Saxo Bank Quarterly Outlook: End of a Cycle Like No Other
Mike Mish Shedlock
What follows below are snips from a 35-page report by Saxo Bank. I condensed the report for readability. Any emphasis in italics is mine. Until the final paragraph what follows are snips from various Saxo Bank analysts.
End of a Cycle Like No Other - Steen Jakobsen - CIO
We are nearing the end of the largest monetary policy experiment of all time, and ascendant nationalism, staggering inequality, and a widespread loss of hope among the younger generation are among its varied fruit. The good news? Things only change when they absolutely must.
Q1’s brief volatility spasms notwithstanding, today’s capital markets are in a zombie-like state, with low volatility and extreme valuations in all assets with no net increase in growth and productivity, and a massive increase in inequality.
The benefits from the globalised system and particularly from the central bank’s asset-pumping response accrued near-entirely to the already wealthy, while the average economic participant lost out. This is the process that drove the advent of Brexit and Trump.
So now we have our first great new showdown since the Cold War, which saw the victory of capitalism over communism. Now comes the fight between nationalism and globalism. Nationalism is winning big, as country by country the outlook is turning inwards, with an increase in placing the blame on external forces from immigrants to the real and imagined misbehaviour of trade partners. Talk of trade policy and protectionism is now labelled “trade wars”.
What we are forecasting is that technology will move from app-creation and data harvesting to becoming compliant with new data regulations – again, a cost. The US economy will get no big upside from the tax cut; housing prices have already dropped 15-20% in New York and inflation still will not materialise as net lending demand, or the velocity of money, continues to be depressed and will soon enter negative territory.
The geopolitical scene will be driven by nationalistic agendas, meaning less and more expensive trade and – in the worst outcome – a world split into China versus the US, with the rest of the world having to decide which side to join.
For yet another angle on how this cycle is different from anything in recent or even distant memory, see the chart above (courtesy of my fellow Dane Torsten Sløk of Deutsche Bank in New York), which I deem to be the most negative I have ever seen.
Please explain to me how a 35-year-old can be less optimistic about the future than a 55-year-old! It defies logic, nature, and reasoning. It is a case of young people feeling the pain of the present economic reality: it’s hard to find a decent job and or even interview for a job when you need a PhD to start with. The young are increasingly indebted by education costs and priced out of getting onto the house ownership ladder.
Equity Burnout - Peter Garnry - Head of Equity Strategy
With the MSCI World Index valued above the average and multiple key macro risks on the horizon, the risk-reward ratio is no longer all that attractive for equities on a two-year horizon. Global rates have risen, thereby improving the alternative to equities. With a recession likely coming with the next two years, the outlook does not support an aggressive stance and overweight position in equities.
Dollar is a Time Bomb and the Fuse is Burning Faster - John Hardy - Head of FX Strategy
When the Fed tightened policy starting in late 2013, the supply of printed US dollars started drying up and the USD exchange rate went increasingly vertical. Many forget just how bad a year 2015 actually was for global asset prices, particularly in emerging markets, and it was the lucky timing of the European Central Bank’s extreme QE starting in early 2015 and China’s eventual massive stimulus starting later that year that likely kept the world from dipping into recession.
But now, most of the policy punch bowls around the world have been removed or are nearly empty. China’s growth priorities are changing to priorities centred on the standard of living for everyone, as well as environmental policy, and Beijing also faces the onerous task of addressing its own credit bubble.
The Fed, meanwhile, continues to tighten policy and supposedly intends to shrink its balance sheet at an accelerating pace. Elsewhere, the ECB has promised to cease expanding its asset purchases entirely by late this year. Only the Bank of Japan continues to drag its heels, though it has also tapered its rate of asset purchases over the past year.
The removal of global policy stimulus has naturally come about as the world economy finally managed a couple of quarters of synchronised growth in 2017. But our view is that this growth is tenuous and very late-cycle, particularly in China and the US, as the credit cycle has already turned. And the next challenges for markets are just around the corner.
First, the escalation of US protectionist rhetoric, most pointedly aimed at China, sets in motion a whole host of potential responses from the Chinese side. Undoubtedly, among these will be an effort by China to reduce the sway that the US dollar holds over global trade and financial markets.
Second, Trump’s freshly minted tax regime has guaranteed unprecedented new fiscal shortfalls during an expansionary phase of the US growth cycle – as much as a trillion USD for the next budget year already. The US actually dipping into a recession over the next 12 to 18 months (as we suggest) is an underappreciated risk, tax cuts notwithstanding; the fiscal gap will stretch beyond even the extremes seen during the financial crisis of near 12% of GDP.
As the US runs a large current account deficit, it will have to fund that deficit with foreign capital – likely at a far lower USD value. Providing added urgency to the search for an alternative to the USD is the need to devalue the world’s stock of USD-denominated debt – which has only increased by leaps and bounds in the offshore USD system that got global finances in such a pickle back in 2008-09.
Last September, the Bank for International Settlements estimated that there was a net $25 trillion in USD-denominated debts and derivatives in the offshore financial system. The world can ill afford another USD funding mishap, one that has already partially been set in motion by Trump’s corporate tax cuts, which are encouraging US corporations to repatriate hundreds of billions of USD from outside the US and draining liquidity from the offshore USD system.
Recession The Evidence Piles Up - Christopher Dembik
At the end of last year, the consensus eagerly embraced the “synchronised global growth” narrative and no one dared question the strength of the United States economy. Optimism prevailed among the financial community. As we enter the second quarter of 2018, the hopes of synchronised growth are vanishing quickly as the global economy suffers a loss of momentum (global PMI has plunged to a 16-month low) and warning signs of an imminent slowdown are popping up in the US.
Credit Impulse Heading South
In a highly leveraged economy like the US, credit is a key determinant of growth. Lower credit generation is expected to translate into lower demand and lower private investment in the coming quarters. There is a high 0.70 correlation (out of one) between US credit impulse and private fixed investment and a significant 0.60 correlation between credit impulse and final domestic demand.
So far, there has been no sign that Trump’s tax cuts could mitigate the negative effect of a lower credit impulse by lifting companies’ investment spending plans. In the last NFIB survey, the proportion of respondents planning to increase capital spending even decreased to 26%, which seems to indicate that there is more to consider than tax alone when running a business.
Spectre of Recession
The main risk for investors is the increasing mismatch between the optimistic view of the market that considers the risk of recession as being less than 10% and what recession indicators are saying about the economy. These indicators suggest that the US is at the end of the business cycle – which is not much of a surprise – and hint that recession is just around the corner and Trump’s economic policy does not seem able to avert it.
Evidence Piles Up
Even unconventional indicators are sending warning signs. Product sales by paper and paperboard mills, which reflect the evolution of sales and therefore give a signal about the future evolution of production, have been falling since the beginning of the year. Although this indicator is certainly less reliable than in the past due to the digitalisation of the economy, there is still an obvious correlation with the economic cycle.
US consumer confidence has returned to a high level but households’ financial situation remains gloomy. Household debt is at a new record of $13 trillion and the most fragile households are starting to face serious difficulties due to higher interest rates and tightening credit conditions.
Even though we agree that history does not always repeat itself, it is interesting to note that historically, such levels of consumer confidence have been followed by recession and a lost decade. This is too much of a coincidence, is it not?
Delinquencies have increased considerably over the past few months, especially in subprime auto loans where serious delinquencies have reached ‘Lehman moment’ proportions, as well as in credit cards.
Commodities Go Their Separate Ways - Ole Hanson - Head of Commodities Strategy
Gold is one of a few metals that has managed to hold onto a positive return this year. However, after several failed attempts to break through the $20 band of resistance above $1,355/oz, many investors have for now adopted a wait-and-see approach.
Despite the fading focus on inflation, which was a key driver at the beginning of the year, we believe that investors will continue to seek diversification and protection against trade and geopolitical tensions as well as increased volatility across global stock markets.
Recent history does tell us that the impact of geopolitical risks and events tends to be transitory unless they lead to a significant change in the economic outlook.
An escalated trade war could be a situation where growth is negatively impacted. That could lend support to precious metals as the speed of future US rate hikes slow and bond yields reverse lower. On that basis we maintain a bullish stance on gold above $1,280/oz and view a break above $1,375/oz opening up for a move towards $1,480/oz. Silver has the potential for making a comeback based on continued support for gold. This is because hedge funds hold a record and now squeezable short due to the lack of lower price action to support, as well as the fact that compared to gold, silver is relatively cheap with the gold-silver ratio trading near a two-year high.
Thanks to Saxo Bank for an excellent and comprehensive 35-page report. I touched on what I believe to be the highlights. Unfortunately, I do not have a link to the full report. It came from Saxo Bank by email and is not yet posted online.
Mike "Mish" Shedlock