Thursday, September 3, 2015

The Festering Reality Of Global Economic Growth..........

The Festering Reality Of Global Economic Growth

The recent wild swings are a precursor of a more insidious trend... which is definitely not going to be our friend!

This could fester into something far more cancerous than just an EM/China crisis. It could catalyze a reversal of sentiment towards the global systemic distortions of market values driven by government QE programmes since 2008. These central Bank distortions have dominated asset prices since 2009.

For instance, ask yourself why stocks are so high when growth remains so fragile and the outlook for corporates is getting worse. QE persuaded folk to buy stocks because i) bond yields were so falsely low, and ii) they kidded themselves low rates meant stock positive growth was just around the corner. For a long time we've been warning too many asset classes look like bubbles set to burst on such flimsy non-causal linkages. After years of low interest rates, low energy costs and low wages, the global economy is still pathetic.

If you take all the key "drivers" of global economic growth, they increasingly look negative. In terms of economic policy, most central banks have gone into ease mode and devaluation. Coordinated global growth through trade agreements have stalled on protectionism. Growth forecasts are falling. No surprises that volatility is rising.

These factors are all contributing to the much deeper problem of how to trade zero real growth and place honest valuations on assets in this environment.

I described the concept of "Null Entropy" – the threat of long-term zero growth and stagnation. (Others call variations of the same economic malaise to be the "new normal".) Despite 5-years of low/zero interest rates, low energy costs, minimal wage inflation, and lots of cheap talk about coordinated economic growth drivers, the world is drifting without any economic wind to propel it forward.

The failure of central banks, politics and markets are only partly to blame. The deflationary threat has discouraged real growth investment. It doesn't matter most corporate balance sheets are pretty robust today, or that banks are lending again – entrepreneurs see little point in investing in goods, services, new plants or jobs when rates are so low, deflation is at the fore, and the business outlook is so negative when major markets like China will be closed because of dollar strength, commodities are crashing and business risks are escalating at a scary pace!

Null Entropy – political failure, central bank manipulation and entrepreneurial disinterest. Now it's set to see real corporate crisis as the new normal bites. Any positive growth figures we do see are local aberrations. Take a look at container rates – record lows. Look at global steel production – 68% of global capacity. There are few signs global commodities are set to rise. Low oil prices look to be firmly established as a long-term feature. Who would want to invest into that picture?

Somehow the global economy needs a jump start – but how? Global coordination has been anything but a success. Any attempt to raise interest rates - as we've seen since the Taper Tantrum last year - simply triggers further shock. 

As this crisis and uncertainty deepens, it feels to me that further distortion by central banks is more rather than less likely, and it will be a bad thing!

With zero growth and a lack of inflation to ease away over indebtedness, it's possible the next few years will contain some real policy and market surprises. In fact I would count on it.

Like making national debt currently held by central banks simply vanish. The effect will be to confirm the massive money creation that happened during QE, which should have been inflationary as too much money was chasing fewer assets – but it still isn't happening except to create financial asset bubbles! 

Now these bubbles are finally bursting, perhaps its better news for real asset inflation – but rising wage pressures in a depressed economy will have all kinds of stagflationary negative effects. I'm beginning to fear for the corporate bond market….. Moreover, the social consequences of Null Entropy will be fascinating to watch – especially in terms of politics. 

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