End of the Year

“For last year's words belong to last year's language

And next year's words await another voice.”

― T.S. Eliot, Four Quartets

Another year is going by and it has been nothing but tumultuous – 

• trade war between US and China;
• real wars in Syria, Ukraine & Yemen amongst others;
• Brexit and political fracturing of Europe with the recent riots in France, the budget wars with Italy and right-wing movements;
• Crude prices and markets went on a tear and have cratered towards later part of the year;
• Global liquidity has been declining with the Fed reducing its balance sheet and raising rates and ECB also stopping QE – this puts global liquidity in reverse.

This list can go on regarding the year past but that is not to forget the lessons of the years gone by. But the way things are set up I see the following trajectory into the next 3-5 years:

• The US markets have witnessed the most unprecedented bull run with very low interest rates and quantitative easing. This is now in reverse. The low interest funded buybacks, high yield issuances, frothy tech valuations are all going into reverse. This reversal will have an impact on real estate, consumer confidence and most important US tax collections. The US is already running on twin deficits – current account and fiscal. Any increase in deficit has to be funded whether by domestic or international savings. US domestic household saving with the baby boomers retiring is decline and will continue at least till the mid-2020s. Which means either corporate savings rise to fund this or current account continues to rise. The easiest path to creating this rise in corporate saving and a decline is US debt is massive decline in the dollar. Once the path of Fed tightening is over this is exactly where we are headed and this will have to large.
• US is by far the largest global consumer and settler of global savings, this dollar decline will essentially mean an erosion of export market for key exporters – Japan, South Korea, China and Germany – which extremely negative for their GDP and their banking systems. And, these are the markets in severe demographic decline only needing their export markets to maintain their manufacturing base and living standards.
• Let me explain China a bit more here. China exports is prior to 2008 was roughly 30% of GDP, when the crises hit it fell 25%. It then started the massive banking driven expansion and where we are is Debt to GDP has gone from 100% to 300% of GDP, GDP being ~$13trillion. Today 18% of GDP is exports and 50% of GDP is investments and by most measure 50% of that is a waste in terms of economic value but not employment. Doing the math again excluding the wasteful, 18% * $13 trillion divided by ($13 trillion - $13 trillion * 50% * 50%) = 2.34 / (13 – 3.25) = 24%. We are pretty much at the level of dependency it was post the financial crises, notwithstanding domestic consumer market growing. With its local markets frozen with over-investment, this is why it cares too much about its export market.
• To top this off US in the first time in 75 years in exporting oil. What was in the global market of ~90m barrels a day was importing in excess of ~10m barrels is now exporting. While this is a bloodbath in the shale markets but this has been forcing US shale technology to evolve rapidly Basic Horizontal Drilling (2004) to Advanced Horizontal Drilling (2011) to Pad Drilling (2014) to Multilateral Drilling (2016) and US full cycle breakeven which was the highest in world in 2012 at $90 is today below $40 just above Saudi crude (the lowest cost in the world) and expected to go even lower. This single issue has been causing a nightmare for the Middle-East with a key market disappearing, with that the pricing and the onset of security disinterest (Trump deciding to leave Syria is the latest example).
• Now add lowest cost of energy in the world to a declining reserve currency and you get a paradigm the investment of the living years in not used to. So, what are some of the implications:
• Hoarding of gold by major central banks as in the last few years;
• Manufactured exports especially that dependent on energy or petrochemicals to the US will suffer and north Asia with its premium priced oil supply will be worse off.
• For the global markets:
• The exporter asset markets are in decline as a combination of demography, currency cost and oil (unlike US notice none of these markets have internal energy supply) leave alone increasing defence costs (which I shall not cover here);
• US markets are the most overvalued and will be in decline until the Fed stops destroying money and initiates the next phase of interest decline / QE / dollar value destruction which might initiate in the 3Q 2019;
• India will also witness a decline but the relative decline will be protected by INR strength and low oil price. The next phase when the USD decline comes India is likely to enter the bull market favoured by the triumvirate of exchange rate strength, low interest rate and low / benign oil prices.

o   Political crises in many nations as employment and incomes suffer (look a France / Italy) and US itself has the political divisions become more and more embedded resulting in a more internal looking country and potentially giving up on its security commitments (like Japan which is acquiring carrier battle groups for the first time since 2^nd world war)

“I will honour Christmas in my heart, and try to keep it all the year. I will live in the Past, the Present, and the Future. The Spirits of all Three shall strive within me. I will not shut out the lessons that they teach!”

― Charles Dickens, A Christmas Carol