area remained at 11.6 percent.

No doubt that the recovery in the euro area is at serious risk of stalling. We'll see what the European Central Bank (ECB) will say about it on Thursday during its press conference following the Governing Council meeting of the ECB in Frankfurt.

All I can say is like Ralph Waldo Emerson said: "Patience and fortitude conquer all things."

Anyway, as a long-term investor I certainly wouldn't overlook all these fresh warnings that are out there and in no way chase yields, because it could very well become something like skating on thin ice.

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Long-term investors would do well not becoming overly complacent.
capex, growth, BIS, euro
Tuesday, 01 July 2014 01:29 PM
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