world economy

Is Italy the next black swan?

There are a number of economic issues in the world which could provide the next economic shock and shake world markets. A prime candidate is Italy and its banking. system. Italy in the past has relied on currency devaluation to maintain its international competitiveness. Italy’s entry into the European Union made devaluation impossible and the economy is now in very bad shape. In recent years there has been an accumulation of bad assets on the balance sheets of Italy’s banks, where 18% of all loans are now classed as non-performing. The Italian banks alone have USD 400 billion in bad loans, equal to about 20% of Italian GDP. The Italian economy is ten times larger than the Greek economy and there is no way that the European Union has the ability or capacity to bail it out.

In October or November there will be an Italian constitutional referendum and Prime… Continue reading

World equity markets are finely balanced.

World equity markets are now finely balanced. There could be a continued bull market perhaps in the United States but there are many uncertainties and it is now May, a time when markets often correct, so it is understandably a time when investors get rather nervous. But is there any reason for nervousness?

In recent times the strength of world equity markets has been due to very low interest rates and the activity of central banks as well as a reasonable performance from the United States economy. But world growth is slowing. Consider the status of the four largest world economies, the United States, the European Union, China and Japan.

The United States economy. After about three years of job gains the recent weak United States job figures are a cause for concern. GDP growth is very concerning with annual GDP now at 0.5% in the latest quarter. Retail… Continue reading

Central banks and the Japanese crisis

The role of a central bank, aside from being a lender of last resort to commercial banks is to manage a nation’s currency and interest rates, taking into account such relevant matters as employment and inflation.

But the role of many central banks has changed. Since the GFC of 2008 and accompanying world economic instability, central banks have become progressively more responsible for the direction of the world economy. This is because central banks have had to use quantitative easing and lower interest rates to stimulate their respective economies. The levels of quantitative easing and low interest rates are now at record levels so the world economy is at the mercy of central banks. Asset values including real estate and equities, are inflated as a result of central bank activities such that current values of these assets bear little relationship to their underlying intrinsic value.

Japan provides a prime example… Continue reading

Is this a set up for ‘sell in May and go away’?

There is considerable evidence for the old Wall Street adage ‘sell in May and go away’. It is well documented that ‘the Dow Jones Industrial Average has had an average gain of 7.5% during the November through April period and a gain of only 0.3% over the May through October period, going back to 1950’.

On the basis of current threats to the world economy investors should be aware of this effect since it seems that a number of elements are now assembled which pose potential threats to the world economy. These include:

  • Continued and expanding conflict in the Middle East region
  • An unstable economy in the European Union heightened by the refugee crisis
  • Continued weakening of the world economy with the threat of deflation
  • A slowing and indebted Chinese economy with manufacturing in decline and a weakening currency
  • Indecision by the US Federal Reserve

Of these factors, the continuing… Continue reading

Lack of control by the Central banks?

Actions by central banks were effective in reducing the fallout from the GFC. Now central banks are so concerned at the problem of deflation that they have continued to lower interest rates and/or continue quantitative easing in an effort to stimulate their economies. As a result we now have inflated asset values in a very low interest rate environment with increasing sovereign debt. Central banks now have few remaining options but to continue quantitative easing or further decrease the interest rate.

Fed chief Janet Yellen took a huge risk in raising US rates in December. It now seems that further Fed rate rises this year are unlikely to occur because of the damage this will cause to the global economy at a time when the United States economy also continues to weaken. Further rate hikes in the US would depress equity markets and it seems more likely that the FED… Continue reading

The United States dollar, debt and default.

This week we have seen a market recovery (or is it a bear market rally) spurred by an increase in the price of oil and central bankers’ promising yet more stimulus in the light of some real economic concerns.

The world debt situation continues to worsen and world GDP growth continues to fall. As expected, the decision of the Fed to raise interest rates has not calmed the United States dollar index (see chart below) which is very high and can be expected to go higher. Apart from depressing United States company growth, a very high USD puts huge pressure on emerging nations which have big debts in USD with little or no capacity to repay those debts. While economic basket cases such as Nigeria, Venezuela and Russia spring to mind there are also Middle East countries who are now facing big problems with declining revenue as a result of… Continue reading

World markets are likely to fall but China is the key.

Although the decision of the Fed not to raise interest rates has at least temporarily removed a variable from the markets, volatility in world equity markets can be expected to continue. Of the several remaining very significant unknowns which contribute to this volatility the most important one is China.

China has recently had four interest rate cuts and reduced the reserve-ratio requirement. These measures and others which in effect reduce financing costs for local government authorities, have created conditions that exacerbate the debt situation and potentially increase the risks of instability in the Chinese financial system.

Easy money conditions were a major contributor to the Chinese stock market boom and as a result retail investors are now the biggest contributors to the national debt. The Chinese debt is now about US$25 trillion and is estimated to be close to 250% of GDP. In fact the rate of growth of debt… Continue reading

Risk, Probability and Investing

Successful investing is all about understanding and managing risk. One approach to managing risk is to consider the probability of longer term trends in major economic indicators.

Consider the probability that the following economic events will occur.

There is a very high probability that:

  • The AUD will continue to fall perhaps to 50 Cents
  • Equity market volatility will continue
  • World economic growth will be low for the foreseeable future
  • Low interest rates will continue at least through 2016
  • The problem of sovereign debt will continue
  • Deflation will continue

While the level of confidence is lower for the following events, there is a probability that:

  • The Australian economy will enter recession
  • The RBA will cut the cash rate by 25 basis points
  • Unemployment will rise in Australia
  • The United States Fed will not raise interest rates
  • Chinese economy will continue to weaken
  • The commodity bear market will continue

The assessment of… Continue reading

Mixed signals

The equity markets continue to give mixed signals. There has been a lot of volatility in markets of late, provoked initially by the Greek issues and more recently by China. The volatility on the Chinese stock markets is less important given that the equity markets in China have little correlation with the overall economy compared to Western nations. Of more significance is the underlying economy and despite the release of economic data from China suggesting that their economy is growing at the rate of 7%, all indications are that growth is slowing significantly and that the real figure is closer to 4%.

The slowing Chinese economy has had an important influence on world trade. Major commodities such as copper, oil and gold are at or near their four year lows. The Baltic dry index (BDI) which is a significant indicator of world’s economic health has recently risen only marginally… Continue reading

Is confidence in this market justified?

Despite a weak Australian equity market most commentators remain very positive for a continuing bull market. But is this justified? Buoyant markets and world recovery is really dependent on the US economy and despite a weak first quarter, most of the economic news coming out of the USA is positive – but elsewhere there is uncertainty. The fall in oil and other commodity prices has been very positive for consuming nations. It is equivalent to a tax cut because it supports consumer demand. As a result, fears of continuing deflation problems in Europe have eased with both headline and core inflation now positive.

The bank of Japan has created uncertainty with its massive quantitative easing program which has stimulated the Japanese economy (although GDP growth and inflation growth remain very weak). The very much weakened Yen (at about 126 to the USD), has had the effect of exporting deflation… Continue reading

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