Earlier today, we brought you one graphic from HSBC which shows that based on at least one metric, the world is already in recession:
That graph is part of a larger thesis HSBC has developed about how a confluence of circumstances have conspired to make asset allocation a somewhat vexing task. The so called “tricky trinity” is comprised of the following three factors:
- Global growth is decelerating
- The absence of a policy put
- Risk premia offers a limited buffer
These are all ideas that we have of course discussed at great length.
As for decelerating global growth, here’s what we said earlier:
...the entire world seems to be decelerating in tandem with China’s hard landing (which most recently manifested itself in another negative imports print).
For evidence of this, one might look to the WTO, whose chief economist Robert Koopman recently opined that “it’s almost like the timing belt on the global growth engine is a bit off or the cylinders are not firing.” And then there’s the OECD, which recently slashed its global growth forecasts. The ADB joined the party as well, citing China, soft commodity prices, and a strong dollar on the way to cutting its regional outlook. Even Citi has jumped on the bandwagon with Willem Buiter calling for better than even odds of a worldwide downturn.
And here is HSBC:
At this point we find few investors that believe growth is likely to accelerate. Rather, consensus growth expectations have moderated significantly in recent months. Our leading indicators found a peak in June and have since declined gradually. As we pointed out in our most recent publication, the downturn has been fairly broad-based with peaking or past peak cyclical data in all regions and most types of data. Only consumer data continues to improve. However, given the broad-based decline in other data we doubt that consumers are going to be able to withstand this cyclical story.
The global PMI story is similar and we can now see that the manufacturing sector numbers have fallen to a 26-month low, which has resulted in a deterioration of the service sector as well. That said, global PMI was still at an expansionary 52.8 in September. Growth on this metric is low but still positive. In effect, September data verifies the slowdown that our leading indicators started to highlight in July. While the current decline in manufacturing data is clearly in the minds of many investors, the slowdown in the service sector PMI is a cause for concern. That said, if our leading indicators are correct, we are unlikely to see a stabilisation of global growth numbers over the coming 3-6 months. This presents global asset markets with a significant growth problem at the time of fairly limited risk premia in US equity markets, for example.
On the absence of a policy put, the message is simple: central banks have lost credibility, but the market is still largely dependent on QE. The BoJ and the ECB will eventually have trouble finding enough supply to purchase, which means that they will have literally monetized everything that isn’t tied down and yet still, both the eurozone and Japan are mired in deflation. We’ve seen the same dynamic unfold in Sweden where, for the first time, QE actually broke and just three months later, the Riksbank is being forced to look at purchasing muni bonds just to avoid the possibility that the scarcity of collateral created by central bank purchases doesn’t end up causing things (yields, the SEK) to move in the “wrong” direction (i.e. higher). And of course there’s the Fed, which is stuck in the impossible position of accidentally accelerating EM capital outflows whether it hikes or whether it holds. In a market that’s still largely hooked on stimulus, it is not good when central planners run out of options, creditbility, and lose the narrative all at the same time. And that is exactly what's happening now.
Back we go to HSBC:
Clearly, in this slow growth outlook it is easy to rely on central banks to provide an economic put. However, as our eurozone economics and fixed income strategy team highlighted in The ECB & QE: Constraints will test credibility from 22 September 2015, there are constraints on what the ECB can do. The chief limitations are negative yields and the relative lack of Bunds in a capital key driven QE program. Most notably, it is worth highlighting that such constraints limit the ability of the ECB to defend a weak EUR or to reignite growth and inflation expectations.
The ECB, however, isn’t the only central bank that faces constraints to its unconventional monetary policy program. Investors continually question the limits of the BoJ’s JPY80trn asset purchase program whilst giving the benefit of the doubt. At present the BoJ owns 30% of JGBs outstanding but at the current run rate that would reach 50% by December 2018. How long can the BoJ keep buying 100% of the government’s new deficit issuance? The BoJ will have to do this to meet its asset purchase target in 2015. At the same time, it is not clear who will sell to the BoJ going forward as the GPIF is close to being done with its rebalancing, whilst life insurers and megabanks are limited in their ability to reduce JGB dependence due to ALM and regulatory considerations.
As we look at the success of QE it appears that the marginal benefit of further monetary policy is constrained. As this prospect starts to affect consumers and corporates alike, their belief in economic fortunes starts to become more volatile. This behavioural effect on global growth is not fully priced into financial markets, in our view. If anything, the distribution of future economic outcomes is becoming more extreme.
Finally, on risk premia:
Monetary policy in the post crisis period has been like one giant blanket that has kept investors sheltered from the stiff breeze of structural stagnation. This blanket has also encouraged investors to move further and further into riskier assets. In effect, risk premia has slowly been pushed down. The eurozone crisis and now the EM crisis highlight that depressed risk premia are unlikely to unravel in a slow and gradual manner. Rather, once risk premia reach unsustainable levels, then only one proverbial straw will break the camel’s back. At the moment, EM assets are in the maelstrom of this unravelling.
There, ladies and gentlemen, is the "tricky trinity" and in a nutshell, the takeaway is fairly simple, so we'll just leave you with the bank's conclusion:
Going into year-end and looking at the financial landscape for 2016, we cannot help but remain highly risk averse.
So sell it all we suppose. Or don't.