|Summary: Markets continue to gain ground, but senior executives have picked up a number of global signals on their radar screens that point to potential issues ahead. They include fears of a new GFC (at some point), ongoing structural issues in Europe, the tapering of the US stimulus program, and an easing of growth in China. But don’t panic. The signals could just be white economic noise.|
|Key take-out: Citigroup has forecast another major round of European sovereign debt and unsecured bank restructuring as soon as the German election is completed next month.|
|Key beneficiaries: General investors. Category: Economics and strategy.|
Last night was full of bullish signals for global markets. The easiest path for a commentator is to jump on the upward bandwagon. Yet, this morning as I looked at an array of deeper events, I found myself being bombarded with sharemarket correction warning signs. I am always nervous about predicting share corrections, especially when the market itself looks, at worst, benign. But I would not be doing my job if I did not pass on the warning signs crossing my desk.
I hope these signs are wrong, but I fear they are not. But please do not prepare to jump off a cliff. I am urging caution not suicide.
Some of the warning signs are specific to Australia, but there are also a series of global warnings. I will start with the global warnings. My first alert came from the CEO of the National Australia Bank, Cameron Clyne, who predicted that “another global financial crisis was inevitable”.
“There will be another GFC, I don’t know when, but there will be.” Clyne then added that the Australian bank funding market needed to create a “greater degree of resilience to shore up investing during the next crisis”. (I read that as meaning that it will be dangerous to cut deposit rates too far in the next round of Reserve Bank interest rate reductions so borrowers will absorb some of the burden.) Cameron Clyne would not have issued such a global warning if he was not receiving the same signals as me. (Indeed, US bond yields jumped last night).
US 10-Year Treasury Bond Yield
My next signal came from Citigroup’s global chief economist Willem Buiter, who forecast a major round of sovereign debt and unsecured bank restructuring as soon as the German election is completed on September 22. Buiter says that soon after the election, Greece will ask its lenders for a haircut of its debt and Portugal and Ireland will not be far behind. Cyprus will also need another round of haircuts because the authorities got their “maths wrong”. Buiter also wonders whether Italy and Spain are safe. Of course, if those crises play out as Citicorp expects then Europe’s banks will be hit hard. The Citigroup economist says Europe’s banks are $US1.5 trillion short of the capital they require, and that means massive bail-outs for governments and banks. Citigroup believes the action will start in 2013. It is no wonder that Cameron Clyne issued the warning.
The United States
And then we go to the US where, despite recent statements, Buiter believes the US stimulus program could be wound back as early as September because QE3 is now having very little impact on demand. To be effective the Federal Reserve would have to move to buying riskier assets rather than their current policy of buying only high-quality mortgages. Once the US slows QE3 it means that American interest rates will rise, as will the US dollar. If it happened that both the European situation and the American reversal took place at the same time, then we would indeed get something akin to a global financial crisis – a reason for delaying a QE3 wind-back a few months, but it’s coming. The US faces another round of sequester automatic budget spending cuts before 2013 is out.
Citigroup underline what we have been saying in Eureka for some time, that there is considerable strength in the US economy. At least, in my view, the current strength of America is underlined by the fact that it is cutting back its government spending by an amount equal to around 2% of GDP, yet it is still growing at 2% per year. The American economy is looking stronger by the day, although more sequester cuts could interrupt progress. We all know how nervous markets become when there is a strong whiff of QE3 being withdrawn, because a huge amount of the share and commodity speculation comes out of liquidity in the US and their low interest rates. Of course, while Australia relies on Europe for a substantial portion of its bank funding, it is China that is the key for our country.
I have been nervous about China for most of 2013 because I could see the growth pattern of the Chinese was swinging away from resource intensive activity. That can only be bad news for Australia. But one of the China bulls has been the former Australian Ambassador for China, Geoff Raby, and I have a great respect for Geoff . But he is alerting now that the Chinese Government looks as though it is serious about restructuring their economy, and so the Chinese are now concentrating on municipal government debt and they have imposed a five-year moratorium on the construction of government buildings. In addition they are cutting back excess production capacity in 19 key industries including steel, non-ferrous metals and construction materials.
The Chinese have made similar moves previously, and then gone back on their undertakings, but this time it looks like they are serious. Not good news for Australia.
It is no wonder that the confidence of the Australian chief financial officers fell sharply in the latest quarter. The Chinese slowdown fears weighed heavily on the outlook of our CFOS, according to a Deloitte survey .
But you don’t need a CFO survey to realise that business activity in Australia is slowing. The latest manufacturing figures show we are way down and building loan approvals have declined. Thanks to Kevin Rudd, our motor vehicle orders are down 20%, and the decline is accelerating; and, of course, we have lower mineral prices and mining investment. Treasury often misreads trends in the business community, but in 2013 it is now clearly alarmed. That is why Treasurer Chris Bowen yesterday announced his draconian tax measures. It is a desperate attempt to shore up falling revenue both in the current year and longer term. In the process it will hit consumer demand. That falling government revenue is a proxy for lower 2013-14 profits. Stockbrokers Baillieu Holst yesterday made a bold prediction that they were concerned that earnings forecasts by analysts could be downgraded by 8%. “Our earnings model based on commodity prices and credit flows, combined with concerning growth signals, points to such an outcome”, Baillieu says.
That Baillieu research really sent a shiver down my spine, because it clearly will not be an even 8% reduction across the board. A number of stocks will escape and others will be hit much harder. The downgrade will not be so much for the year ended June 30, 2013, but for the current financial year. When analysts get it wrong they usually panic and their clients dump stock.
And remember we are already seeing the Australian dollar fall below US90 cents. That is causing overseas investors to become nervous about Australian share and property markets. We have seen before that a vicious circle can develop as shares and the currency fall because overseas investors are selling. That may not happen in 2013, but we have danger signs. And, finally, if Kevin Rudd is re-elected there is a danger of a big increase in selling. My guess is he won’t be re-elected but that is not what the opinion polls are saying. Once again, I repeat this is a caution and not a panic signal, but it was a rather frightening evening last night.