Tags: US | economy | taper | growth

Keep Your Feet on the Ground and Be Patient

Tuesday, 29 Oct 2013 01:46 PM

By Hans Parisis

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The highlight for this week will be without any doubt the Federal Open Market Committee (FOMC)'s statement on Wednesday. All level of market players and participants will be eager to learn how the Fed is thinking about "tapering."

Anyway, I think this week's statement should (probably) put to rest any doubts about tapering before the end of this year. That said, it could become really enlightening when we will be able to read the minutes of this FOMC meeting in a few weeks.

Also this week, we could have a first hint of how the government shutdown impacted the ADP employment numbers. Nevertheless, we'll have to wait until next week to read the postponed non-farm payrolls numbers.

On Monday, UBS published its 2015 economic forecasts. UBS expects the slow recovery to continue in most places, which should translate in a 2.5 percent global growth that could pick up further to 3.4 percent in both 2014 and 2015. The United States is expected to lead growth among the developed economies, which should, if that growth projection comes true, let the Fed finally engage its absolutely necessary tapering operation next year.

Growth in the euro area is expected to only improve very slowly, which could allow the European Central Bank to lower interest rates further and even down into "real" negative interest rate territory. This could help to bring down the overvalued euro exchange rate, which is already estimated as too high by a large part of the EU industry and various euro area governments.

As far as Japan is concerned, UBS expects its economy to slide into a downward trajectory, with growth expected at only 1.5 percent in 2014 and further down to 1.1 percent in 2015, which would translate to serious negative stress on the "Abenomics" project of the Japanese government. This project aims to expand the Japanese economy by 1) aggressive quantitative easing from the Bank of Japan, 2) a surge in public infrastructure spending, 3) the devaluation of the yen and 4) a 2 percent target inflation rate.

Of course, a failure of "Abenomics" is still "only" a possibility and there is no doubt the Japanese government would do everything in its means to avoid that, as public debt already accounts for a mindboggling 240 percent of GDP.

By way of comparison, U.S. public debt stood at $16.74 trillion (average interest rate at 2.43 percent!) on Sept. 30, which is slightly above the 100 percent mark of GDP.

The emerging economies as a whole are expected to slow further because of weaker domestic demand.

Please, keep in mind that in case the Fed starts tapering, which could occur in 2014, and if UBS is right and the United States leads growth in developed economies in 2014, tapering by itself will negatively impact the emerging economies, no doubt about that.

Long-term investors should do their homework if they are considering asset allocation in emerging economies and they should take into account a time horizon of about three to five years when many "bubbles" will deflate all over the globe. Keep in mind that all this should occur in a rising interest rate environment (interest rates normalization.)

In a new working paper titled "Transmitting Global Liquidity to East Asia," the Bank for International Settlements, which is considered as the bank "for" central banks, warns of substantial financial stability risks associated with dollar funding of many countries in East Asia, as dollar-denominated loans to that region have risen from $270 billion to probably over $880 billion over the last four years.

This is important because the world has been really shocked by the recent threat of a U.S. default and the U.S. government shutdown caused by political bickering in Washington. I'm not saying the world has lost its confidence in the dollar and the United States paying for its $100 trillion+ in debt, but it must be said that this kind of totally unnecessary political bickering in Washington better not be repeated in January/February, otherwise there could be serious risk of a damaging backlash for the dollar and U.S. debt as a whole.

Nevertheless, as a long-term investor I would put these risks on my radar screen.

In this context I think it could be good to take notice of what happened on Monday in China. Yu Zhengsheng, the fourth-ranked member of the Politburo Standing Committee of the Chinese Communist Party, said the party's forthcoming plenum would "principally explore the issue of deep and comprehensive reforms," adding that "the reforms this time will be broad, with major strength, and will be unprecedented."

I could be wrong, but in my opinion we shouldn't be surprised that next month's plenum could allude to a historical potential change in the international use of the Chinese currency, the renminbi, in the global foreign exchange markets. As always, we'll have to wait and see what happens.

Finally, my view that we are heading for a correction hasn't changed. When I see the amounts of money borrowed to play the so-called momentum (no, not playing the fundamentals) in equities, the numbers as communicated by the New York Stock Exchange show nominal margin debt stood in September at a historical high of $401 billion. The credit balance, which subtracts margin debt from the sum of free credit cash accounts and credit balances, also stood at a mindboggling $111 billion.

Historically, these extremes occur just before very deep corrections, as was the case in March 2000 (decline started in August 2000), July 2007 (decline started in October 2007) and . . . maybe now?

To me, this situation has turned into a Russian roulette game "to the end" that, of course, will end badly. No, in my opinion there is simply no escape.

So far, the momentum game has been fueled by the Fed's quantitative easing program, whereby "bad news" has meant, until now, "good news."

I'm sorry, I don't play these kinds of games and I prefer to remain with both feet on the ground and do my best (no, it's not always easy!) to keep my patience.

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