Tags: Fed | policy | Japan | economy

Markets Don't Reflect the 'Real' Economies

Tuesday, 12 November 2013 10:28 AM Current | Bio | Archive

Five years after the greatest post World War II financial crisis started, there are finally some signs starting to appear that an important part of the developed world has timidly started its very long journey back to normality. Of course, nobody really knows when that normalization process, not only in the developed, but also in the emerging economies, will finally and fully have run its course. Yes, let's remain cautious that that really ever will occur.

Anyway, the fact is that for getting there, there are some key conditions that will have to fall into place, such as: 1) the United States will have to turn back in a cyclically leading position, which the Organization for Economic Co-operation and Development's composite leading indicator for the United States shows it is growing "around" trend; 2) the emerging economies will need to show they have made "good use" of the problems that took place in the developed economies and those that haven't done that will pay the price and face deep trouble; and 3) China will be obliged to rebalance its economy, whereby its massive and exuberant credit growth of the recent years will have to be reined in with a strong hand and in an orderly, but certainly not in a disruptive way. All this will take much longer than expected and will have to take hold in a transparent way and to be "respected" by the players involved, which will be easier said than done, believe me.

No doubt there will be obstacles that will come from, among other things, applied policy risks, which in the United States probably should concentrate around "fiscal" related matters concerning the debt ceiling and, I hope not, another government shutdown, and in the euro area, where we still have the ongoing implementation of fiscal consolidation policies that should allow a return to sustainable public finances in all its 17 member states (Latvia is scheduled to introduce the use of the euro on Jan. 1), which is an enormous challenge that hasn't found a complete, let alone an "accomplishable," solution yet.

And then, and notwithstanding whatever is said about Japan and its ambitious "Abenomics" policy project, which is in fact a combination of 1) aggressive quantitative easing from the Bank of Japan, 2) a surge in public infrastructure spending and 3) the devaluation of the yen in the hope for creating growth as well as higher inflation. To me, by far the biggest risk that is out there in the whole world is that Japan won't succeed in implementing its "Abenomics" in full.

Yes, I do expect Japan will succeed in creating inflation at 2 percent or even higher, but I don't expect they will achieve their growth rate as hoped for, as well as their expected tax revenues objectives.

I hope I'm wrong, but if I'm right, and this is extremely important for long-term investors, we can expect a run on their bond markets and because Japan's public debt has just (on June 30) gone over the yen 1,000 trillion mark, yes, 1 quadrillion! ($10.3 trillion), which corresponds to about twice (200 percent) the size of its annual GDP. That said, and this should give long-term investors some time for putting this subject on their radar screens, I don't expect troubles to arise within the next six months, but things could easily spin out of control further on.

Long-term investors should always keep in mind that monetary policy errors in full and in communication with the general public are not that uncommon and will happen again, no doubt about that. For example, we saw such an error when the Fed earlier in the year announced its intention to taper and then when it didn't taper markets got understandably nervous and volatility was back.

Monetary policy errors can turn lethal, as we have learned from history, when "big" economies like the United States, the euro area, China and Japan are involved.

Talking about tapering for a moment, I think and in accordance with U.S. economic data that are coming in, for the moment, tapering should be back on the Fed's agenda in the beginning of next year, while, again if the economy continues to grow as it does now or even better, tapering will be phased in over the course of next year.

In this context, Janet Yellen hearing before the Senate Banking Committee next Thursday could really become interesting because I think it can't be excluded she appears as less dovish than is generally perceived, which should certainly be some kind of a surprise.

When I look at all that, I must admit I can't detect the beginning of "real as well as sustainably" better economical times lurking on the horizon.

Besides, the only better places that could support external shocks, but that still remain in a bad neighborhood are, on top, the United States, but also countries like Switzerland, Norway and a few others, although there are bubbles everywhere. We shouldn't overlook that!

For long-term investors it's certainly not the perfect moment to start investing (building) on a basis of hope and generalized optimism.

In my opinion, markets at this moment do not reflect the "real" economies, but instead "financially or monetary-stimulated" economies that still haven't passed their down-to-earth-reality acid tests!

Maybe it's not such a bad idea to take notice of a recent Citi Private Bank survey of more than 50 representatives from large family offices, which manage assets on behalf of high net-worth families, that showed these families had, on average, almost 40 percent of their portfolios allocated in cash and cash equivalents, while stocks averaged 25 percent and the other 35 percent was in bonds, commodities and real estate. Yes, food for thought.

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Five years after the greatest post World War II financial crisis started, there are finally some signs starting to appear that an important part of the developed world has timidly started its very long journey back to normality.
Tuesday, 12 November 2013 10:28 AM
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