A Stimulus for the Rest of Us
Do we all have our neck braces on? The first quarter of 2016 was intense, to say the least. We started the year with a drop in the markets not seen since the Great Depression and ended the quarter with one of the strongest one-month rallies not seen since the Great Depression. The central banks around the world converged on more rounds of stimulus or what we would call “shots of cortisone.” As with cortisone, stimulus for economy just masks the issues and each round has to be that much larger and the effects are that much smaller. So, it begs the question, when will this end? We don’t pretend to know, so we’ll answer that question with a maxim from Gary Shilling, “The market can stay irrational longer than one can stay solvent.” In essence, don’t try to guess.
Market Review
So how did we get here? After a tumultuous January, the central bankers of Japan decided to cut their key benchmark rate to below zero, punishing all who are holding Yen and not investing in the economy. In addition, the Chinese government learned the hard way about miscalculating the rollout of circuit breakers within their stock market, which were repealed almost as fast as they were instated. That was followed up by Mario Draghi, of the European Central Bank, announcing more bond purchases and expanding the type of bond the bank can purchase as well as lowering rates. Our Fed also participated, though in milder form, by holding off on raising rates.
To the surprise of many, the markets bounced back on all of this news, which reaffirmed that stimulus around the world was not ending. The DOW and S&P ended the quarter up 1.5%, 1.4%, respectively. Foreign markets fared worse, ending down 3.0% for the quarter. The main four drivers this quarter were: government stimulus, interest rates, commodity prices, and slowing growth from China.
The Global Debt Hangover
There are still glimmers of hope as the US economy is still growing, doing much better than overseas. Europe and Japan are facing economic contraction, yet again. The European Central Bank and Bank of Japan have now implemented various forms of negative interest rates. Yes, you are reading correctly, negative interest rates. This is an effort to spur spending and lending while discouraging saving, another stimulus or cortisone shot for the economy. In the short term, it will spur demand. However, it is not sustainable in the long-run. Every subsequent stimulus must be larger and its effects are that much smaller, making it an impossible course of action over time. It is hard to imagine that the US economy can continue to grow as the economies of the world are slowing down.
The central banks around the world recognize the dangers. Simply put, there is too much debt, and it’s creating huge deflationary pressure on the world's economy. We do not believe that we're on the brink of economic disaster as in 2007 but there are worrisome signs. The slowdown in China gives us particular pause.
China… China… China
As you may have read from the headlines, China's economic growth is slowing. It is only natural for an economy that doubled in the last 5 years to slow down. The latest reported data showed the economy grew at 6.9% in 2015. We believe that the numbers are not what they seem. In a recent paper from American's National Bureau of Economic Research, economists Serrato, Wang, and Zhang examined census date and concluded that Chinese officials who falsify data had a greater chance of being promoted (Economist.com, 2016). The findings are not surprising and certainly calls for the questioning of the reported economic data. We strongly believe that the growth figures are worse than reported and that the slowdown in manufacturing and exports will cause further turmoil. China may prove to be a large contributor to market volatility for the remainder of the year.
The signs of slowing in China are quite great. The worst performing companies in steel, industrial and energy posted a 45% or greater drop in net profits in 2015. The big question here is, what will the GDP growth rate for China in 2016 and beyond be? China has maintained a policy of soft currency peg, low interest rates, and "lax" capital controls. These three policies are contradictory and working against each other, causing friction within China's economy. The capital flow out of China in recent years has led to a clampdown in Macau, a money laundering haven, and shrinking capital accounts. It is highly probable that the Yuan will be further devalued to spur exports. The common belief that the Yuan is undervalued may no longer be true.
The Great Seesaw
Just as we saw in January and for half of the month of February, the market will overreact to the upside as well as downside. With all of the "cortisone" that is flowing in the economy, we anticipate future opportunities to take advantage of the market swings as we seesaw our way to new highs. Still, our focus remains on maintaining the appropriate risk for your portfolios. We are taking the current breather the market has given us to reevaluate the risks at play, raising cash and rebalancing portfolios as necessary. As long as we maintain the right level of risk, the returns will follow and the overall financial plan will stay on course.
We thank you for your continued support and the confidence you have placed in our firm. As always, if you have any questions or concerns please give us a call. Follow us on Facebook, Twitter as well as our RSS feed to stay up to date on what we’re reading and thinking.
Your Team at Archvest,
Eric Lai, John Wenzel, and Kimberly Terry
Eric Lai, John Wenzel, and Kimberly Terry | Archvest Wealth Advisors