Seven Reasons To Be Fearful

Hope springs eternal that 2015 is the year that the US economy stretches its escape velocity growth as consensus growth expectations at 2.9% are still at their highest since 2005 (although world GDP expectations are falling rapidly). However, as Bloomberg's Rich Yamarone explains, with 5 of the Top 10 economies in the world in or near recession, the wall of worry can be constructed as follows...

 

 

1) Strong Dollar

A strong dollar is in the best interests of the U.S. Until it isn’t. Dollar strength can carry some costs, particularly for investors. Corporate profits usually get crimped by a rising currency. Recently U.S. companies have started commenting on the dollar’s earnings impact. Lower profits traditionally mean diminished capital spending and hiring. Import prices fall and this may be an invitation to deflation, which is something the Fed wants to avoid at all costs. Further dollar appreciation can be viewed as a tax on exports, since they appear higher-priced compared to products fabricated overseas.

2) Emerging Markets

For the developing world, persistent dollar strengthening invites a great deal of instability. In the past, this has led to revaluations, pegging and de-coupling from the dollar. The Thai baht crisis in 1997 had long tentacles that hit Russia, causing a default on sovereign bonds, and a Fed-arranged rescue of the hedge fund Long Term Capital Management.

3) Cheap Oil

The dollar rally has also resulted in lower-priced commodities. This is welcomed by businesses in general, but hurts a good number of oil-producing companies and nations that depend on those revenues. Savings at the pump are positive for most households. Economic costs of cheap oil are more unevenly distributed. North American oil corporations’ capital expenditure plans are getting slashed for 2015 and job cuts are probably not too far away if the price slide is sustained. Regionally, low oil prices could prove costly to some outperformers among the United States in recent years, including Texas, North and South Dakota, Minnesota and Oklahoma. This also carries negative consequences for state and local tax revenues.

4) The Federal Reserve

The least likely risk is that the Fed adopts a severely restrictive policy stance that precipitates a recession. Historically, it’s always been the Fed that trips up the economy. That’s probably not the case with Fed Chair Janet Yellen at the helm. Her feelings are well-known about keeping the foot on the accommodation accelerator for as long as necessary. She also has total support of the Fed governors. Rates will rise when the data support a full employment and stable price environment. That appears close, if not already achieved. Yet the rate increase won’t happen if the situation regarding key world economies, the stronger dollar or oil unfolds in an unpleasant manner.

5) China

In the Chinese Zodiac, 2014 was the Year of the Horse, and the second largest economy in the world pulled up lame. Estimates by economists polled by Bloomberg expect 7.0 percent growth in 2015, and some respected forecasting outfits now anticipate growth as low as 5.6 percent for China in 2016. China’s current pace of aggregate demand is the same as during the global crisis and market meltdown in 2008. In order to combat that, the Chinese government implemented a four trillion yuan ($586 billion) stimulus plan, ultimately sending economic activity toward 12 percent growth. Today, Chinese policy makers have no such plans. Rumors are running through the market of a Chinese devaluation. Don’t look for China to be the hero. We’re entering the Year of the Goat.

6) Japan

When a country is stuck in a liquidity trap, monetary policy prescriptions of lower interest rates are ineffective. If it adopts a fiscally restrictive policy such as a consumption tax increase when things are just barely improving, it tends to send the economy into a tailspin. That’s exactly what occurred for Japan, as its economy slipped into its third recession since 2008 and entered its third lost decade. Japan cannot even benefit from the plunge in oil prices since the massive devaluation of the yen has negated much of the price decline in purchase terms.

7) Europe

Multinational companies complain about Europe, where too many economies are on very thin ice. A collapse in Greece or Russia could precipitate a global crisis. If Russia implodes, the likelihood of a severe European recession increases sharply. Essentially all companies in the Bloomberg Orange Book of CEO Comments that have dealings in Russia have already made mention of the drag on their performance because of the sanctions imposed internationally.

 

Source: Bloomberg Briefs