Has Anything Really Changed?
It has been five years and five months since the Financial Crisis of 2008, and we find ourselves still answering the same question from existing and prospective clients alike. “Has anything really changed? Of course, what they really mean is, “Has worldwide market risk decreased substantially since the last financial crisis”?
So, for that answer, we would like to first reference an article posted on Bloomberg News on March 10, 2014.
Excerpts from the article…
“The amount of debt globally has soared more than 40 percent to $100 trillion since the first signs of the financial crisis, as governments borrowed to pull their economies out of recession, and companies took advantage of record low interest rates.
Marketable U.S. government debt outstanding has soared to a record $12 trillion, from $4.5 trillion in 2007, according to U.S. Treasury data compiled by Bloomberg. Corporate bond sales globally surged during the period, with issuance totaling more than $21 trillion, Bloomberg data show.
“Total debt levels, the sum of household, government and corporate debt, haven’t declined at all in recent years,” said Ben Bennett, a credit strategist in London at Legal & General Investment Management, which oversees the equivalent of about $120 billion of corporate bonds. “Each time there’s a wobble, the central banks turn on the taps. Either that works by creating growth with asset prices eventually coming into line with fundamentals, or it doesn’t and we’re in for a massive fall.”
Worldwide financial risks have continued to increase. Yes, the Europeans are borrowing less these days, as is the US, but not nearly as little everyone should. Poland is the sole European country projected to be in surplus for 2014. Only the governments of Germany, Sweden, Bulgaria, Latvia, and Estonia are projected to be close to balanced budget. Britain, France, Spain, Portugal, and Croatia are projected to incur 2014 government budget deficits in excess of 4% of GDP. Despite large tax increases over the last couple of years, the US also projects an annual deficit in the 4% range.
All this borrowing in the United States and Europe over the last twenty years has raised geopolitical risk as evidenced by the Russian incursion and annexation of Ukraine’s Crimean peninsula. Long the base for the Russian Black Sea naval fleet, it was a key strategic asset. This morning, we awake to reports that the Russian military has taken actions to control the eastern half of the Ukraine by taking over many government buildings. The tepid response to the crisis by the US and its European allies all but guarantee Putin will continue to exploit his opportunities. After all, the South Ossetia region of Georgia remains under Russian control.
Worldwide, for every indicator we see of economic strengthening, we see offsetting evidence of weakness. The recent decline in commodity prices is troubling. If the worldwide recovery were clearly gaining steam, commodity price stability, if not growth, would be evident. To the contrary, signs of deflation are beginning to show up in the weaker European economies of Spain, Greece, and Cyprus.
Recently, concerns about the Chinese economy have also begun to take root, as growth has steadily declined to 7.4% for the most recent quarter reported. The Chinese PMI (“Purchasing Managers Index”) during the last two months has decreased to near recessionary levels. Significant factors ailing China are the sluggish growth in the US and European economies, and the surplus of Chinese real estate. In response, the Chinese government, has two days ago, announced new “stimulus measures” concentrating on accelerating transportation infrastructure (railways), and by extending tax cuts to a wider range of businesses.
Domestically, US government ten-year bond yields remain subdued despite significant Federal Reserve “Tapering” over the last three months, this morning opening weakly at 2.7%.
Finally and most importantly, US corporations’ profit growth slowed significantly to 6-7% over the last year, against an S&P 500 average that increased by 29.6% during the same period. Absent an increase in corporate profit growth during 2014, we do not see significant advances in the broader domestic equity indexes. In other words, it will be a “stock pickers” market more than in any of the last five years, and it could be a tough year for index and mutual funds.
As a result of our view, we continue to favor a “belt and suspenders” approach to equity investing with heavy reliance on the application of techniques to mitigate specific and market risk. Over five years after the Financial Crisis of 2008, we continue to see elevated risks in worldwide equity markets.
Paul A. Balboni
April 7, 2014