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Dow shines, but doomsayers warn of dire times ahead

Jun 27 2019 10:23
Maarten Mittner

With the Dow Jones industrial average hitting a decade-long expansionary period in June, the longest on record (disregarding blips in 2015 and 2018), it did not take long for the doomsayers to come to the fore again. 

And they’re predicting dire times ahead. From investment guru Jim Rogers to economist Nouriel Roubini, respected economic commentator Joseph Stiglitz and investment legend Warren Buffett, all are echoing the prediction that the US will fall into recession within the next two years, dragging the globe down with it. 

Rogers has said it will be the biggest fall ever – “a lifetime setback”.

The problem with doomsayers is that they might be right in the end and after all, based on the law of averages. 

If you continuously repeat the same message, it might become a self-fulfilling prophecy based on the extended period of time it has been raised and not really related to any fundamentals. 

But, in fact, the record of doomsayers is quite patchy, to say the least. 

Remember those who said that quantitative easing (QE) in 2008 will lead to a massive inflationary bubble? 

Put all your money in gold, it was said then. Well, the exact opposite happened. 

The world is still teetering on the edge of a deflationary meltdown, despite all the artificial printing of money and the inflation of assets since then. 

Should the present warnings of doomsayers therefore be heeded?

Doomsayers share one thing in common. 

The dire prophecies are seldom linked to an expected date in the future when the adverse happenings will occur. 

And they are usually unable to isolate what the main cause would be. 

Those are impossible to predict, they say, as it is based on fickle human emotions.What is clear, is that global markets have become hooked on easy money. 

And it seems likely that central banks will continue to support loose policies, “whatever it takes”, despite tentative moves to tighten policy (as recently affirmed by the European Central Bank [ECB]). 

In the US the Federal Reserve has turned dovish after pausing with its rate-hiking strategy.

What is the problem then?

The problem is that all these actions by central banks are in themselves artificial. 

Fake, if you like. 

Real money has an intrinsic value. 

If that intrinsic value is deemed to be unsustainably high, and not related to economic reality, then at some point that money will fall out of the system – as happened in the Great Depression of the 1930s and financial crisis of 2008/09.

Then there will be a reversal back to the mean or average, where real monetary value as opposed to inflated value is created anew. 

QE has prevented that from happening by distorting reality, creating easy money to stimulate markets and economies.

It is not clear what the extent of the inflated asset base is. 

Equity markets are at present trading at reasonable valuations – slightly above long-term averages, but not massively so. 

An element of caution has crept in, but the Dow is still 25% up since Donald Trump became president.

The debt market, however, tells quite another story, with debt yields at all-time or recent lows. 

Here things might look a bit scary, depending on how you view it. 

In 2008, the US national debt stood at $11tr. 

Now it is at $22tr, and set to climb further to around $27tr over the next few years if nothing is done to curtail it. 

The US is inexorably heading to a 100% debt-to-GDP ratio from a present 73%.

Once again, it can be argued that this is not out of kilter on a comparative basis, as China has a ratio of 100% and Italy 130%.

However, the debt growth is occurring within the realm of the twin deficit reality in the US economy, with the current account deficit at 2.6% of GDP and the budget deficit at 4.7%. 

This indicates the US is not living within its means, occurring against the backdrop of rising debt.

Conventional economic theory states that at one point debt has to be brought down. 

Or redeemed. 

A consumer cannot spend on a credit card indefinitely. So also, governments. 

The limit on the credit card cannot be extended ad infinitum.

Much the same logic applies to equity markets. 

A rerating is likely if share prices continue to rise way above their net asset value (NAV), their intrinsic worth. 

More so if the asset growth is being affected negatively by higher rates and subdued growth in an environment where debt is curtailed. 

Shares trading at NAV or below may not be offering that much value as the asset base itself has come under pressure.

A good example of this may be the SA property sector, where a recovery has remained elusive as the asset base in the sector – as reflected in malls and offices – may be too high amid the present economic headwinds. 

Therefore, some quality property shares are trading way below NAV, but with still little buyer interest.

Against this backdrop the doomsayers may be correct. 

On the other hand, central banks may again just kick the can down the road. 

Then, for the umpteenth time, the doomsayers will have been proven wrong again. 

Maarten Mittner is a freelance financial journalist and a markets expert.

This article originally appeared in the 4 July edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.

dollar  |  recession  |  us economy
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