Home' Trinidad and Tobago Guardian : January 14th 2016 Contents The US stock markets had the
worst five-day start to a year
ever. It is unnerving as it is
disconcerting. The market
moves suggest this is not a
rotation from stocks into
another asset class but rather a move into
cash; a trend symptomatic of fear and panic.
So, what is driving the stock market rout?
Many point to China, with the authorities
having to suspend trading on two occasions
last week because a steep fall triggered newly
introduced circuit breakers.
The role of a circuit breaker is to cause a
pause in market trading after a sharp move
so that investors can assimilate the information
causing the market action.
When the circuit breakers in China resulted
in the suspension of trading for the day, those
with capital at risk sought to trade proxies
for the positions that they held in other mar-
kets, resulting in a global sell off as markets
opened from the East across to the West.
Yet, while China may be the catalyst for
the market uncertainty, it is not the singular
cause of the current stock market and global
economic angst. The truth is: the price action
in 2015 masked some of the underlying weak-
ness in the US stock market and that is now
being laid bare at the start of 2016.
Appreciate as well that the US economy
was---and still is---the best performing econ-
omy in the world. If, as I am suggesting, there
was an underlying weakness in the US stock
market during 2015, then it would suggest
that the US economy and the global economy
are not as sound as they may seem. If there
were signs of caution before then there are
signs of worry now.
Shares in companies like Amazon, Apple,
Google, Facebook, Netflix performed excep-
tionally well last year. In the case of Amazon,
the share price just about doubled and Apple s
share price moved around 30 per cent. The
size of these companies and the size of the
price action would have kept the stock indices
going even while the rest of the market was
either flat or---as was the case with the energy
and mining sectors---significantly down.
To emphasise the point, the share price of
Amazon doubled while the rest of the Standard
and Poor s retail sector declined by about 30
per cent. Amazon now accounts for about
one third of the market capitalisation of the
retail sector in the US.
No stock can keep going up forever, espe-
cially when there are economic headwinds.
So the market leaders of last year are now
seeing profit taking and, in some cases, ques-
tions are being raised about their ability to
grow at the historic trends. As these stocks
sell off, there isn t much on offer to move
into and so the overall market is in decline.
So far, the narrative speaks to stock valu-
ations. Essentially, valuations have gotten out
of line with company fundamentals, as mar-
gins are on the decline and, as the US labour
market tightens, wage pressures are going to
result in further margin compression creating
a headwind to corporate earnings.
Once the correction takes place the markets
will steady and everything will settle down.
However, there are sectors that are not see-
ing any light at the end of the tunnel and,
depending on how this plays out, we could
be in for a much deeper adjustment than sim-
ply allowing for valuations to be reset.
A report from Bloomberg last Friday sug-
gested mining stocks lost about US$1.4 trillion
in value since 2011. For reference, that exceeds
the total market value of Apple, Exxon and
Google. Miners ramped up production during
the China boom and now face markets with
significant overcapacity as China has slowed
down. If the global economy is also slowing
in sync then the challenges faced by this sector
The statistic to note is, as at October last
year, world trade is down by 12 per cent in
US dollar terms year-on-year. This takes you
back to levels in 1981. The collapse in world
trade is driven by the significant rise in the
US dollar, something that our policy makers
here in T&T would do well to take note of
in touting local manufacturing for export as
a panacea for our economic woes.
The strength of the US dollar is itself driven
by the US Federal Reserve as they embarked
on their first interest rate hike in nine years
last December. This is coming at a time when
other central banks around the world are still
in easing mode.
The US Fed is signaling that they would
be seeking to hike rates four times this year,
effectively producing a Fed funds rate of 1.25
per cent by the end of 2016.
In my view, that appears overly optimistic
and I would suggest that we may only get to
two rate hikes before the narrative changes.
A stronger US dollar has seen a drop in
industrial production in the US, and the trans-
portation indices suggest that fewer goods
are being transported.
In 2013, 40 per cent of all capital expen-
diture in the US went into the energy sector.
The fall off in energy prices means that is no
longer a driver but a drag. I would suggest
that the US is currently in an industrial reces-
The latest readings from the Atlanta Fed,
which tracks gross domestic product (GDP)
in the US suggest that fourth quarter GDP
for 2015 will come in around 0.8 per cent.
This is down from the expected 2.5 to 4 per
cent estimates that many analysts where post-
ing during the first half of 2015.
If the industrial recession is sparking a
growth recession then it is difficult to see
how economic growth in the US can accelerate
significantly given the headwinds of higher
interest rates, especially with a projected 100
basis point increase over the next 12 months.
What is taking place now is disinflationary
and, if not managed carefully, can lead to out-
Over the past eight years, as central banks
around the world have progressively cut rates
to zero, the financial markets have used lever-
age to generate returns. When people are con-
cerned that the ability to leverage is becoming
challenging they exit. That exit results in a
reduction of leverage which manifests itself
as deflation, either in terms of asset prices,
as we are seeing now with stocks and com-
modities. If it continues, you eventually end
up with deflation in terms of consumer prices.
This is why in September 2015, I suggested
that while the US Fed may seek to raise interest
rates in December, it would ultimately prove
to be the wrong policy perspiration. History
will show that the policy of low interest rates
created excessive leverage in the global financial
system and the policy to now raise interest
rates will create intense dislocations.
The issues that we face are not solved by
playing with the supply and price of money,
at least not in the long term. They are solved
by better fiscal management and regulatory
and governance standards. Those actions have
been way behind the curve and so we are
where we are.
Once again, I hope our economic planners
take note of this perspective.
At the onset of the financial crisis, the cen-
tral banks of the world---especially the US
Fed---sought to quickly create the scenario
where the sun started to shine by monetary
easing. Easy money made for increases in
asset prices which, in some ways, trickled
When the sun is shining you really don t
bother to fix your roof, even though you know
it is leaking. However, over time, the hole gets
bigger and, eventually, when the rain comes,
the inside of your house can be flooded out.
That s the major risk of today and the big
question is: how the markets, especially the
emerging markets, will hold up in the face of
rising US interest rates and a stronger US dol-
lar.The key emerging market economy is China
and---for all intents and purposes---it is still
an export economy. China markets are, how-
ever, shrinking as the world is in an industrial
slow down. Debt has roughly doubled since
the last financial crisis.
Growth in business activity has to take
place in order to service these debts but, if
business activity is slowing, then the risk pro-
file of debts on a global basis increases.
Policy makers, including those in China,
understand this. This is why they are seeking
to introduce structural reforms into their
economy to shift from an industrial, manu-
facturing-lead economy to one where services,
at the very least, is in balance. The challenge
is whether they can make this transition at
the rate required in order to provide the capital
flows needed to in aggregate service the debt
levels that are already in place.
As these dynamics ebb and flow, 2016 will
be a very interesting but likely turbulent year
Ian Narine can be contacted via email at
BUSINESS GUARDIAN www.guardian.co.tt JANUARY 14 • 2016
A bad start to 2016
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