I frankly don’t see how this turns out well in the long run.
Yesterday, Japanese Prime Minister Shinzo Abe announced that his government would delay a scheduled sales increase for two-and-a-half years. Given the inability of Abe-nomics to revive Japan’s moribund (again) economy and the upcoming July 10 election for Japan’s upper house I certainly understand the decision. The Japanese economy in general and the Japanese consumer in particular don’t need to see sales taxes go up from the current 8% to 10%. The prior increase in the sales tax from 5%to 8% is widely credited with tipping Japan’s economy back into recession.
But the decision is 1) an admission that Abe’s policy of a weak yen and massive asset purchases by the Bank of Japan hasn’t worked to revive growth or to raise inflation to anywhere near the government’s 2% target, and 2) it sure seems like a surrender on Abe’s goal of producing a primary budget surplus by the fiscal year that starts in April 2020. (A primary budget surplus is a surplus aside from interest payments on the government’s debt.) Japan’s public debt is already more than twice the size of Japan’s annual GDP.
The thing that I find really disturbing about Abe’s decision is that it doesn’t come with a Plan B. There is no new thinking on how to revive Japan’s economy. It’s simply delay the sales tax and hope that the old formula of a weaker yen and bond buying by the Bank of Japan will work–when this formula hasn’t worked before.
Japan’s still huge pool of domestic savings gives the country some time and room to maneuver before international capital markets decide that Abe’s policy amounts to monetizing Japan’s huge government debt. The danger in that is that once international investors decide that Japan has no intention of paying back its government debt and no ability to do so, those investors will start to demand higher interest rates on that debt. And that would be devastating for Japan’s government budget since the only thing really keeping Japan from budgetary disaster has been extraordinarily low interest rates.
The only reason I can find–other than the desire to win an election and we all know that politicians never make policy decisions just to win an election, right–is that Abe hopes that international capital markets will find this move just scary enough to weaken the yen–which has been stubbornly strong in the face of delays from the Federal Reserve in raising interest rates–and thus help out Japanese exports, but not so scary that capital markets will demand higher yields on Japanese government debt.
That’s a very fine line to walk. And subject to easy disruption by bad news on global (read Chinese) economic growth, higher oil and natural gas prices (since Japan imports most of its energy), a decision by global money managers that the yen isn’t the best choice for a safe haven currency, and more.
The two things that are certain are that Japan is the oldest country in the world and getting older very rapidly and that Abe’s policy decision does not address that basic reality.
Today the Nikkei 225 index closed down 2.32% in Tokyo and the yen finished at 108.83 to the dollar.
Most technical indicators say we’re in a bear market. Whether you want to call it a rolling bear, or a consolidation, or pick nits since the Standard & Poor’s 500 as a whole hasn’t yet hit the down 20% territory now inhabited by many of former market leaders. (The February 12 issue of James Stack’s InvesTech Research newsletter does a superb job of summarizing the technical indicators pointing to a bear market. To check out Stack’s newsletter and/or subscribe go to investech.com)
But so far economic indicators aren’t pointing to a U.S. recession. Job growth and income growth are healthy. Although the Institute for Supply Management’s survey of purchasing managers in the manufacturing sector has fallen below the 50 mark that indicates contraction in the sector, the survey for the services sector hangs above that mark, despite recent weakness. In the housing sector the confidence survey for the National Association of Home Builders hasn’t shown the downturn that usually proceeds a recession.
This is a good moment to remember Nobel-prize-winning economist Paul Samuelson’s quip that “The stock market has forecast nine of the last five recessions.”
Why is this important?
Stocks can certainly experience a bear market without a recession so the fact that the economy may not enter a recession isn’t some kind of proof that stocks aren’t actually in a bear or headed for one. (The S&P 500 is hanging around a drop of 13% or so in a bad week–not bear market territory–but 60% of S&P member stocks are 20% or more off their highs.)
But the worst bear markets in terms of percentage drop and in terms of duration require a coincident recession. If the U.S. isn’t going to slide into recession, the bear that is breathing down our necks right now will probably resemble a deeper version of the 12.4% drop from the May 21 high of 2130.82 on the S&P 500 to the August 25 low at 1867.61.
By November 2 the S&P 500 had climbed back to 2109.79. Painful certainly but not terribly long-lasting.
To get a really, really painful and long-lasting bear you need to combine a drop in stock prices with a recession as we did in 2007, 2000, and 1980. The 2007 bear–and the Great Recession–took stock prices down 56.8% and lasted for 517 days, according to Yardeni Research. The 2000 bear resulted in a 49.1% drop and lasted for 929 days. The 1980 bear took stocks down 27.1% and lasted 622 days.
Now that’s pain–and the duration of that pain was enough to test–if not wash out–even the most steel-nerved of investors.
So the big question for 2016–after the horrendous start to the year–is will we get a U.S. recession in 2016?
I wish I could confidently scoff and say “No way,” but I can’t. I think a U.S. recession in 2016 is unlikely–but it certainly isn’t impossible.
The economy, I’m afraid could go either way–although I think the odds are in favor of “No recession.”
As I noted above job growth is very solid and income growth actually looks like it is starting to pick up. Low oil prices mean low gas prices mean more dollars in consumers’ wallets for spending on things other than fuel. The U.S. auto industry set a sales record in 2015 and doesn’t look poised to fall off a cliff in 2016. After it’s best year in a decade in 2015, the U.S. housing industry is forecast to see 1% to 3% sales growth in 2016. That’s not a house on fire but growth isn’t recession. U.S. interest rates are low–and I think it’s likely that the Federal Reserve will pause its rate increases until it sees signs that U.S. growth is a solid 2% or so. Right now forecasts call for earnings growth to resume in the second half of 2016 as year-to-year comparisons with the slow growth of the second half of 2015 make beating estimates easier. That would have a big positive effect on CEO confidence levels. That’s important because worried CEOs fire people and don’t invest in their businesses. A modest increase in oil prices to, say $45 a barrel, would take pressure off some oil companies and reduce worry over banks’ exposure to bad loans in the energy sector.
That’s not a forecast for rip-snorting economy in the second half of 2016–but it is a picture of an economy that isn’t in recession.
Unfortunately, none of those positive trends or news items is a lock. China’s economy, despite the current round of stimulus, is likely to continue to slow. The U.S. economy doesn’t look like it will get any help from Japan and a EuroZone growth recovery is possible but questionable and won’t produce big numbers in any case. Developing economies and commodity-oriented economies such as Australia and Canada are likely to struggle. There is the possibility of a beggar-thy-neighbor round of currency devaluations that would further hurt U.S. exports. We’ve got weak governments coping with big problems in the EuroZone, the Middle East, Russia, and Japan. And I certainly would never rule out that U.S. politicians might be something stupid in an election year that might hurt U.S. growth. Nor can I absolutely rule out the possibility that the Fed got it wrong when it decided to raise interest rates in December.
It’s going to be hard to tell what the economic trend line is over the next few months because beginning in March we’re likely to see splashy moves from the central banks of the EuroZone, Japan, and China. I think all three of these central banks are signaling that they will move strongly in the early spring to stimulate their own economies. The likelihood is that will rally stock markets for a while but then leave markets open to a return to the crisis of confidence that I see in the financial markets right now. To my eyes a big part of the current slide in global stocks markets is due to investors and traders losing confidence in the ability of central banks to produce growth in their economies or to prop up the prices of financial assets for very long. That could see us return to the current malaise after the failure of a promising rally in the spring. That kind of volatility will make it very hard to find a longer-term trend worth hanging onto.
I guess you could color me “hopeful” that the U.S. will avoid a recession–which would help investors avoid the worst kind of bear market–but worried that a recession is possible and that financial markets having lost faith in central bank policies will wander lower.
Back in recession again.
Japan’s economy contracted at an 0.8% annual rate in the third quarter on a drop in business investment and reductions in business inventories. That follows on a revised 0.7% drop in the second quarter. The recession is the second since Shinzo Abe took over as Prime Minister in December 2012. Economists had estimated that Japan’s economy would contract by 0.2% in the third quarter.
With Asian markets down on Monday morning on the horrific terrorist attack in Paris, it’s hard to tell exactly how much the news of the recession is pushing Asian stocks downward. The MSCI Asia Pacific Index was down 0.6% at 9 a.m. in Tokyo. Japan’s Topix was off 1.5%. The yen was up slightly—0.1% to 122.46 to the dollar–as traders and investors looked for a safe haven after the Paris attacks.
The economic contraction in the third quarter was a result of weakness in the global economy. With growth in China’s economy slowing, Japanese companies cut back on investment—weaker business investment subtracted 0.2 percentage points from GDP growth in the period—and reduced inventories—that, the Japanese government said, reduced GDP growth by 0.5 percentage points in the quarter.
The next monetary policy meeting of the Bank of Japan comes this week on November 18 and November 19. The bank will issue its regular monthly report on Friday, November 20. Economists are expecting that growth will pick up in the fourth quarter, but they still forecast that the economy’s slip back into recession is likely to be enough to prod Bank of Japan Governor Haruhiko Kuroda into boosting monetary stimulus and expanding the current program of bond buying that is intended to boost inflation and weaken the yen. The government is also expected to announce a budget with increased spending in an effort to increase growth and to address the economic effects of Japan’s rapidly aging population.
What a week for potentially market-moving news!
Let me give you a quick run down, ok?
Monday: Beginning today and running through Thursday, the Central Committee of the Chinese Communist Party meets to formulate a new 5-year plan that would go into effect in 2016. Certainly on the agenda are a new target for economic growth, reforms for the country’s huge state-owned enterprises, and goals for continued urbanization, environmental regulation, and registration for China’s migrant workers. The goals aren’t actually released until ratified by the national legislature, which meets in March, and typically they don’t go into official effect until the fall. But while remaining officially unimplemented, many parts of China’s government start to react as soon as the meeting is over. That’s especially true of monetary authorities such as the People’s Bank. China’s central bank cut lending rates at the end of last week in anticipation of this meeting, but there’s still room for more moves on mortgage rates and restrictions, and bond issuance by local governments, just to name two issues. The Shanghai and Shenzhen markets were up modestly overnight (0.5% and 0.68%, respectively) in anticipation of the meeting.
Tuesday: Call it a preview of Thursday’s report on third quarter U.S. GDP growth. Wall Street is expecting a 1.3% drop in orders for durable goods for September. That would be an improvement from an even bigger decline in August. Look to see what the figures ex-aircraft show since a shift in the timing of one or 10 of these big-ticket orders can skew the entire top line of the report. Anything worse than Wall Street’s expectations will color opinion ahead of the GDP report.
Tuesday: It’s Apple (AAPL) day. The company reports revenue and earnings for its fiscal fourth quarter. Key issues will be sales of the new iPhone, where analysts will be looking for any signs of weakness in the launch, and sales in China, where they will be looking for signs that slowing growth in the Chinese economy has cut into sales. Apple CEO Tim Cook has repeatedly said that Apple isn’t seeing problems in its China results—that may have created expectations that could bite the company this quarter. I think Apple’s results this quarter are likely to have more effect on the market as a whole—where investors will look for clues to growth in the Chinese and global economies—than for technology stocks. Still watch for reaction from shares of Apple’s suppliers such as Analog Devices (ADI), Qualcomm (QCOM), and Synaptics (SYNA.)
Tuesday: More on strength or weakness in the U.S. economy when Ford Motor (F) reports third quarter earnings. (General Motors (GM) reported last week and showed a larger-than-expected gain in operating profits in North America.) Of particular interest at Ford will be sales for the company’s new mostly aluminum F-150 pickup truck.
Wednesday: The Federal Reserve’s Open Market Committee will probably do nothing on interest rates, but investors will be intently parsing any Fed comments for clues on what the U.S. central bank might do in December. Look for any change in the post-meeting statement on the Fed’s degree of worry about China now that it looks like that market has stabilized–for the moment, anyway.
Thursday: The U.S. Department of Commerce releases its preliminary estimate of third quarter GDP growth. Economists are looking for a year over year growth rate of just 1.9%, down from a 3.9% rate in the second quarter. The report will certainly move the odds on a December interest rate increase from the Federal Reserve. The odds for a December increase have moved up slightly recently on a decline in volatility in emerging markets.
Friday: The Bank of Japan meets: Will it stand pat on asset purchases and just reiterate recent comments from Governor Haruhiko Kuroda that the current program of quantitative easing is working (despite a lack of economic growth or inflation), or will the bank decide to increase its asset buying? Without some progress toward those two goals, the credibility of Abenomics will continue to erode. A promise last month from Prime Minister Shinzo Abe that the Japanese economy would be 20% larger by 2020 has resulted mostly in derisive laughter.
The euro had Mario Draghi’s pledge to do whatever it takes to support the currency. The dollar had Ben Bernanke’s pledge to keep short-term interest rates extraordinarily low for an extended period.
And now the yen has an “unlimited” loan program from the Bank of Japan that is looking more truly unlimited.
With Japanese GDP growth unexpectedly slowing to an annual 1% rate in the fourth quarter and with the Japanese consumer facing an increase in the national sales tax to 8% from 5% in April, Japan’s central bank today extended its unlimited loan program for another year. The program, which had lent 5.1 trillion yen ($49.8 billion) in low-interest cash to banks since December, had been scheduled to expire at the end of March. At the same time the bank loosened a limit on how much “unlimited” money a bank could borrow. Previous rules restricted a bank to borrowing cash equal to its net increase in lending. Now banks will be able to borrow twice the amount of any increase in lending.
The central bank also slightly increased the size of its monthly purchases of Japanese government bonds to a range of 6 trillion to 8 trillion yen from a target of approximately 7 trillion yen a month.
Today in Tokyo the Nikkei 225 stock index closed up 3.13%. Financial and real estate stocks were the big winners. In the financial sector Mitsubishi UFJ Financial Group (MTU) rose 5.03% and Sumitomo Mitsui Financial Group climbed 5.0%. (Mitsubishi UFJ Financial Group is a member of my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/ ) In the real estate sector Heiwa Real Estate gained 4.13% and Mitsui Fudosan advanced 3.31%. The yen fell against the dollar by 0.4% to 102.34 yen to the dollar.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/, I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did own shares of Mitsui Fudosan as of the end of December. For a full list of the stocks in the fund, see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/.