Connecting the Dots

Economic Switcheroo: from Unbridled Optimism to Deep Pessimism

May 3, 2016

“In the global economy, there are not many bright spots around the world.”
Jim Yong Kim, President, World Bank

“It is worse than in 2008… Freight rates are lower… The external conditions are much worse.”
—Nils Andersen, CEO of shipping giant AP Møller-Maersk

I pay scant attention to the International Monetary Fund (IMF) and the World Bank when they gush about how great the global economy is doing… which is almost always. However, I do pay careful attention to them whenever their near-perpetual optimism turns negative.

  • The IMF lowered its 2016 global growth forecast for both 2016 and 2017 by 0.2% and 0.1%, respectively. Specifically, it is worried about the drop in oil prices, a sharp economic slowdown in China, rumblings about trade wars and tariffs, disease epidemics, refugees crises, and military conflict.

  • The World Bank is even more pessimistic, lowering its 2016 global GDP forecast from 2.9% to 2.5%.

Those are some pretty somber forecasts that should not be ignored. But the handwriting on the wall is pretty obvious—the global economy is losing steam fast. Here are some more penetrating warning signs:

World Bank, IMF Are Right Sign #1: The Merchandise World Trade Monitor tracks global imports and exports in two measures: by volume and by unit price in US dollars. So far in 2016, world trade is down by 0.4% on a volume basis and down 3.8% in dollar terms.

“Both import and export momentum became more negative in the United States,” said the Merchandise World Trade Monitor.

World Bank, IMF Are Right Sign #2: June of 2014 was a significant month because it was the point when total business revenues of US companies hit a peak and the price of oil really started to fall. Since then, the unit price index of world trade has plunged 23% and is now lower than during the worst part of the Financial Crisis.

World Bank, IMF Are Right Sign #3: The latest JPMorgan-Markit global manufacturing purchasing managers index (PMI) showed the weakest quarterly performance in years.

Markit noted that “conditions remained lackluster in the three main industrial regions covered by the survey” and “manufacturing production was near-stagnant in Asia.”

World Bank, IMF Are Right Sign #4: In a connect-the-dots exercise, it is easy to see how manufacturing jobs—the good-paying jobs—are disappearing in the US. Our economy is creating lots of “Would you like fries with that, sir” jobs, but not much else.

World Bank, IMF Are Right Sign #5: Industrial production was down 2.0% in the month of March. That’s bad enough, but this is the seventh month in a row that it has declined on a year-over-year basis. The US economy has never seen industrial production drop for seven months in a row without being in a recession.

The good news is that the world economy is slowing down, not contracting.

The bad news, however, is that stock prices are sky-high. The S&P 500 is now trading at the highest price-to-sales (PS) and price/earnings-to-growth (PEG) ratios in the history of the stock market.

In short, the stock market is priced for perfection, largely on the assumption that Janet Yellen and her Fed buddies will keep stock prices from falling with a combination of interest rate cuts—perhaps even negative interest rates—and/or another zillion-dollar QE program.

To me, the question isn’t whether or not the Federal Reserve will swamp Wall Street with more monetary steroids… because I’m sure it will.

The more important question is: Will more monetary steroids work? My answer is, “Not a chance,” and that is why I urge you to have a clear strategy to protect yourself when things turn ugly.

There are many defensive strategies to consider: protective stop-loss orders, inverse ETFs designed to profit from falling stock prices, a small allocation for portfolio insurance (aka put options), market timing tools like moving averages, or simply taking some chips off the table and increasing your cash cushion.

One strategy that I don’t recommend is “Buy, hold, and pray”; buy stocks, hold on for dear life, and pray that they go up.

Tony Sagami
Tony Sagami

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