- In a paperless and cloudy world, are investors and citizens as safe as the markets assume we are?
- In a flat, networked and interconnected world, is it even possible for America to be an “oasis of prosperity” and a driver or engine of global economic growth?
- With the G-8’s geopolitical coordination at an all-time low, how slow and inept will the reaction be if the wheels do come off?
The “we have seen this before” crowd is predictably unperturbed by the Italian debt crisis and the possible contagion from it.
Rather they continue to look through the rear view mirror and are excited about the (one-time) tax reform influenced improvement in corporate profits.
And they seem to believe that a never ending deluge of monetary easing is the solution to the problem in Italy and elsewhere in Europe.
As it is said, past results may not be predictive the future – in charts or in policy. If it was, librarians would be the richest investors in the world.
And masking over structural problems by throwing money (QE, NIRP) is also not the solution. (It is first level thinking, at best – from my perch).
What I believe they don’t understand is how interconnected the global economy is today compared to the past. As each year progresses, the role of world trade increases and the role of non US operations in our largest multinationals multiply. Just look at the ever expanding role of exports (and non US sales) in the S&P Index – it’s increased as a percentage of total revenues by 2.5x in the last few decades.
What does the Italian debt crisis have to do with Bristol-Myers (h/t Jim “El Capitan” Cramer)?
My answer is…Plenty!
Remember, a year or so ago, when the smart money confidently found more value in European investments than investments in the U.S.?
In The Bull Market of Complacency even the most deep rooted problems are often ignored. Indeed, it took a full fledged crisis in Italy to finally fully expose the extent of the Italian debt crisis to global investors.
While the Bullish cabal will no doubt dismiss the Italian debt crisis – as they have multiple other sovereign debt issues – the paper overing by the ECB of the EU’s debt laden and structurally unsound economies are most real and have grown so large that a European contagion seems inevitable.
The collateral risks to Europe are large – most notably to ECB and to Germany. In it’s extreme it could mean Italy separates from the rest of the EU. To me, as I have written in the past, Deutsche Bank (DB) is particularly exposed.
Deutsche Bank is Likely the Next Black Swan
But, to this observer [who has consistently warned about Deutsche Bank being the next Black Swan and the imbalances in the European banking system (particularly in Italy)], the risks of a possible negative multiplier effect on other European financial intermediaries and on the region’s economic prospects is profoundly real.
As I have also warned, while Italy represents an extreme, US public and private debt is at record levels.
The circular debt “doom loop” is upon us.
Recap Of The 10-Biggest Risks
1. A tug of war between fiscal expansion and monetary contraction seems likely to be won by Central Bankers in the year ahead. History proves that the monetary typically wins out of the fiscal particularly since there are legitimate concerns whether the tax cuts will “trickle down” to the consumer. Moreover, we are at a tipping point towards higher rates (in the U.S. and elsewhere) after nine years of interest rate repression in which the accumulation of debt in both the private and public sectors are at record levels. Not only has the Fed turned, but each day gets us a day closer to the end of ECB QE. (The Italian 2 year yield went from -.265% to -.10% in one day). So, risk happens fast when a massive bubble has been created.
2. There is a growing ambiguity in domestic and non US high frequency economic data. Citigroup’s Global Surprise Economic Index has turned down and Citigroup’s EU Surprise Index is at a two year low. U.S. data (ISM, PMI and others) have often failed to meet expectations. Reports are that retail started the quarter weakly and, this morning, retailer Home Depot (HD) missed consensus comp views.
A flattening yield curve is endorsing the notion of late cycle economic growth. And, according to my calculus, the yield on the ten year U.S. note (given current inflation breakevens) implies U.S. Real GDP growth below +1.70%/year.
3 . The rise in global interest rates may continue – providing a reduced value to equities (on a discounted dividend model) and serving as a governor to global economic and US corporate profit growth. C.I.T.A. (“cash is the alternative) is getting busy while T.I.N.A. (“there is no alternative”) seems to be without a date to the prom this spring.
For the first time in 12 years the yield on the three month U.S. Treasury note now exceeds the dividend yield of the S&P Index:
Source: Zero Hedge
Meanwhile, the six month Treasury bill yields over 2% (2.09% this morning) and the two year Treasury bill’s yield is over 2.55%.
Inflation, too, is likely at a multi-year infection point.
I continue to view June/July 2016 as The Generational Low In Yields. Non US yields are at even more unjustified levels and will lead to large mark to market losses over the next few years – imperiling retail and institutional investors and banks in Europe that have leveraged positions in over-priced fixed income. (Just look at Argentina, a country that has defaulted on its sovereign debt on eight separate occasions – most recently in 2001. As a measure of lameness, investors scooped up 100-year Argentina bonds last June).
Bonds are in year two of a major Bear Market – fixed income (of all types) are overvalued (and I remain short bonds).
4 . The Orange Swan represents clear risks for the equity markets and for the real economy. As I have written in my Diary and stated on Fox News yesterday afternoon, hastily crafted tweets by the White House are dangerous in a flat, networked and interconnected world. The inconsistency of policy (which seems to be designed and conflated with politics as we approach the mid-term elections) seems to be weighing on business fixed investment plans which, I have learned through many of my corporate contacts, are being deferred (and even derailed) in the face of uncertainty and lack of orthodoxy and inconsistency of the delivering policy by “The Supreme Tweeter” who resides in Washington, D.C.
5 . Investor sentiment has grown more optimistic and fears of a large drop in stocks has been all but disappeared.
6 . Technicals and resistance points mark a short term threat to stocks. Not only has the market risen for eight consecutive days but an important Fibonacci point has been been met (from the January highs). As well, the S&P Index is now at the 2725-2750 resistance level – the upper end of the recent trading range. Yesterday, the lynx-eyed David Rosenberg remarked, on CNBC, that on breadth and volume the rally has been less powerful than recent rallies.
7 . The dominance of passive and price momentum based strategies are exaggerating short term market runs– contributing to a false sense of investor security. Though our investment world exists as buyers live buyer and sellers live lower, beware of a change in momentum that can turn the market’s tide.
8 . After nearly a decade, both the market advance and a sustained period of domestic economic growth have grown long in the tooth.
9. Though market valuations are high they are not too stretched – but other classical market metrics (equity capitalization to GDP, price to book, price to sales) are very stretched.
10. A new regime of volatility, seen recently, might signal a change in market complexion.
The world is flat and interconnected.
Doug Kass, since 2004 Doug Kass has served as President of Seabreeze Partners Management, Inc. He runs a hedge fund and individual managed accounts, co-authored “Citibank: The Ralph Nader Report” with Ralph Nader and the Center for the Study of Responsive Law in the 1970s and wrote "Doug Kass: A Life on the Street" two years ago (John Wiley). Since 2003 Mr. Kass served as a guest host on CNBC's "Squawk Box" and has guest hosted Bloomberg's "Market Surveillance" for the last five years. Along with Jim Cramer, Doug is the principal contributor to Real Money Pro.