Global Economies have Stalled, Now where do Investors go with their Money?
Global growth is weak, and will be eroded further by Brexit, Crude Oil prices are low, and falling, the he world has excess capacity and a wage-depressing labor surplus, corporate profits are shaky, and deflation is laying bare the impotence of central banks.
So, where would investors logically expect financial markets to be going, given that economic, financial and political environment?
One would expect to see increased demand for safe-haven US Treasuries, a soaring USD, falling commodity prices, and increasing investor aversion to junk bonds, emerging market debt and equities and other low-quality securities. But that is not the case.
Commodity prices in general and Crude Oil in particular have risen this year. Money has poured into emerging market bonds as well as junk bonds, depressing their yields.
The Big Q: How can current equities prices be justified in the face of the fundamental picture?
The Big A: Well, maybe they cannot.
The most likely outcome to my mind is a major market correction to bring prices back into line with economic fundamentals. Distortions such as negative interest rates and slow economic growth in the face of super-aggressive monetary policies in many countries suggest that things are way out of alignment, and that the resolution may be a very painful process, and a big shock for many market participants.
Nevertheless, there may be some forces at work that might help explain current market conditions even if they don’t justify valuations, which in turn could lessen the blow of an abrupt reversal.
U.S. stocks may still be cheap despite historically high price/earnings ratios. Looking at dividend yields on the S&P 500 index against those available on 10-year government debt, equities remain attractive:
If the dividend yields dropped to match the US Treasury yield, the price/earnings ratio of the S&P would be closer to 63 than its current level of about 20. Following this logic, stocks are arguably undervalued by more than 60%.
Then there is the prospect of a fiscal stimulus (QE) program to revive growth. With even central bankers tacitly admitting that monetary policy has failed to generate meaningful economic growth, the pressure on politicians to do their bit will grow, in the Eurozone as well as the US
Once a new US President has been inaugurated, infrastructure spending might be a feasible middle ground for both political parties.
The US needs major refurbishing and expansion of roads, bridges, public transportation and other infrastructure. The most recent Global Competitiveness Ranking from the World Economic Forum rates the US 3rd overall in competitiveness but 13th for infrastructure quality as a whole, 14th for roads, 15th for railroads and 16th for electricity supply system.
It’s estimated that aging roads and bridges are costing an extra $377 annually per American driver. Infrastructure spending would not only create jobs and economic activity but also enhance lagging productivity.
The National Association of Manufacturers calls for major infrastructure spending of $100-B per year for each of the next 3 years. It noted that outlays grew 2.2% per year between Y’s 1956 and 2003, but fell 1.2% annually from Y’s 2003 through 2012. Total spending for roads and streets fell 19% between Y’s 2003 and 2012.
Even if the political climate improves after the election, and the spending taps are turned on in the U.S., investors may still be too relaxed about the outlook. The VIX index, a measure of expected future stock market volatility, remains at historically low levels. The S&P 500 index is up about 6.2 percent this year.
But Europe offers an example of what might happen if things reverse. The region’s benchmark Stoxx 600 index is down more than 5% this year, erasing almost all of Y 2015’s gains. In this environment, investors should hold universally large cash positions until there’s a clearer picture of what comes next.
Cash is an asset, there will always be a trade.
By A. Gary Shilling
Paul Ebeling, Editor
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