Global assets face storm clouds in 2017
With three trading sessions till Election Day, the S&P 500 index has fallen 80 points, or four per cent, from its high. Crude oil has fallen 10 per cent as the Algiers agreement unraveled in Vienna and gold, which I flagged as a mispriced asset three weeks ago at $1265, has risen above $1300.
Something nasty and ugly is happening to risk assets. Even if Trump does not win the White House, populist/protectionist policies have redefined the DNA of the Republican Party, which could well retain control of the House of Representatives. This is bad news for the world economy — and bad news for Wall Street. Even though the unemployment rate has fallen below five per cent in the US, the zeitgeist has turned xenophobic, isolationist, the legacy of failed wars in Iraq and Afghanistan, a horrific financial crash and a decade of near zero saving rates for Baby Boomers well into their retirement years. Political gridlock in Washington will abort Hilary Clinton’s fiscal stimulus policies to goose economic growth.
The Bernanke Fed’s money printing saved the world from another Great Depression in 2009, George W Bush’s TAPP recapitalised the American banking system and “animal spirits” in the stock market led to a triple bagger on the S&P 500. Central bankers were the subliminal architects of the great Obama bull market, which was so spectacularly profitable for owners of American equities. Yet the world money game will be different in 2017.
Global exports have bottomed and inflation has begun to rise. Average hourly earnings are 2.6 per fall in both brent and West Texas from post Algiers peak cent and the 10-year US Treasury bond yield is headed to 2.5 per cent, a formula for a bloodbath in the world’s leveraged, illiquid (Thank you, Volcker Rule!) debt markets.
The Fed will raise rates in the December FOMC. Yet one rate hike will not be enough if US economic growth momentum accelerates. The capital markets will tighten for the Fed. Equity valuation metrics will compress.
An ursine caveat for the S&P 500 if the Fed is behind the “curve” on inflation and risk spreads. The rise in Chinese production prices suggests the Peoples Bank of China and the Politburo have successfully reflated the world’s most indebted (250 per cent of a $10 trillion GDP. The Middle Kingdom no longer dances to the tune of Confucius but Ponzicus!) major economy.
The sharp rise in US high yield spreads is a recession SOS, as is King Dollar, rising wages and flat revenue growth in the Fortune 500. This means earnings disappointments across corporate America is inevitable. GE, Honeywell and Cummins all foretell the future, like ancient Greek oracles of Delphi.
In 2017, the Federal Reserve will no longer be in easy money mode even as earning risk rises. Trump’s refusal to accept the verdict of the electorate if he loses, it is a soft coup against the Constitution. This is not exactly a formula for a new bull market. Election call? Fade a Clinton win, short a Trump win and stay short property REIT’s! The oil market has concluded that Iran and Iraq’s intransigence dooms the risk of a Opec ministering agreement on country output quotas. This is the message of the 15 per cent fall in both Brent and West Texas from post Algiers peak.
However, the oil market’s binary calculus is dead wrong. Saudi Arabia cannot afford another Doha debacle and a plunge in oil below $40. The business cycle in the kingdom has turned ugly, with a contractor credit crunch, front loaded fiscal austerity and stress in the bank funding markets.
Saudi Arabia needs at least $5052 Brent even if means (as usual) bearing a disproportionate share of the OPEC output cuts. This will be the signal for the Russians to make a symbolic cut as Saudi Arabia, UAE and Kuwait remove 750,000 barrels from the market even if Libya, Iran, Venezuela and Nigeria are exempted from an output deal ratified in Vienna.
Of course, Opec politics are not the only variable in the oil market. The Energy Department stunned the world with the biggest gain in US oil inventories on record, 14 million barrels.
The US land rig count has also soared, meaning shale out is rising. The freefall in oil makes it essential that Saudi Arabia and its GCC allies prevail in the next OPEC conclave in Vienna. If not, King Dollar and a market share price war will ensure black gold plunges to $25 a barrel in 2017.