The Great Malaise Continues
Joseph E. Stiglitz
NEW YORK – The year 2015 was a hard one all around. Brazil fell into recession. China’s economy experienced its first serious bumps after almost four decades of breakneck growth.
The Great Malaise Continues
Joseph E. Stiglitz
The Big Mac index
After the dips
Big currency devaluations are not boosting exports as much as they used to
$590 Billion…Gone in a Day
Oil just hit a fresh 11-year low.
The price of oil dropped 6% today. It’s now down 68% since peaking in June 2014. Oil hasn’t been this cheap since February 2004.
Dispatch readers know the world has too much oil right now. “Fracking” and other new technologies have unlocked tens of billions of barrels of oil that used to be impossible to extract.
U.S. oil production is at a 30-year high, and the U.S. is now the world’s largest oil producer.
According to the International Energy Agency (IEA), oil reserves of developed nations reached a record high of almost 3 billion barrels in September.
• OPEC is also pumping record amounts of oil…
The Organization of the Petroleum Exporting Countries (OPEC), a cartel of Middle Eastern countries, produces 40% of the world’s oil. Until recently, OPEC limited its oil production to keep prices high.
But last month, OPEC abandoned its production limit of 30 million barrels per day (bpd). According to Bloomberg Business, investment bank Goldman Sachs (GS) expects OPEC to pump 32 million bpd this year. That would be a new record.
The economies of OPEC nations depend on oil. For example, crude oil accounts for 83% of Saudi Arabia’s exports. And it makes up 68% of Iran’s exports. These countries must keep pumping oil…even with prices at 11-year lows.
• Shares of major oil companies dropped…
ExxonMobil (XOM), the largest U.S. oil company, fell 0.8%. Chevron (CVX), the second biggest U.S. oil company, dropped 4%.
Oil services companies, which sell “picks and shovels” to the industry, also tanked. The Market Vectors Services ETF (OIH), the largest U.S. oil services ETF, fell nearly 4.5%.
Eventually, this cycle will end with absurdly low prices for oil stocks. We’ll get an amazing opportunity to buy oil stocks at fire sale prices. But, for now, the world is simply pumping too much oil. We’re staying away.
• Energy is just one sector that’s struggling…
If you’ve been reading the Dispatch this week, you know U.S. stocks have had a horrible start to the year. The S&P 500 fell 1.5% on Monday, its biggest year-opening drop since 2001.
Today, U.S. stocks slid again. The S&P fell 1.3% to its lowest level in nearly three months.
Foreign stocks have sold off too. The Japanese Nikkei 225 fell 1% today…and the Euro STOXX 600, which tracks 600 of Europe’s largest stocks, fell 1.3%.
• Emerging market stocks are hitting new lows…
The iShares MSCI Emerging Markets Index (EEM) plunged 1.9% today, and is down 4.4% this year.
That follows a 16% decline last year, its third losing year in a row. Emerging market stocks are now at their lowest level since 2009, when the world was in a financial crisis.
• And Chinese stocks are off to their worst start ever…
The Shanghai Composite Index tanked 6.9% on Monday. The crash erased $590 billion in value from Chinese stocks. China’s stock market is the second largest in the world, behind only the U.S.’s.
The selloff triggered China’s new “circuit breaker” rules, which automatically suspend trading for the rest of the day. The Chinese government put these rules in place to prevent panic when stocks crash. But, like most government rules, they do more harm than good.
While the maneuvers may stabilize the market temporarily, they’re unnecessary because intervention creates price distortions and fosters moral hazard as traders come to view the government as a backstop for shares, according to UBS Wealth Management, Henderson Global Investors and Wells Fargo Funds Management.
Many investors also expect Chinese officials to extend the ban on short selling (betting that a stock will fall). Chinese regulators banned short selling over the summer, and the ban is set to end on Friday.
Chinese stocks are extremely volatile. They have huge booms and huge busts. If you prefer safe, steady investments, don’t buy Chinese stocks.
If you do invest in Chinese stocks, use stop-losses. A stop-loss is a predetermined point at which you’ll sell a stock if it declines. Using a stop-loss will allow you to make money while a stock is rising…then automatically sell when the uptrend ends. It allows you to speculate in volatile stocks without risking huge losses.
• With stocks around the world falling…
We recommend owning a significant amount of physical cash and physical gold. And to avoid major losses, we suggest selling any stocks that are expensive or vulnerable to an economic downturn.
Holding a significant amount of cash will ensure you can buy stocks next time they’re cheap. And physical gold is wealth insurance. It has protected wealth through stock market collapses, economic depressions, and full-blown currency crises.
If you’re interested in other proven strategies to protect your money from a bear market, watch this free video we put together.
Chart of the Day
Emerging market stocks just hit a six-year low.
Today’s chart shows the performance of the iShares MSCI Emerging Markets ETF (EEM), the second-biggest emerging market ETF. As we mentioned earlier, EEM has dropped to lows not seen since the global financial crisis of 2008-9.
Yesterday, Financial Times explained why emerging markets stocks could drop even further…
The emerging markets-focused investment bank [Renaissance Capital] predicts that 17 of the 36 EM countries it covers are likely to be downgraded by at least one of Moody’s, Standard & Poor’s and Fitch in the next 12 months.
Such a tally would comfortably exceed the joint record of 11 sovereign downgrades in 2008, 2012 and 2013.
Credit agencies like Moody’s (MCO) and Fitch downgrade countries whose financial health is worsening. If Renaissance Capital is right about the record amount of defaults coming this year, emerging market stocks will likely take another big leg down.
Up and Down Wall Street
The Trouble With China
Stock-market bulls’ hope that the big emerging nation will save the global economy by encouraging spending by its consumers. But that seems to be more pipe dream than reality.
By Jonathan R. Laing
True, the Standard & Poor’s 500 finished the year in a virtual dead heat with its beginning level, and the U.S. economy continued to grow. But the economic slowdown in China wreaked considerable havoc around the globe. Commodity prices plummeted, punishing emerging markets and other exporters of metals, oil, and other resources. Credit spreads widened dramatically in the U.S. high-yield bond market and beyond. Even U.S. stocks endured some nasty downdrafts as a result of Beijing’s ham-handed handling of its A-share markets last summer and its attempt to devalue the yuan in August.
Will China regain its footing and again boost global economic growth, as it did following the global financial crisis of 2008-09? To do so, the Middle Kingdom would have to dramatically rebalance its economic model, making it less export-driven and more consumer-based. And this is unlikely, given the imperatives of a nation in which control by the Communist Party and personal, but not societal, wealth enrichment are paramount values. In fact, chances are that the Chinese economy will get far worse in 2016.
From his perch as a strategist at New York’s Silvercrest Asset Management, Patrick Chovanec sees possible trouble ahead for China, even after its well-publicized slowdown.
Chovanec, who has knocked around Asia quite a bit, first as a venture capitalist and then as a university professor in China, says the Chinese face an era of “creative destruction” to create a true, self-sustaining market economy built on amped-up consumer spending and a strong private service sector. This transformation would mean largely sacking the existing model of insensate state capital spending on industrial capacity, splashy infrastructure projects, and commercial and residential construction that spawns unproductive and redundant factories, ghost cities, and unneeded roads, bridges, airports, and the like.
Yet, Chovanec sees few signs of a rebalancing, despite all the rhetoric from Communist Party functionaries.
Credit growth continues to run at an unhealthy pace, well above the recently reported third-quarter gross domestic product rise of nearly 7%. This, despite or because of the fact that a credit crisis looms from all the mal-investment aimed at stimulating growth in China since the global recession began. Now, to avoid defaults, loans must be evergreened.
To boost competition and efficiency, state-owned enterprises that dominate many economic sectors must be broken up and perhaps partially privatized. Yet, Chovanec observes, recent “reforms” in the shipping, airline, and oil industries have done nothing to foster consolidation or destroy monopolies.
He notes that Party officials lately are predicting that there will be no V-shaped economic recovery, but instead one that’s L-shaped. “And even that pessimistic goal of mere stabilization is just aspirational,” he notes. “The reality is that things could get a lot worse, with few if any green shoots apparent now.”
At least some old China hands contend that the nation should be able to muddle through its problems without suffering a major mishap because it has $3.4 trillion in foreign-currency reserves, relatively modest central-government debt, and public and private debt that’s mostly internally financed and thus immune to foreign capital flight.
BUT CHOVANEC NOTES that Japan boasted many of the same strengths in 1990, just before its stock market crashed and its real estate and banking sectors began long implosions. Tokyo fought back with monetary easing, and huge stimulus programs that eventually heaped mountains of bad debt on the taxpayers. But that didn’t let Japan avoid 2½ decades of economic narcolepsy.
Many expect China to soon begin another push to devalue its currency, with the aim of bolstering exports and GDP growth. Chovanec insists that this would merely trigger competitive devaluations, particularly by other emerging market lands, in a ruinous beggar-thy-neighbor free-for-all. Expectations of further devaluations also would encourage rich Chinese and foreign investors to flee the Middle Kingdom and its weakening currency.
Finally, China would have to pay more, in yuan terms, for imported raw materials and components. That, of course, would cancel out many of the benefits of increased exports.
Despite these caveats, at least some observers’ faith remains undiminished in the rapid and inevitable rebalancing of the Chinese economy. In this brave new world, wasteful government-dictated investment decisions will give way to free-market signals from untrammeled consumer demand. Capital will therefore be put to more productive uses.
But another longtime observer of the Chinese economic miracle, Anne Stevenson-Yang of the Chinese research outfit JCapital, thinks that such a magical transformation will remain elusive.
DEBT DEFAULTS IN CHINA are increasing apace, despite the best efforts of Beijing and the government-owned financial system to paper over the problem. Stevenson-Yang fears that a Lehman moment could suddenly occur, or that the credit system gradually will falter under an accumulation of woes.
In any case, rebalancing would be hard enough to achieve under ordinary circumstances, let alone under the current conditions of high stress. The main impediment Stevenson-Yang sees to a consumer-led service economy is…the Chinese consumer. Despite some government figures to the contrary, consumer spending is rising more slowly than the economy is growing. The World Bank reports that household consumption as a percentage of GDP is under 40% in China, versus 55% in Germany and 68% in the U.S.
Stevenson-Yang regards with skepticism the widely quoted numbers from China’s National Bureau of Statistics showing that retail sales have been expanding at a 10% year-over-year clip in recent months (October’s reported increase, in fact, hit 11%). She claims that the numbers are rigged by, among other things, including some government procurement figures in the total. Of course, most observers believe that China’s GDP growth numbers, reported at 6.9% for the third quarter, are cooked, too. But the retail sales data seem even more outlandish.
This is especially the case, says Stevenson-Yang when one looks at other Chinese statistical surveys, some official and some not. For example, the Chinese Ministry of Commerce shows that retail sales at 3,000 key enterprises had increased only 4.5% in 2015 through September, down from 8% in 2013 and the high teens in 2010. And a respected private Chinese data service, Wind Information, estimates that retailers’ gross revenue rose just 1% in the third quarter.
To be sure, household consumption has undoubtedly been hurt by the slowdown in the Chinese economy. But the Communist Party, the state, and the elite have little incentive to change the economic model by directing resources toward households and away from industrial state-owned enterprises, state banks, big party-dominated private enterprises, and investment funds.
Households under the traditional model are supposed to be sources of cheap money, with their savings sitting in state banks at suppressed interest rates. This mountain of savings, in turn, is redirected by the elite to all manner of capital projects, from new plants, roads, and bridges to convention centers, airports, and high-end housing. These projects, whether they make sense of not, generate plenty of skim for the party bosses and their patronage armies. This is one big reason why annual capital spending in China has been running at a breathtaking 40% of GDP or more over the past decade.
The Chinese state controls, directly or indirectly, the nation’s means of production, but not the household retail economy. Certainly the Party is loath to cede control to a sector that is entrepreneurial and independent.
In addition, Stevenson-Yang contends, other factors also are working against the development of a robust consumer economy. The very sectors that in most developed countries attract the lion’s share of spending by individuals—health care, education, financial services—have been stunted in China by overregulation and inadequate investment.
Wealth is so grotesquely concentrated that the superrich have more money than they can spend. A true middle class, in the Western sense of the word, doesn’t exist, at least not to the degree it does in Europe or the U.S. “They lack sustainability of income and are forced into increasing debt and taking wild speculative headers into the stock market or condo market to get ahead,” the research executive observes.
One last negative, stemming from what otherwise might be a positive: Xi Jinping’s anticorruption campaign is slowing consumer spending on high-end goods, jewelry, junkets to Macau, and the like.
Thus the Great Rebalance that has fired the hopes of so many investors is not months, but years away from happening, if it ever does. One must also remember that a consumption-led service economy doesn’t deliver nearly the GDP punch of capital investment in early-stage economies. Service industries simply don’t boast the same immediate productivity gains.
The old growth engines in China seem to have run out of steam. Don’t expect the Chinese consumer to pick up the slack and deliver the global growth that we’ve become accustomed to.
A former star of the emerging world faces a lost decade
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By: Gordon Long
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