18 Trillion (And 9) Reasons To Fear The Global Recession

The last three months have been a shock to many global investors as equity markets refused to obey the BTFD mantra that has made gurus out of idiots for a decade. Quite a slew of massive point plunges (and no Plunge Protection Team)...

Leaving December (for now), the worst end to the year for stocks since The Great Depression...

“You feel like you leave here you’ve been in a boxing match all day,” said Bradshaw, a portfolio manager at Hodges Capital Management.

“We’re kind of dumbfounded by the huge sell-off in the market versus what we’re hearing from companies..."

And while Friday was a 'quad witch', which tends to see trading activity elevated, NYSE volumes exploded to their highest since Brexit as US equity markets collapsed - failing to respond to Fed's Williams' efforts to talk it up...

As US markets catch down to the rest of the world...

But, it's not just US stocks that are suffering. World Stock Market Capitalization has collapsed by $18,281,024,000,000 (just over 18 trillion dollars) since the peak in January.

Note that since the trade war "truce" that was supposed to save the world economy, global equity markets have lost almost $6.5 trillion!!

Second only to 2008's collapse, 2018 is the worst year for global equity markets value destruction ever...

 

As Bloomberg notesthe list of potential motivations for the sell-off is long and includes rising geopolitical risks, the prospect of trade wars erupting, the risk that a slowdown in global growth that could degenerate into a worldwide recession, and the evergreen what-goes-up-must-come-down.

And just in case you were thinking about Buying-The-F**king-Dip, here are nine more factors to consider (on top of the eighteen trillion above)... (via Bloomberg)

1. Talkin’ About a Recession

It’s clear that one of the fundamental worries spooking investors is that the period of coordinated global growth that propelled stock markets higher in recent years is coming to an end.

The First Rule of Fight Club Is...

Occurrences of the word "recession" in stories on the Bloomberg terminal have reached their highest since first week of 2017

Source: Bloomberg

The R word is increasingly cropping up in news articles. But economists put the chances of a recession in the coming year at 15 percent in the U.S. and 18 percent in the euro zone, according to Bloomberg surveys. Even the Brexit-battered U.K. economy is only at a 20 percent risk, while for Japan the likelihood rises to 30 percent. Perhaps those concerns about a recession are overdone.. or perhaps we should remind ourselves how many times economists have actually successfully forecast a recession.

2. Curving to Inversion 

Or perhaps those economists should look to the markets. One trend was omnipresent in 2018 - the relentless flattening of the yield curve in the U.S.

Yields at the short end of the Treasury market pushed higher with every quarterly increase in the Fed’s benchmark interest rate. Longer-dated bonds danced to a different beat, particularly as the October equity shakeout drove a flight to quality.

Flatter Than A Pancake

The flattening trend is spreading further out along the curve

Source: Bloomberg

An inverted yield curve - when yields on shorter-dated bonds are higher than their longer-dated counterparts - is often seen as an indicator of impending recession. It’s finally happened: Yields on five-years are below those for two-years. A key question for 2019 will be how the feedback loop develops between the Federal Reserve’s policy intentions and the shape of the curve. 

3. Quantitative Tightening

The Fed has been reducing its economic stimulus by not replacing the bonds it bought under its quantitative easing program as they mature.

Taking Away The Punchbowl

The Fed's quantitative tightening program is reducing its QE holdings by $50 billion per month

Source: Federal Reserve, Bloomberg calculations

But this “normalization” is already taking its toll, as the sharp equity market sell-off in October showed.

The Fed has a tricky choice to make in 2019 about whether it can persist both with hiking rates and reducing quantitative easing. Is the world ready yet to stand on its own feet without ongoing central bank support?

4. No Alarms and No Surprises

Economic surprise indexes - which measure actual economic data compared to forecasts - are designed to be portents of the future. And for 2018 they largely did their job. U.S. strength is waning, and Brexit is taking a toll on the U.K. In particular the third-quarter weakness in euro-zone growth, when both Germany and Italy turned negative, was well-flagged from as early as the first quarter.

Lack Of Surprise

Economic reality has steadily underperformed hope this year - not much is factored in for 2019

Source: Citi, Bloomberg

It is interesting that the U.S. economic data is reaccelerating lower again recently, tracking China lower. Europe continues to be the worst performer - quite something considering the predicament the U.K. is in.

5. Europe Stumbles

Europe has seen growth falter this year, with Italy’s political crisis and Germany’s diesel vehicle emissions scandal taking their toll.

Wilting Europe

Italy's future orders may have fallen the hardest but it is not alone, only Spain is showing life

Source: Markit, Bloomberg

Italy’s third-quarter growth was revised to -0.1 percent, beating only Germany. The prospects for 2019 are none-too-rosy, bar the notable exception of Spain, as momentum has evaporated. Europe remains in the sick bay of the developed world — just as the European Central Bank prepares to remove its monetary stimulus to the economy.

6. Relying on China

China came to the global economy’s rescue in the wake of the financial crisis, but it is starting to pay the price for increasing its debt to create additional GDP growth. Total social financing as a percentage of gross domestic product — a broad measure of credit creation — is flat-lining. Adding extra debt to boost the economy is becoming a less effective measure. It’s not just the threat of a trade war with America that has pushed Chinese equities down by 20 percent in 2018. 

Keeping The Plates Spinning

China's rising leverage is increasingly pushing on a string

Source: Bloomberg Intelligence

China faces the classic emerging-market middle-income trap where growth fueled by credit runs out of road. This debt bubble will not be easily fixed.

7. Finding Reverse Again

Japanese Prime Minister Shinzo Abe’s famous three economic arrows are failing to hit their mark. Debt that stands in excess of 250 percent of GDP is hampering all efforts to resuscitate inflation and sustainable growth in the world’s third-largest economy. Third-quarter GDP contracted 2.5 percent on an annualized basis, the worst performance for four years.

Backsliding Again

The sun is still struggling to rise in the world's third-largest economy

Source: Bloomberg

Tokyo might be hosting the Olympics in 2020, but there is little benefit flowing through so far. Japan, like the rest of the once dominant Asian export powerhouses, is just as beholden to the outcome of the trade war with Trump as China is.

8. Hunting for Neutral

Until very recently, many economists were anticipating at least four more rate increases from the Fed next year at a pace of one per quarter. The outlook for monetary policy in 2019 has shifted significantly in recent weeks.

Shifting Sands...

The shrinking gap between eurodollar futures contracts for the ends of 2018 and 2019 illustrates waning expectations for further Fed tightening

Source: Bloomberg

Even Goldman Sachs has trimmed its forecast for number of potential Fed rate increases in 2019; billionaire fund manager Paul Tudor Jones said earlier this month that he’s not expecting any additional tightening from the U.S. central bank next year. A halt to the hikes might prove as pleasing to financial markets as to President Donald Trump.

9. Credit Squeeze

Companies with dollar bonds have seen their borrowing costs soar relative to those of the U.S. government as the Fed has driven its benchmark interest rate higher this year. Investors have seen a corresponding slump in the value of the corporate debt they own.

Spreading the Pain

The yield premium on corporate debt versus Treasuries has widened this year

Source: Bloomberg

Any slowdown in the ascent of U.S. borrowing costs as the Fed pauses for breath should give succor to corporate bonds - provided it isn’t accompanied by a rise in defaults.

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But apart from all that - stocks are cheap, right? Traders don't seem convinced...

“I don’t remember December being this bad, which doesn’t make the holidays very wonderful,” said Frank Ingarra, the head trader at NorthCoast Asset Management LLC.

“I don’t think people have any semblance of where it’s going in the New Year. When we get more certainty, they will be able to form a better plan and in general digest the news and react to it. Right now, people are still trying to find their feet and figure out what this means.”

“If you don’t have a few anxieties in markets like this, I have no response,” said Tom Stringfellow, chief investment officer at Frost Investment Advisors.

“The good news is the markets are closed on Christmas.”

Good news indeed.