Time has come to prepare this year’s forecast.
Unprecedented increase of supply of currencies and zero interest rate held for nearly 7 years inflated many bubbles: starting with stock market, real estate and the incredible government debt bubble.
What surprises is the fact that Richard Fisher – former Dallas FED President – in the interview for the CNBS openly stated that blame for the latest falls in stock market cannot be assigned to China but rather the FED. He continued that when he was a part of the Federal Reserve they pushed for big boom market to create an image of economy rising and what can be seen now is just a reverse of this artificial intervention. The difference with today is that the FED does not have more ‘ammunition’. He also added that that we should not be looking for any FED officer taking the blame for what FED did.
Words of Fisher confirm theory that central banks affect financial market in a limited way. Through their stupidity a lack of responsibility central banks created many speculative bubbles that simply cannot be controlled. When bursting of those bubbles started previous crises in 2000 and 2007 central banks were able to lower interest rates and flood markets with cheap money. Today they indeed do not have ‘ammunition’ as having zero interest rates created the main problem from the very beginning.
Many factors shows that slump which started at the end of 2015 will gain momentum and we will meet its peak in upcoming year. Now let us see what 2016 holds in particular areas.
Raise by 0.25% served by the FED in December 2015 is in my opinion only a desperate call to defend its credibility. They announced it for over a year and result is that investors around the globe understood that with increasing capital costs (interest rates hike) getting stocks on their new record highs will be ever more difficult. Thanks to that capital flight started first in developed countries accountable for approximately 85% market capitalisation of globe’s exchanges. In addition when we take 1998 or 2004 when FED started raising interest rates the GDP growth sinusoid revolved around 5% growth. Overheating of the economy was the reason behind bigger inflation not – like it is today – printing fiat money.
Blaming recent increase in interest rates for the situation is absurdity – it is last 7 years of zero interest rates. This circumstances misallocated capital and inflated bubbles in bond, stocks and real estate markets.
My belief is that 0,25% interest rates are not here to stay. Yellen will go back to solution she prefers – zero interest rates and printing – and act like a hero with the excuse of dying economy. The biggest problem for the FED is now debt of shale sector. Its yield stay now around 19%. Bankruptcies can cause domino effect and it is possible that this will flood financial sector due to chain effect. Either the FED starts buying junk shale bonds or it has to take the risk of their insolvency on itself. Both ways it’s the taxpayer that loses.
There is another way to transfer toxic assets. Two or three banks could buy them out and doing ‘one-time’ Bail-in. Check your ability to take the cash out – in the US it is getting harder to take out 3,000 USD. This horrifying setting of financial Armageddon can coerce people into bending and accepting loss of 10% of their savings. Especially when the troubles touch everyone in the population. Well, get your solidarity on the table folks.
From those two I would say that going back to ‘normal’ (zero interest rates and printing) is more likely to happen. One good reason is presidential election in 2016. Secondly in Europe we hold negative interest rates which gives margin to work with on the other side of the Atlantic to lower rates and still be above European levels. This affects bond market a lot.
I believe that share prices at the end of 2016 will land lower than we see them now. Boom that peaked around in August 2015, was one of the longest in the history of last 80 years. Moreover regarding P/E (price/equity), CAPE (price/earnings over last 10 years), P/S (Price/Sales) – indicating extremely high share prices. Margin debt levels (very high) is another gauge of very expensive stocks.
Another thing showing that investors wait until prices will go down is their conviction that central banks have to raise interest rates and this has to push prices down (self-fulfilling prophecy!).
Strong USD is another reason to believe in downward push on prices. We see it since 2014 and for many international conglomerates this drives their revenue (estimated in USD) down from abroad of the US.
Across big range of stocks that are bound to be affected the biggest losers will be in my opinion FANG – Facebook, Amazon, Netflix and Google). This group’s P/E is 351 – astronomically high comparing even to dot-com bubble. FANG’s severe overestimation confirms the fact that last 6 months was filled with insiders (members of board of directors or supervisory boards) only selling their shares.
When it comes to developing markets against general opinion 2016 will do better than already developed ones. Purpose is simple: developed markets delivered less value this cycle in comparison with their developing brothers. On top of that slump in developing economies started earlier and they experience cheaper stocks today than developed markets do.
Let us take example:
- 31.12.2015 CAPE ratio for developed markets equals 20,5 while in developing markets only 13,5
- For S&P to reach minimum from 2009 crash, stock prices from today levels has to drop by 65%. In Brazil this difference is only 10%.
Further fall of majority of currencies last year is another argument for lower plummet in developing economies. This happening when global economies are slowing down may help solve some financial problems and thus, make companies listed on respective exchanges boast with better results.
Today many markets look attractive already. Among others polish market but we need to wait until mid-2017 to see amazing deals.
I advise to stay back from all types of bonds. Globally we reach the zenith of 35-year cycle of yield drop and correlated increase in price of bonds. To properly explain this situation I will highlight some details.
a) European governments’ bonds
Yield of 10-year bonds made in Germany, Austria, Netherlands and Finland – countries with sensible fiscal policy – revolve between 0.48-0.74%. Yield of bankrupted Italy or Spain is 1.7%. Lower than Singapore. Low yield (and consequently high prices) are the outcome of the EBC’s interventions with newly printed EUR.
In environment like this coupon definitely do not compensate the risk of losing control over long-term interest rates (increase of yield) and also - what is worse - the Eurozone crashing. The latter will happen sooner or later.
Whether prices of Eurozone members’ bonds fall in 2016 depends only on the amount of money the EBC is able to print. This is not an asset I take into consideration when thinking about my future investments. If I should estimate future movements I would say that before 2016 ends bonds made in Spain, Italy, France, Belgium and Portugal for sure will rise.
b) The US bonds
I have mixed feeling when it comes to 10 Y UST (10-year US government treasury bonds). In 2016 we can witness two vectors crashing:
- wave of insecurity and fear initiate capital flight from stock market to bond market. Plus yield above 2% is still attractive comparing to lower quality EU bonds;
- On the other hand, USD grew by significant margin between 2014 and 2015. This can discourage capital transfers to the US and should lift the price of government bonds.
I am of opinion that in Q4 2016 yield of 10 year treasury bonds is able to situate itself marginally lower than it is now.
c) Corporate bonds
Corporate bonds yield recently climbed from 7 -15%. Shale bonds have to offer impossible 19% to attract capital. Normally we all should short shale bonds. Especially low oil and gas prices puts stress on producers. Unfortunately many companies are able to use revenues only to pay the interest rates of their debt. Increasing the debt. This debt will never be paid back!
Sector of shale gas is strongly highlighted as one that can give the US energy security. This is big enough argument for the FED to save whole sector to buy out from commercial banks all worthless shale bonds. With one condition being to further finance bankrupted shale producers. Simply put: we are financing sector which is already insolvent by saving financial institutions that irresponsibly credited those energy companies. It does resemble 2008 and buy out of mortgages.
Using Mark Faber’s words it is hard to predict anything without knowing what crazy thing central banks will do.
When talking about gold and its price in USD there are few things to consider. Firstly price of gold gained when markets were filled with fear. Example of this we have seen during September 2015 and beginning of 2015 when prices of stocks plunged.
Although I remember 2008 when during the panic after Lehman Brothers collapse all asset prices declined due to major financial institutions needing liquidity. They were selling everything they had just to get their hands on cash.
I think positively of gold price in the long term but I wonder if sudden panic could make it touch 1000 USD especially that Commercials systematically increase their short position.
Optimal solution for gold would be stock market crash and reactionary QE4 from the FED. Scenario like this may leave gold at level of 1500-1600 USD/oz at the end of 2016. Whatever central banks do looking at gold price in the USD – it will be higher than now. Absolute majority of currencies experienced their minimums at the end of 2013 and we are not going to see them any time soon.
According to my predictions price of argentum can rise more than gold. Reasons? Let us tart with the gold/silver ration is very high. Secondly silver reserves are equivalent to 4 month production. With copper, zinc and lead production falling they will follow. Majority – 60% - of silver supply is a by-product of other industrial metals production and their prices achieved levels last recorded in 1999. Many mining companies (e.g. Glenconre or BHP Billton) limited production of industrial metals and this has to slow down silver supply.
Silver as a metal is very volatile when it comes to price. It is very shallow market. Annual production is around 13 bn USD and this sum is negligible looking at the financial transfers around the globe. Nonetheless I see silver at the end of 2016 at 22USD/oz.
I am not entirely sure what to think of mining companies.
One side of the story is that this group of assets is extremely underestimated with great potential of growth. Still with prices of precious metals climbing those of mining companies had different fate since begging of the year. I remember ending of 2008 and similar situation when XAU (Gold & Silver miners) index lost 60% because of panic.
With that in mind severe stock exchange panic can lead to situation where gold and silver go up and mining companies receive a discount. I want to say that this setup may only happen in the beginning of the market slump when investors sell every kind of shares in fear. Only after second look the search for valuable assets is due. We can count mining companies with <1bn USD capitalisation as very good candidates to that role.
I am far from being super-optimist with regard to mining companies but I will not sell their ETFs in my portfolio.
Industrial commodities indexes lost a third of their value levelling at 70% of their peaking price from 2008. We are officially below the bottom of 1998 crisis and the lowest levels since 1980. I cannot stop myself from asking: what value had a dollar then and now? Very low resource prices are the end result of global trade nosedive. When consumers do not buy products, factories lower production and this drives demand for resources down and prices in the same direction.
The lowest in history Baltic Dry Index (maritime goods transportation price) is a proof that low prices of industrial commodities takes account of economic depression already. What could be implied form that is a suggestion that industrial production is halted and any goods are not required any more. You just need to print another trillion USD or EUR and everything will be fine right?
Base metal prices (copper among others) in my view still have not touched the bottom but possibility of further lows is now minimal. Likewise after acute dip we have seen in second half of 2015 the ascent could be equally sharp. We may call them one the few assets ending 2016 in the black.
Forecasting price of geopolitical weapon of choice has its perils. One angle is the US trying to break Russia with cheap barrel. Another angle is Saudis hoping to kill shale competition, majority made in the US of A.
Cheap oil put real pressure not only on oil exporters but also on financial sector. During times of expensive barrel it was easy to get money to fund expansion of the giants like Brazilian Petrobras. Today Petrobras has huge problems. Whole shale sector is another drama of itself.
2015 was still an ‘ok’ year as 70% of the oil sales was hedged with higher prices. Problem is on the horizon as those contracts will quickly expire and whole sector cannot be saved.
Without intervention of central banks buying shale debt production can drastically fall. I cannot believe in countries dependent on expensive oil will calmly sell under 30 USD. Lastly you still can disrupt supplies and spread fear in the market causing sudden hikes and then hedge produciton on better terms.
Personally I think that in 2016 price will come back to 70 USD despite oversupply.
As of now I consider their potential as being higher than industrial commodities. Regardless of agricultural commodities price falling less brutally than industrial (now we are marginally lower than 2009 levels), in 2016 we can see some weather anomalies taking its toll. Example being El Nino anomaly. In the past both floods in South-East Asia and droughts in Australia immediately affected market prices.
Independently from weather conditions today’s prices are a fraction of those in 1974-1980. I will definitely write an article about that soon. I feel that agricultural commodities should bring very nice profit.
Global real estate prices are still expensive thanks to central banks and historically low interest rates. Between March 2009 and January 2015 Global REIT Index (mirroring real estate for rent) expanded 230%. Whole 2015 we noted slow decrease which in my mind will snowball with crisis and financial market troubles speeding up. Although REIT’s prices in many developing countries are very attractive the potential of falls is huge.
In other words I stay away from real estate market. What can make it interesting is freezing credit lines, higher interest rates and general panic in the financial markets.