Year’s Difficult Start Continuing

January 12, 2016

Much of the damage emanates from China.  Turning back from the transition from investment- and export-led growth to consumption-led expansion in the world’s second largest economy is not a socially or economically sustainable long-term option.  The switch is proving to be messier than hoped.  One problem is the shroud of secrecy surrounding all aspects of the economy.  Reported data are not trusted, and government leadership often seems incompetently reactive to crisis after crisis.  Two intermediate initiatives are whacking world financial markets.  People’s Bank of China officials are steering their currency downward and scaling back direct support for Chinese share prices.  Nor is it constructive when western “experts” proclaim that China is not really very important to comparatively closed economies like the United States because U.S. exports to China are a very small share of U.S. GDP and the federal government no longer is excessively reliant upon Chinese investors to fund the fiscal deficit.  So long as China’s slowdown rattles global markets and policymakers proclaim that such is unlikely to impact the tightening of U.S. monetary policy, markets will continue to dish out more of the same:  lower commodity prices, a flattening yield curve, share price instability, and dollar strength against a wide swatch of developing and O.E.C.D. currencies.  Those movements will continue to seen as the path of least resistance.  Confidence in the invisible hand and wisdom of price mechanisms will be eroded, too.

The price of oil can’t find a stable equilibrium.  At today’s low of $30.06 per barrel on WTI crude, it showed a year-to-date decline of nearly 19% and  a 41% slide relative to the 2015 average, and it was some 68% below the four-year 2011-14 mean.  The mean in each of those four years had been between $90 and $100, and even the average price as far back as 2000 of $30.11 was marginally above today’s low.  The pundits now speak about $25 as the potential floor in a weak price scenario but not long ago were assuming a rebound this year into the $40-50 range, if not above.  Commodities are still in retreat because emerging economies led by China face headwinds that are depressing global demand and Middle Eastern tensions are preventing chances of cooperation between nations to reduce supply. 

Many of the optimistic financial analysts dismiss falling share prices this month as an overdue correction and therefore a buying opportunity.  Set against the lows of March 2009, it’s understandable to draw such conclusions, but March 2009 as a base date generates misleading conclusions as July 1932.  A more sensible point of comparison lies 16 years ago when a 17-1/2 year bull market crested.  The DOW crested on January 14, 2000, completing a 17.5-year bull run averaging 16.9% appreciation per annum.  Over the ensuing 16 years, the market has risen on balance just 1.9% per annum, and the intuitive presumption that surely sixteen years is a sufficiently long sideways movement to expunge imbalances from the system is likely wrong.  For one thing, income distribution, household debt, and neglected infrastructure present huge challenges to the U.S. economy.  The virtual war between Democrats and Republicans doesn’t inspire confidence about politicians coming together for the greater good of the most people.  Beyond these obvious impediments, stock market history in fact points to consolidating intervals longer than sixteen years.  From 386.1 on September 3, 1929 to 163.2 on May 17, 1947, the Dow on balance fell 4.7% per year over nearly 18 years, and from 735 on December 13, 1961 to 777 on August 12, 1982 on August 12, 1982, it went up merely 0.3% per annum over a stretch of just over 20.5 years.  Over the nearly 87 years since the pre-Great Depression peak to the present, most to the cumulating equity wealth build-up in America was confined to two periods: a 9.0% annualized advance from between May 1947 and December 1961 and the aforementioned gains during the last 17.5 years of the twentieth century. 

Occasionally the trends in financial markets and real economic activity can be disconnected, but this happens infrequently, rarely for a long while and is not generally associated with low inflation.  The most glaring example was the 1987 crash, a 22.6% drop in the Dow on a single day in mid-October.  Surrounding that quake, U.S. real GDP posted consecutive annualized growth of 2.8% in 1Q87, 4.6% in 2Q, 3.7% in 3Q87, 6.8% in 4Q87, 2.3% in 1Q88 and 5.4% in 2Q88.  Several  factors insulated the U.S. economy, one of which was a sharp drop in the dollar after the stock sell-off and other was the highly compressed length of the bear market in stocks, which had peaked in August and never closed lower afterward than on the day of the big blowout. 

The dollar appreciated in 2015 against a broad range of currencies.  Lately, the biggest gains have been against commodity-sensitive monies and and those of emerging economies.  Focusing only upon the currencies of advanced economies as this web site does understates dollar appreciation and the potential lagged drag on growth if market trends continue along recent lines.  Former U.S. Defense Secretary warned of unknown unknowns, adverse developments that will invariably arise that at the moment aren’t even being counted in lists of potential economic problems in 2016.  The push-back of reassurances from Wall Street analysts isn’t very compelling when one tallies the known factors behind the year’s bad start, and that’s an incomplete list of the headwinds that will be discussed a year from now.

Copyright 2015, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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