Will 2017 Be Year Of The Bear?

There is an old saying in the financial markets: Bull and Bears make money, but Pigs get slaughtered. But what's wrong with bears? They are cute and cuddly. They even make stuff animals in their likeness and give them to children to play with. The real bears can of course be dangerous, especially if they feel threatened. However, if you leave them alone they are content to eat berries in the woods and sometimes salmon (who doesn't like salmon?). But should we be afraid of the financial market bears? Can a bear market ever be a good thing and are we now entering a bear market in 2017?


The thing about economics and markets is that they go through phases or cycles. Everyone wants the upside of the cycle to keep on going forever, but it does not work that way. There are down cycles also which are in fact necessary to bring things back to the median (as markets can get out of balance, sometimes too much on the upside and downside as well). The problem with the last 8 years (and even prior) is that the western world's central banks have viewed money printing and cash infusions as the cure all to everything. Basically, they did not want the upside to end and decided to foolishly continue to prop up markets that should have been allowed to purge themselves of weaker players and excessive debt in the system. The result has been that such central bank monetary cocaine has found it's way into some parts of the real estate sector once again (parts of Manhattan and London stand out), apart from creating a bubble in the bond markets and unrealistic levitation of equity markets.


In terms of stock prices, I read something interesting recently that compares the CAPE numbers for the developing markets versus emerging markets. For those of you not aware, the CAPE calculation is basically a price to earnings ratio for stocks, credited to Yale University economics professor Robert J. Shiller as someone who has touted it's use as an investment forecasting tool. The historical average should be somewhere about 15 or so, but right now (or at least before June 24) it was 27 for US equities, indicating excessive valuations. The CAPE valuations however for emerging markets are a bargain by comparison. On average right now, these valuations are somewhere in the 10 to 12 range with Eastern European equities way down to about 7. So, in short, equities in so-called developed western nations are over priced and cheap in the emerging markets. But there are other indicators that support this as well and also support the fact that the US (and arguably the European Union as well) economy has been in recession since 2015.


One key leading indicator we like to watch is shipping. After all, about 95% of the world’s goods move or are transported by shipping containers. Slow downs in that sector started showing up in 2014 and 2015. Between the end of 2014 and the end of 2015, there are a 12 percent decrease in port calls in Northern Europe by container ships. Cargo volumes went down by HALF over the past 24 months at the Belgian port of Zeebrugge. And the world's largest shipping container company Maersk announced in late 2015 it would be laying of 4,000 employees and delaying new ship building orders. When the largest shipping container company in the world tells you things are bad, you should take notice.


So why did US and European stock markets go up previously (when they should have been going down)? One of the reasons has been company stock buy backs, which push up stock prices and PE ratios by reducing the amount of publicly traded shares. They have been able to do this, foolishly I might add, by taking on debt at zero percent interest (or very close to zero) and using those funds to buy back their own stock on the exchanges. In fact, this activity is actually greater by dollar amount recently than prior to 2008. Between March 2015 and March 2016 US corporations spend an all time high of US$589 Billion dollars in stock repurchases. In addition, total non-financial business debt outstanding went from US$11 trillion in 2007 up to US$13.5 trillion in 2016. So, corporations overall have been taking on even more debt and not necessarily doing long term productive investing with it (meaning investing in new factories and new equipment as one example). And it has been these close to zero interest rates, courtesy of the magical people at the central banks, that has permitted such an activity.


Did anyone see this coming? David Stockman, former White House budget director to President Reagan, certainly did. His April 2016 articles and interviews pretty much warn of such. In fact, in his April 20,2016 article titled On The Impossibility Of A Soft Landing, Mr. Stockman goes on to point out that as of April 2016, corporate earnings have fallen 18% since September 2014. New York Times columnist Jeff Sommer writes in a June 16, 2016 article titled The Fed’s Policies Have Gotten It in a Tangle (remember this article was written BEFORE the BREXIT vote) that: The markets have been sending out distress signals. He also points out that the US Federal Reserve own data indicates they have caused financial imbalances. So, apparently there are some journalists and financial writers looking at things differently than the official government version being portrayed.


Research firm NPD group reports that patronage at fast food establishments has gone flat in the second quarter of 2016. This is an industry that has been growing at about 2 percent quarterly and now it has flat lined. Ms. Bonnie Riggs, a restaurant analysts with NPD says: that’s a red flag because it’s been an area of growth and it’s 80% of the industry. On this theme, the Mcdonald's fast food restaurant chain apparently are finding that some consumers are not loving it. After announcing 350 closings for 2015 they seemingly are set to close an additional 500 locations in 2016, mostly in the US apparently. The chain did announce the opening of 1,000 locations globally which would add a net of 500 new total additions (which where the 500 closings come from). And the fact is that this number represents a closing of about 3.5 percent of the total 14,000 locations inside the US, so it may or may not be clearly indicative of any issues. However, in the US both Walmart and McDonald's were considered to be recession proof bell weather sort of businesses, so it is interesting to watch.


Government and Central Bank balance sheets are not much better. Current government debt to GDP in the US is pushing 100 percent, in the UK it is currently 85 percent, in Italy it is 135 percent. In the case of Italy specifically it is interesting to note that Italian Banks are holding $400 Billion worth of non performing loans (that is loans whereby the borrowers stopped paying). In addition, Italian Banks are said to also hold $400 Billion in Euros of Italian Government sovereign debt, some of it now trading with nominal negative yields. In regards to Mr. Mario Draghi's plans to buy up $80 Billion of European Bonds monthly, Mr. David Stockman summarizes this is nothing more than a stealth European Central Bank bail out of the Italian and Spanish banks. He goes on to opine that this bond buying program is a monetization of these bonds held on the books of said banks. Now that's Italian!


So, in short we have fundamentals that are not very sound and under normal circumstances we should be entering a bear market to correct these various imbalances. Alan Greenspan, the former US Federal Reserve Bank Chairman that really birthed this central banking levitation of markets paradigm in 1987 states during a recent Bloomberg interview that: The fundamental issue is the fact that productivity growth has ground to a halt. He also goes on to proclaim that: Unsustainable entitlement spending is eventually going to lead to a crisis.


However, we do currently live in magical times with magical central bankers printing magical money out of thin air to prop everything up. The problem though with any number of economic policies is that there are going to be winners and losers. For example, if we even returned to historical normal interest rates of say between 4 and 7 percent for bank savings accounts, time deposits and bond yields, those benefiting are going to be savers, those people retired attempting to live off of the interest from various fixed income investments, pension plans and insurance companies. Those impacted in a negative way are going to be any individual, government or institution that wants to borrow money and thus face higher borrowing costs (from present day levels). Likewise, when any central bank keeps interest rates artificially low, zero or even negative these days (as the case may be), while beneficial for borrows, savers are going to detrimentally impacted. And here is where we get to the Brexit vote once again.


While magical central bankers have been busy propping up financial markets, the mainstream has been suffering. Mr. James Traub, during a very recent speech to the Council on Foreign Relations admits as much when he opines the Brexit vote was a utter repudiation of bankers and economists. However, Mr. Traub considers such complaining a form of extremism that has gone mainstream. He goes on to say that: With prospects of flat growth in Europe and minimal income growth in the United States, voters are rebelling against their dismal long-term prospects (you think so Jimmy?). He incredibly enough blames the discontent on: Older people whose familiar world is vanishing beneath a welter of foreign tongues and multicultural celebrations are waving their fists at cosmopolitan elites (end of quote). Well Jimmy, I do not think it is xenophobia but rather you yourself admit that the mainstream economy and the retired in particular have been hurt by central banking policies of the last decade. Yet, such people are extremists for complaining? Interesting viewpoint. Very wrong, very arrogant, but interesting.


So, will we end up in a bear market in 2017? Honestly it all depends upon the central bankers. Will they finally allow the markets to do what they need to do (feel the burn, not the presidential candidate kind but the real economic kind)? Or will they continue to mimic SNL characters Hans and Franz by pumping up the markets? I guess we will have to wait and see.


A very good article posted June 23, 2016 by Mr. Jeffrey P. Snider detailing the failure of central bank policies can be found here: http://www.alhambrapartners.com/2016/06/23/what-current-interest-rates-really-mean/


Another good read by Mr. David Stockman dated June 27, 2016 is the following: http://davidstockmanscontracorner.com/the-end-game-of-bubble-finance-political-revolt/