The global equity markets are looking precariously vulnerable in the 2016 New Year. This is destined to be one of the worst starts to a year in memory. We haven’t even left the holiday season, and markets are apprehensive. Yesterday the Shanghai Composite Index fell almost 7%. The Chinese market is of course ‘not the global economy’. The reason why the fall in the Chinese economy is a concern is because its weakness is evidence that the US economy is not supporting Chinese exports. China is of course the more vulnerable economy because of its high savings rate and export-orientated production capacity.
We are on the tip of a market correction, and only since Nov-Dec 2015 has the media started to acknowledge this. We first wrote about this weak market outlook in mid-August, with a follow-up article on the Chinese economy a week later. The concerns centre upon the US economy.
These articles are interesting in themselves, however there is actually more to the story than an ‘asset price correction’, ‘asset inflation’ and a ‘weak real economy’. There are a number of pervasive underlying risks for the market. People can of course look to the ‘record low interest rates’ and ‘low inflation’ as a source of positivity. The problem is that these are ‘negatives’. Consider the following facts:
- Structural adjustment – The Western markets are highly indebted and the low interest rates are effectively incentivising paying down debts, which is only subduing the real economy. Export-orientated economies are poorly positioned to ‘shift gear’ in their economies, to turn their cultures into ‘mass savings’ cultures to ‘mass spending’ cultures.
- Weakened Western economies – The Western economies are poorly positioned to resurrect their economies as well. There is no political will to cut the size of inefficient government. There is little hope that the overarching system of statutory law can overhauled in any time. Without such reforms, the costs of living and business in the West is excessive, and these economies simply become service centers focused on financial services, food and other lifestyle activities. Of course larger markets can cling to their industrial bases more easily, whilst smaller countries like Australia & NZ perversely benefit from a weaker currency in niche markets. The labour participation rate in these economies continues to fall, and the media are oblivious to it; focusing instead on the number of people ‘looking for work’ rather than the number of people actually unemployed relative to the workforce.
- The shift in inflation. We know that ‘cost-of-living’ inflation is benign. It has been low for the last 25 years. The problem is that its not the ‘full story’, and its eventually going to change. The focus upon ‘cost-of-living’ inflation ignores the most significant consideration of ‘asset inflation’. There is a popular belief that markets are ‘in a bubble’. This is not the case. The true picture is that assets are ‘relatively high’ to a relatively devalued USD (and every other currency since all global currencies are trading under a USD monetary standard). This has been the case since the gold standard was abandoned in the 1930s along with budgetary discipline. The question is – what can we expect from inflation moving forward. The reality is that there is little good news here, for reasons we will explore in our next article.