Ignacio de la Torre. Professor. IE Business School
21 January 2016
In spite of a turbulent start to 2016 the world will grow this year more than the last one, but this improvement hides a serious threat, the much put upon ten-year bond.
“The market has forecast ten of the last three recessions” is a popular saying about world markets. No that we are seeing the prices of raw materials plummet, the feared rise in interest rates by the FED, a US recovery above and beyond what was expected, the ECB’s disappointment, a large number of emerging economies in or on the verge of recession, and the first closure of a monetary fund in years, messages that point to a new world recession are back with a vengeance. But are there real grounds for concern?
Given that the US economy is still the biggest in the world, it would seem an appropriate place with which to start this analysis. The “recessionist” argument is that the current economic expansion has been going on for 78 months, which is a longer period than that of 29 out of the 33 expansions that have occurred in the US economy since 1854. The question that comes to mind is if the economic engine, namely consumption, is tied to a clock that suddenly stops after 80 months, which means Americans will stop buying and the economy will fall into recession. That would obviously be a no. Consumption does not determine salaries, job creation, family wealth and consumer confidence. All these factors are at very positive levels and are continuing to rise. If we add, moreover, the bonanza associated with credit and real estate recovery, the growth picture becomes even clearer. It is true that the strength of the dollar made for a reduction in export levels in 2015, but exports only make up 13% of America’s GDP, and in 2016 the base effect will be different. The same can be said about the weakness of energy prices in terms of investment in the sector, but the US economy reaps more benefit than harm from cheap energy. As a whole, the US economy will grow at a rate of around 2.5%, inflation will continue to rise, little by little, and the FED will raise interest rate up to at least 1.25%, above what the market has discounted.
The PMIs of the Eurozone economy show us that it may already be growing at a rate of about 2%, far faster than the forecasts made by many supranational institutions led us to expect. The reality is that Europeans are now shopping again with gusto, while unemployment figures and energy prices fall, and wage levels are being reactivated. Recovering consumption levels mean that European investment is also slowly coming out of the doldrums. European investment levels are currently better than in the US, partly due to a smaller presence of the energy sector, and also because of high levels of export activity, thanks to the weak euro. In the context of an ultra-expansionary monetary policy (which in my opinion will last for less time than we have been told) and an incipient recovery of the real estate sector, everything is aligned to make the Eurozone grow 2% in 2016, with the European Union as a whole growing at a higher rate. Meanwhile Japan is showing signs of surprising dynamism, considering how exposed it is to what is happening in China. Japan’s economy is growing at a rate of over 1%, which could rise to over 1.5% in 2016 as evidenced by the very stimulating results of Tankan’s corporate climate survey (the best barometer for gauging the health of the Japanese economy). Quite an achievement for a nation that is losing a million workers a year (in fact, if we observe the evolution of GDP growth per active worker, we would discover the surprising fact that Japan is the fastest growing economy in the East).
The bad news is obviously coming from the block of emerging economies that are now facing enormous corporate debt in dollars which will be difficult to repay, an incipient banking crisis as a result of said debt, a fiscal crisis and the devastating effect in many economies brought by weak levels of demand for raw materials. Brazil and Russia are in recession, and India and China are now facing deceleration, just like many other emerging economies, but even so they are set to grow at a rate of over 5%. Despite everything, the block of emerging countries will grow as a whole over 4%, largely due to the enormous weight that China and India still have. In my opinion, China will end up in recession, but not in 2016. What better paradox could there be of the times we live in than the disappearance of the “BRIC” acronym, coined by Goldman Sachs? GS has now merged its “BRIC” fund with its emerging economies fund.
Let’s not kid ourselves. The biggest risk in 2016 is not a world recession (the world economy will grow by 3.5%, compared to 3% in 2015), but rather the enormous risk associated with a risk-free asset, the ten-year bond. All assets are valued, directly or indirectly, based on the price of a ten-year bond. If the price of these bonds is prostituted, then the price of every other asset is too. That said, 2016 marks the beginning of the end of this prostitution with a change in monetary policy in the most important central bank in the world… with major consequences for a vast range of assets.