Tricky global currents pull investors into perilous waters
U.S. stocks are expensive, government bond yields are low, Donald Trump plans to trash trade deals, the United Kingdom is quitting the European Union, and the Islamic State is detonating car bombs in Saudi Arabia.
The world is an awfully risky place for investors at the moment.
The British decision to exit the EU has precipitated the gyrations of financial and currency markets, but major central banks in the U.S., U.K., EU and Japan set the world up for the bizarre behavior currently underway as investors seek yield in increasingly risky places.
The Federal Reserve has kept interest rates at historic lows for almost nine years, while the European Central Bank is experimenting with negative interest rates. The Bank of England is expected to slash rates soon.
Lowrates and uncertainty over the global economy have sent many investors into government bonds, driving down yields. The German and Japanese 10-years have dropped into negative territory, while U.S. 10-year and 30-year bonds have reached record lows. Fitch Ratings re- ported more than $11.7 trillion in negative-yielding debt just after the Brexit vote.
“With the Brexit vote, a key global risk identified by the Fed has become a reality. Along with the recent poor jobs numbers, this will see the Fed sitting tight until late 2016,” said Brian Coulton, chief economist at Fitch Ratings.
That spells trouble for banks, particularly European banks, that are posting a growing number of bad loans.
Frustrated investors have turned to stocks, triggering a post-Brexit rally that is based more on desperation than faith in the global economy. The result is unusually expensive stocks, with the S&P500 registering a trailing price-to-earnings ratio of 24, compared with the historical mean of 15.
Higher stock prices typically indicate a thriving economy, while plummeting bond yields predict a slowdown. But since
investors appear to be pouring into stocks for yield rather than growth, a bubble may be developing unless corporations start posting better earnings.
Bubbles, though, need a pin to prick them, and politics can do the trick.
Aweek fromMonday, the Republican National Convention will meet to nominate Donald Trump for president. Trump has promised to renegotiate this nation’s most important free trade agreements.
Hedoesn’t care that thousands of corporations have built business plans on the existing trade rules. Addin his bewildering tax plan and federal budget proposals, and the wrong policy pronouncement, or an uptick in Trump’s popularity, will rock the markets.
Aweek later, the focus turns to Hillary Clinton and her plans to appease the leftists in her party. Populist rhetoric about cracking down on Wall Street, the need for more government regulation and higher government spending will strike fear into anyone whocan add or subtract.
The U.K.’s Conservative Party race to pick a new prime minister runs through October, while opponents of Brexit try to dream up a way to turn back the fateful referendum. Confusion abounds over howto lift the British pound from 32-year lows, or howto stop the outflow of capital from the world’s sixth-largest economy.
The global economy’s growth is important to Houston because expansion boosts energy prices, while recessions depress them. Houston is avoiding a recession this year only because the national and global economies are cushioning the impact of low oil prices. But S&PGlobal has revised the forecast for U.S. GDPgrowth for 2016 down to 2 percent from 2.3 percent.
The most disturbing wild card, though, is the Islamic State group. It recently announced a new strategy, urging overseas supporters to launch suicide attacks at home, intelligence sources say.
Claiming a divine purpose is great when you are winning, but when you lose, doubt spreads among volunteers. The Islamic State has suffered signifi- cant casualties and territorial losses in the past year, and intelligence agencies report that morale is low and desertions are high.
Asking supporters to fight at home not only relieves the Islamic State of training, feeding and supplying new recruits, but it spreads the terror around at no cost to the group. Recent attacks in Europe, Turkey, Bangladesh and Saudi Arabia demonstrate the strategy’s effectiveness, and more attacks are likely.
Most worrisome were four bombings in Saudi Arabia last week. The Islamic State demonstrated the capacity to launch complex attacks inside the world’s largest oil producer just as the king is meeting resistance to his plans to modernize the kingdom’s struggling economy.
The group is almost certainly trying to launch an attack in the United States during the election campaign to provoke a violent response and cripple the global economy.
For all of these reasons, the economy will be on a razor’s edge for the rest of the year, completely dependent on political decisions that could have enormous significance. Investors either need to head for safety or batten down the hatches for rough seas.
Chris Tomlinson is the Chronicle’s business columnist. His commentary appears on Sundays and Wednesdays. He also posts a daily news analysis at HoustonChronicle. com/Boardroom. chris. tomlinson@chron.com twitter.com/cltomlinson