Saturday, June 25, 2016

Why The Bears Are Acting Rationally And The Bulls Are Not


Why The Bears Are Acting Rationally And The Bulls Are Not

William V. Rapp
Jun 24, 2016

The markets have essentially been moving sideways for over a year as the bulls and the bears seem to be equally convinced that world economic growth will continue or that it is in a period of economic stagnation comparable to the 1970s but without the inflation. Since there are plausible arguments on both sides the two groups appear to have roughly equal financial weight. 

US growth does appear to be moving forward and employment has continued to increase. Indeed the Fed felt confident enough last Fall to raise interest rates for the first time in roughly 7 years. On the other side energy and oil prices remain depressed and according to S&P defaults and issues highlighted for downgrades are now at the highest levels since 2009 with energy, commodities and financials especially vulnerable.

While the Brexit may or may not be related to these events it certainly adds uncertainty and complexity to the analytical brew. Thus the Fed and other central banks are likely to remain cautious in the months ahead at least through the US presidential elections. However even after these events begin to sort themselves out it would be wise to remain conservative because the bears were right all along even before Brexit and the current Presidential circus added their impacts to the global economic and financial market environments. 

This is because global growth for several years has been highly dependent on explosive Chinese growth and a continuation of this growth has been built into the micro and macro DCF models used by a wide range of global financial institutions and investors. Yet these assumptions are now clearly questionable as already identified at the 2014 Leir Bubble Conference and later confirmed at the 2015 Conference. However this view is now more widely accepted. Last year I attended an investor lunch hosted by a major global financial advisor where they forecast that Chinese growth would continue in the six to seven percent range. At this year’s lunch they had revised this forecast to three to four percent. The implications of this changed view are huge as analysts worldwide are forced to revise their DCF models downward.

Further at last year’s Leir Conference Professor Aliber forecast that like Japan after the 1989-90 crash China could experience a serious recession [actual negative growth] in the next three to five years and would then like Japan would have to recapitalize its banks. Whether a similar period of economic stagnation would follow is not clear but should be considered a possibility in any forecast. Thus as financial analysts continue to factor these considerations into their valuations including linkage effects to other countries’ economies, industries and companies in terms of the global economic multiplier we can expect that markets will continue to move sideways or down no matter how Brexit actually evolves.1


1 If China does not buy more iron ore from Brazil or Australia then they will not expand capacity and CAT or Komatsu will sell less mining equipment and will employ fewer people or may even reduce employment. Such reduction in demand has a downward global multiplier effect.