FINANCIAL AUTUMN AT SIGHT

FINANCIAL AUTUMN AT SIGHT

During the latest period, a discussion comes to the foreground: the central banks' excessively loose monetary policies have brought the bonds' long-term yields to record low but it is believed that it is no more useful and in case of a new recession wave, the central banks don't have any weapons left in their arsenal.

There is no progress in the inflation, in the demand for loans and in the economic growth, despite issuing money to the marketplace by the massive buying of the bonds by the two main central banks of the European Region and Japan where the central banks passed to the negative interest rate in their respective monetary policies. For example, despite the buying by the Bank of Japan not only of bonds but also of stock funds too, this has not changed much the expectations.

The fact that the global bond stock of 13-14 trillion dollars has turned to negative return is not only showing the fear but it also feeds it. And this fear is the fear of the collapse of the financial sector. Due to this, the leading "investment gurus" are whispering "buy Gold".  As you know, gold is the only investment vehicle which does not carry a "counterparty risk". Whether a stock or a bond, the issuer has an obligation. The issuer has a bankruptcy, a default risk.

With the strengthening of data, the central banks may raise the interest rates but it is not the end of the world as the investment community thinks. If things go to worse, past monetary policies could be adopted as well as some unorthodox vehicles not used so far and which have been very effective in the past.

The normalization in the raise of the interest rate by the Federal Reserve is imminent but not undertaken which, in turn, hurts the Federal Reserve's credibility and the economy. Consequently, the Federal Reserve should eliminate the pressure that is felt by the economy and the emerging markets by changing this attitude.

Also, the pessimism regarding the economic growth is due to the productivity. The central banks cannot find a solution to this productivity problem with monetary policies alone and the politicians should take the relevant measures by coming into the game.

A GLOBAL VIEW OF THE WORLD ECONOMY

A GLOBAL VIEW OF THE WORLD ECONOMY

The stock markets’ transaction volumes have fallen and are still weak; there was a heightened volatility. Emerging countries are having fluctuations in their currencies. We are seeing zigzags in the stock markets. We have fluctuations in a band but the volume looked shallow. Everyone is looking at the same place: what will the Fed do?

There are problems that have resurfaced in Europe. Let’s start with the example of Spain; Spain’s debt is high; because it has not been restructured like Greece’s debt and a portion of it has not been deleted, the problem is still not solved. It has been ignored for a while but the debt is there. The problems that Spain had 5 years ago are still present and one has to take into account that it got a bit worse. Currently, because the problem has spread across the continent, Spain stayed in the background; actually, the European baking system is ill. They cannot find the formula for recapitalizing them, the central bank’s efforts are not sufficient in meeting the demand. Let’s suppose that they’re enough; as long as the emerging economies are stagnating, it will look like turning the wheel with borrowed energy. You're correcting something, but the problem continues to grow; due to this, it’s going to nowhere, it carries on regressing. Europe is very problematic…

In the United States, the Fed is about to lose its mind. Obviously they saw something.  In 2013, they determined a calendar for the application of the interest rate increase in order to get away with the least damage; they aimed at reducing the overseas risks and to avoid the ballooning of the assets in the domestic market. They did not succeed in both objectives.

The minutes state the reasons why there no rise in the interest rate and why they cannot lower it. But the problem is: central banks are becoming ineffective, the Fed is no exception. That is, it wanted to stay the sole power but it will no longer have the chance for this. Currently, the Fed cannot raise the interest rate; so be it! If things get worse, a new monetary expansion could be undertaken, interest rate could be lowered; so be it! But the problem is the following: first; USA will not be able to reduce its risks with minimum damage; second, even if the Fed lowers the interest rate, the trend of taking risks across the globe will not come back in force. The pyramid is crumbling. In this game, the play makers took a risk and will suffer the consequences. Another information ca be derived from this picture. The West is losing its ability to direct the capital. It was the West’s most powerful weapon. The other strong elements were derived from there. If it loses this power, we can say that the current days are the better days of the West. Let’s combine them: the tendency to stagnation in the world is continuing, the growth forecasts will be reduced gradually; the global employment will shrink; nonperforming loans’ volume will increase across the globe. Things are not going well and the horizon is dark. The persons who are seeing this will try to reduce their risks while everyone is asleep; the markets will be choppy and everyone’s primary objective will not be to run for a win but make others try to do it. They will try to limit their losses. This is the main strategy and the picture points to this.

This is valid for the individuals as well as for the State. As an economic system, the West is collapsing; the East is rising but no one will come out alive from a world economic crisis. More precisely, there can be some who can come out alive. Imagine two boxers who punch each other at the same time; whoever survives will be declared as the winner. But both will be worn out. Wars are the same; currently the world economy is worn out, the wear rate will vary in some regions, but all the world will be losing.

Stieglitz is talking about two currencies. What was Europe's trouble? In 1957, EU which was the EEC since then, had taken the path of homogenization. For this purpose, it determined some standards; it is obvious that it didn’t go the way they wanted it to go; they could not provide homogenization and the application of a single currency has aggravated these problems because the homogenization was not achieved. 15 years ago, Europe had a design; after 9/11, a multi-speed Europe. The activated the Convention poll; it is obvious that some are saying that the currency should be two-speed, but as long as how this subject is going to be becomes complex, it will create a problem. One thing is clear; with this current structure, Europe will be overwhelmed by problems and will not be able to solve them either.

After 9/11, the capital poured into the emerging economies. There was an abnormal increase in capacity in the emerging countries; the consumption and the employment increased rapidly as well as the investment capacity increased abnormally with the inflow of the said capital. When we look at the current situation, we can see that there’s stagnation in demand but a terrible supply has been created. If there is an excess supply, what can be done? First; one will work to increase the demand but the consumption is problematic and it cannot increase permanently. Then, the supply will shrink. At the moment, the financial markets are pricing the demand side and are ignoring the problems of the supply; but the economic balances are forcing the necessity of the urgent liquidation of the excess supply. This chaos is also an element that reinforces risk aversion. Due to this, the ones who think that today’s balances will be permanent and will go for the better are simply dreaming and cannot get rid of the wrong strategies; more serious problems may be encountered, everybody must be careful. There is an excess supply in the emerging economies. Their common feature is the following: there is a large increase in employment and the service sector has come to the fore. One creates an employment; if this is 50% in the emerging countries in the past, today this stands at 60%-70%. The increase in the domestic demand has fed from here and there’s no chance to protect this demand. What will happen then? Service sector employment will contract. In order to prevent this contraction, one can adopt public spending, loose fiscal and monetary policies and these will not solve the problem. Second; they will eliminate one way or the other the excess supply; this cannot go on forever. This imbalance will not only batter the banking sector in the emerging economies but also, it will increase the volume of non-performing loans. What do we have in the world? Economic growth will lose momentum, the employment will not increase, contractions will happen (it may differ by regions), prices will not stabilize, there will be widespread fluctuations, some of which could be devastating. The more the volume of non-performing loans increases, the more the banking system will become fragile; public deficits will grow and to hide them will not solve any problem. The world is moving towards an emerging countries’ based new global credit crisis and there’s no solution to it. 

AUGUST RALLY IN THE STOCK MARKET

One should expect a rally in August in the stock markets. Because, following the very weak growth of the USA in the 2Q2016, there isn't any single investor who thinks that the Fed will dare to raise the interest rate in the foreseeable future. And as ECB will not make additional monetary easing in the short term, there is no justification for gaining more value for the dollar. Both the EU and the US entered into a moderate increase in inflation trend, but the decline in oil prices can break this trend. When coupled with the exceptionally loose monetary stance of central banks, government securities yields in developed countries will be trading in low values. Furthermore, S & P 500 is trading at a forward 17.5 P/E as measured by the estimated profit, 2 points above the median coefficient. There is a false perception regarding the acceleration in economic growth of the emerging countries.

When one adds all this up, one can see that the direction of the money will be the Emerging Markets. Moreover, it is a necessity and because the liquidity rally does not take into account the main factors and does not care too much about the political risks. Roughly 25 billion dollars entered the Emerging Markets this July only and one may expect about the same amount to enter in August. Will this favourable trend continue until autumn? We don't have any concerns about the Fed for it cannot dare to raise the interest rate in September but the fear of the Fed may be replaced with the fear of a global recession or a wave of Emerging Markets private sector bond defaults. Due to this, it is difficult to make long-term predictions.

THE BEGINNING OF THE END IN THE MARKETS

THE BEGINNING OF THE END IN THE MARKETS

Despite the fact that the BoJ has disappointed the investors, because there is an abundance of liquidity in the marketplace, not a single investor would like to miss the bonds of emerging countries which have a high yield, if there isn't any financial crisis. And if the rally in the bonds continue, it will support the currencies of the emerging markets against the dollar and also the stocks. At the same time, the loose financial conditions and high oil prices will carry on supporting the risky assets of the emerging countries during May.

The risks start in June. According to the latest poll, those who want the Brexit in England are leading by 46% compared to those who want to stay in the EU who are %44. China's economic growth is pumped up with a very dangerous credit boom, the rise in the price of oil is in an extent due to the weak dollar; but these are passive variables. The most important reason for the change in the direction of the markets will probably still be the United States. In the first scenario, we will see that the increased employment and the rise in the inflation will go beyond the endurance limits of the Fed, the signal will be given in June and the second interest hike will take place in July. In this case, the dollar will once again enter into the appreciation trend and this will trigger a hard sell in the emerging countries. In the second scenario, the Hillary Clinton-Donald Trump race will damage the confidence in the economy and the economic growth of the United States will remain below %1 throughout the year. In this case, the dollar will continuously remain weak, and the global growth story will take an end and this time, the sales which will start in Wall Street will spread to the emerging countries.

Thus, for the June-August period, the most likely scenario is: the Fed will raise once more its interest rate and the speculative funds will leave the emerging countries. Due to this, one should hold its positions in order to catch the last buy wave in May but pass to gold in June.

AN EXPENSIVE OIL WOULD BE A BLOW TO THE US ECONOMY

AN EXPENSIVE OIL WOULD BE A BLOW TO THE US ECONOMY

The rise of price of oil could be much larger than expected. In this case, it would become a serious threat to the US economy.

The increase in the barrel price could carry a heavy blow to the economy of the United States. Given the growth of prices of the black gold, the balance between supply and demand is likely to return soon to normal. In this case, prices should stabilize between 40 and 60 dollars, the cost of a barrel.

However, some factors may prevent this scenario to occur, as many situations where the US oil market may not have time to adapt to the growing demand. This could be the case if the OPEC countries finally manage to find a compromise or if the United States reduced their oil production faster than expected.

To date, the production of oil exceeds the demand only one or two percent. In this context, if demand continues to climb and some countries cut the production slightly, the surplus will disappear.

Therefore, the oil price should rise and in this case, the United States will be deprived of all the benefits offered by a cheap oil.

Turkey: the new monarchy of the Gulf (!)

TURKEY: THE NEW MONARCHY OF THE GULF (!)

Turkey that is about to take over the temporary presidency of the Organisation of Islamic Cooperation (OIC), accentuates the rhetoric of political Islam in its internal affairs and on the international stage. The official visit of the Saudi King to Turkey became further evidence.

The events of the Arab Spring have pushed Turkey to regress within the Islamic world. The Persian Gulf monarchies, currently regarded by Ankara as its closest allies, have played an important role. The international community is worried by the attempts of Turkey to incorporate in its political strategy, ideas such as moderate Islam and democracy.

From 2011, the Turkish authorities have started making plans to boost their influence in the Middle East and to become a regional leader. The essential purpose of this political strategy was to bring the Muslim Brotherhood from Tunisia to Turkey. However, the Turkish ambitions to push the Muslim Brotherhood to the centre stage in the Islamic world have been destroyed by the joint efforts of the UAE and Saudi Arabia, and Turkey was left alone with her despair.

Regarding the situation in domestic politics in Turkey, everything is also very sad. Currently, the situation in the country is such that free and democratic elections are impossible, and the opposition parties are in effect deprived of the right to hold rallies and protest.

The Muslim Brotherhood, unlike Saudi Arabia, not only based its policy on a religious basis; this movement had long been supported by the West. Western countries call this strategy "moderate political Islam", "the Turkish model", but what is happening in Turkey, causes severe criticism from the Western press. The authoritarian government, violations in the field of freedom of expression, press, assembly, all this shows that the Turkish model is not working, even in Turkey. A particular important sign is the presence of financial resources coming from the Gulf countries to Turkey which have increased significantly since the 1980s.

HEADING TOWARDS THE MEGASTORM

HEADING TOWARDS THE MEGA STORM

The recent plunge in stock prices and the slowdown in global growth are taking place at the same time that investor confidence in central banks is waning. Underlying some of the turbulence of the past few months was a growing perception in financial markets that central banks might be running out of effective policy options. The global central banks have already used their most powerful weapons and are currently trying to put forward the untested, experimental policies like negative rates that cut bank profitability while having little impact on lending. But the sluggish performance of the global economy, the massive debt overhang, and the erratic behaviour of the stock market are all directly attributable to the cheap money policies coordinated and implemented by central banks following the Great Recession in 2008. While it's true that China is facing slower growth, oil prices are plunging, emerging markets have been battered by capital flight, and yields on junk bonds are relentlessly rising, it’s also true that central bank policy is not primarily designed to address these problems, but to ensure the continued profitability of its main constituents,  the big banks and mega-corporations. Keep in mind, the global economy has been sputtering for the last 6 years, but major financial institutions have only expressed alarm just recently.  Why? What’s changed? 

What’s changed is profits are down, and when profits are down,  Wall Street and its corporate allies lean on the central banks to work the levers to improve conditions. 

"There’s a big difference between companies’ advertised performance in 2015 and how they actually did. How big? S&P earnings per share fell by 12.7%, according to S&P Dow Jones Indices. That is the sharpest decline since the financial crisis year of 2008. Plus, the reported earnings were 25% lower than the pro forma figures—the widest difference since 2008 when companies took a record amount of charges. The implication: Even after a brutal start to 2016, stocks may still be more expensive than they seem. Even worse, investors may be paying for earnings and growth that aren't anywhere near what they think. The result could be that share prices have even further to fall before they entice true value investors." (Wall Street Journal)

Profits are down and stocks are in trouble. Also, corporate earnings have dropped for two straight quarters which is a sign that the economy is headed for a slump. 

“Recessions have followed consecutive quarters of earnings declines 81 percent of the time, according to an analysis from JP Morgan Chase strategists, who said they combed through 115 years of records for their findings.”(CNBC)

“The increasing desperation of corporate CEOs is clear, as accounting gimmicks and attempts to manipulate earnings in 2015 has resulted in the 2nd largest discrepancy between reported results and GAAP results in history, only surpassed in 2008…..Based on fake reported earnings per share, the profits of the S&P 500 mega-corporations were essentially flat between 2014 and 2015…..earnings per share plunged by 12.7%, the largest decline since the memorable year of 2008….With approximately $270 billion of “one time” add-backs to income used to deceive the public, the true valuation of the median S&P 500 stock is now the highest in history – higher than 1929, 2000, and 2007. Wall Street’s latest con game, with the active participation of corporate CEO co-conspirators, is a last ditch effort to fend off the inevitable stock market crash….All economic indicators are flashing red for recession. Stocks are poised for a 40% decline faster than you can say Wall Street criminal banks." (Jim Quinn at Burning Platform) 

When the profitability of the world’s biggest corporations are at stake, the central banks will move heaven and earth to lend a hand. This was the basic subtext of the discussions at the recent G-20 summit in Shanghai, China. The finance ministers and central bankers wrecked their brains for two days to see if they could settle on new strategies for boosting earnings. In fact, the austerity-minded IMF even called on the G-20 to support a coordinated plan for fiscal stimulus to  boost activity and decrease the risks to the equities markets. Unfortunately, finance ministers balked because fiscal stimulus puts upward pressure on wages and shifts more wealth to working classes. That’s why the idea was shelved, because the oligarchs can’t stand the idea that workers are getting a leg-up. What they want is a workforce that scrapes by on minimum wage and lives in constant fear of losing their job.  

The “failed” G-20 summit was clearly a turning point for the markets. Now that the central banks are out of ammunition, the only hope to keep stock prices artificially high rested on Keynesian fiscal stimulus injected directly into the real economy. That hope was extinguished at the meetings. The prospect that equities can continue to climb higher in the face of shrinking profits, tighter credit, slower growth and bigger corporate debtloads is unrealistic to say the least. 

“Companies still have a little time left before they must pay down the bulk of $9.5 trillion of debt maturing in the next five years….But it’s not getting any easier for these corporations to borrow, at least not in the U.S. In fact, many of these obligations are becoming harder and more expensive to repay at a time when companies face a historic pile of bonds and loans coming due. It’s not terribly surprising that companies have a bigger debt load to pay down. They borrowed trillions of dollars on the heels of unprecedented stimulus efforts started by the Federal Reserve at the end of 2008 during the worst financial crisis since the Depression. They kept piling on the leverage as central banks around the world doubled down on low-rate policies and kept purchasing assets to encourage investors to buy riskier securities..." (Bloomberg)

The central bank policy seduced corporations into borrowing tons of money that they frittered-away on stock buybacks and dividends, neither of which create the revenue streams necessary to repay their debts. So rather than build their companies for the future, (Business investment is at record lows) corporations have been behaving the same way the Wall Street banks acted before the Crash of ’08. They've been borrowing trillions from the average investors via the bond market, rising their share prices through stock buybacks, increasing executive compensation, and dumping the money in offshore accounts. Now the bill is coming due, and they don’t have the money to repay the debt or the earnings-potential to avoid default. Something’s gotta give.

Like the gigantic asset-price bubble in stocks, it’s a sign that the economy and the markets are headed for a long and painful period of adjustment...