It is been a while since the last time I wrote. Lack of time, certainly not lack of issues to write about. I could write about the tug of war in Europe between Germany and , at this point, all the other countries, with the latter pressing for stimulus, the first ,stuck to its austerity policy; or about the ineffectiveness ( so far) of Abenomics in boosting the Japan’s economy; or the slowdown in China and the increasing risk of a bank crisis. Let’s not forget the failure in combating ISIS or promoting peace in Ukraine. Also, the Brazilian scandal involving Petrobras, a company that is being destroyed for lack of governance, corruption and bad government decisions. On a more insular view, the eruption of a measles epidemic in California because crazy parents do not want to vaccinate their kids or the freezing temperatures and the recurrent snow storms that are putting a toll on business activity in the USA.
The geo political risks, the problems in the European, Japanese and Chinese economies are not new. The impact of a weak economic growth and the threat of increasing interest rate in the Emerging markets is known. So, why are the markets much more volatile in 2015? Will this volatility be the norm in 2015? Or it is just a bump on the road and we will continue the march towards new highs? Another, more important question is: how much longer the United States can remain impervious to the rest of the world’s problems?
I’ve been very optimistic in the past few years in regards to the USA economy and I have been an advocate of investing in the stock market (mostly in the USA, without diversification).Those who believed me and followed my advice are probably happier than the ones who continued to invest in bonds and stocks around the world, mainly in Brazilian bonds and stocks. What has changed on my view, is that I do not believe that will be an easy ride, like it was in the past few years. I believe prudence and caution will be in order and more than ever, active portfolio management is a must. The market today present more challenges than it has presented in the past few years. My recommendation is that one should not think for a minute that just because the market in reaching new highs your portfolio will follow suit. It is also good to remember that everything that goes up….eventually will go down.
Let’s go back to the potential dangers of a world in disarrange : we know Chinese banks are holding plenty of bad debt, result of years of financing real estate projects that are now plunging; what would be the effect around the financial world if the Chinese banks decide to sell assets to improve their balance sheets? What would happen to Brazil and other EM dependents on exporting to China if in fact Chinese economic growth goes down to 4% or 5%?
We can also think on another daring scenario for emerging markets: with the impending increase on interest rates in the USA a bigger appreciation of the dollar is a given. How will the strong dollar impact commodities, and then again, economies that have those products as main exports? To make answers more difficult, how would a combination of higher interest rates and strong dollar impact emerging markets debt?
If we move out attention to Europe, what do we see? The stock market celebrated the Greek deal on Friday with the Dow Jones and the S&P ending at record highs. However what was reached Friday was not really a deal, instead, was a deal to deal. On Monday, the 23rd, Greece must present a list of all the measures it plans to take over the next four months. If they are acceptable, the deal will be signed on Tuesday. Then in April, Greece must present a detailed acct on the reform and measures taken. Finally in 4 months, everything starts over. So the problem was pushed for June 2015.
The new Greek government has a problem, very similar to the new (old) Brazilian government: how to conciliate campaign promises and ideology with the harsh economic reality? That is the only thing the two economies have in common, the dilemma of their leaders. In the past few years the Greeks followed the austerity recipe which lead to a shrinking economy and 25% unemployment. Brazil, on the other side, was in a spending spree. The Brazilian finance minister J. Levy was in NY trying to convince investors that the Brazilian Government is committed to go back to sound macro-economic policies, mainly in the fiscal side. It will take more than talking to convince investors and it will take more than power point presentations to put the country in the right path to prosperity. Brazil, as some other emerging markets will face headwinds given the change in the international scenario, with less liquidity, rising interest rates and flight to safety. Levy will also face political opposition.
The United States has been an isolated beacon of prosperity in a world of slow economic growth. Even wages have improved lately. Now however, I am starting to ask myself how long can that last considering so many threats? The strong dollar will affect American sales abroad and the earnings season is showing that already: although 4th quarter earnings were in line with past results, revenue growth rate fell from 4% in Q3-14 to 1.2% in Q4-14. More troubling was the decline in estimates for the first and second quarters of 2015. It is only one data point and we have to see what happens next but it is nonetheless, one bad data point.
At the same time we are witnessing the kind of excess we saw right before the financial crisis. One look at the real estate market in the US should be enough to make us worry about the future; aside from the fact that the real estate in NY, Miami and other parts of the US became the new place to hide money as recent articles in the New York Magazine and the New York Times has showed, the market is been reaching new highs. Prices have reached peaks that defy imagination: since when should we consider normal for an apartment to be priced at 100 million dollars? The number is even more absurd when we take into account that the median existing-home price is less than 200 thousand dollars. Maybe this money -coming from nobody knows where in need to find a place to park - is causing the avalanche of new developments in NY and Miami at crazy prices. Maybe the Government at one point will propose legislation requiring the kind of disclosure and due diligence needed to open a bank account in the USA. Then, what happens to all this new developments? What if a terrorist with an American passport puts a bomb in a public building in the USA?
I don’t mean to be alarmist or gloomy although the world is giving me plenty of motive for that. I believe each of us should pay attention to what is going on in the world. Those who have financial advisors, should be even more attentive. Don’t forget that when things goes badly you still pay the same fees.