Is A Global Capex Boom Coming?
As you can see in the four charts below, the global capex cycle is about to increase. The first chart shows the historical global investment growth. After spending a few years below the average since 1990, Morgan Stanley is forecasting it to improve. The global economy appears to be emerging from a mid-cycle slowdown. Emerging markets rebounded in 2017 after a having a few bad years. They are looking to accelerate in 2018 especially India and Brazil.
The second chart on the right shows this breakdown I discussed. The emerging markets excluding China didn’t have much capex growth for about 3 years before accelerating last year. China’s capex growth is decelerating as its overall economy continues to see lower GDP growth; it appears 2017 was a temporary blip up for Chinese GDP growth. The G3 economies have led capex growth for the first time in at least 13 years. To be clear, the G3 countries are America, the EU, and Japan. They are mostly developed nations which have finally recovered from the financial crisis which is prompting hawkish policy from their central bankers.
The third chart on the left shows global fixed capital formation and an investment tracker which both exclude China which seems to be on a separate track downwards. The investment tracker is at the highest level since 2011 which signals fixed capital formation growth is about to pick up even more. The table on right shows the specific projections for each region. As you can see, China is slowing down, but the rest of the emerging markets are expected to pick up the slack. Global fixed capital formation growth is expected to be 4.1% in 2018 which is up from 3% in 2017.
Effect Of Fed Unwind & Deficits
I’ve discussed the unusual problem which faces the treasury market. The tax cut was passed at a terrible time because the economic cycle is almost over. It also increases deficits at a bad time because the Fed is unwinding its balance sheet. Treasuries might see the most selling pressure in years, pushing yields higher. The chart below shows the historical deficits combined with the changes in the Fed’s balance sheet. The stock market is being hurt by the 10 year bond yield going above 2.7%. If this policy goes through, the 10 year bond yield might go much higher. Furthermore, in the next recession, deficits will explode which might force the Fed to back up the debt with QE. As I mentioned previously, this balance sheet unwind will start to make Fed policy more hawkish than it appears. The Fed will be very hawkish next year which could cause a recession.
Government Shutdown Ends
The government shutdown ended in less than a day as the President signed a $400 billion budget deal on Friday. The House voted in favor of the bill 240-186 which passed in a bipartisan fashion with 73 Democrats and 167 Republicans supporting it. This plan is $300 billion above the spending caps set in 2011. It is now clear the debt will skyrocket even if the economy grows. The government re-opening is good for the stock market in the short term, but there will be pressure on the treasury market in the next few years. There appears to be some sort of correlation between deficits and yields in the past few years as deficits were the lowest in 2015 and the treasury yields bottomed in the summer of 2016. The treasury market isn’t just affected by deficits and the Fed’s balance sheet. It’s also affected by the cyclical economic factors like inflation, investor demand, and economic growth. The increase in supply doesn’t necessarily mean yields will increase, but it certainly adds some pressure to the market.
My Updated Thinking On Global QE
I went into this year with an open mind when it comes to how the markets will be affected by the changes in the QE policy by global central bankers. I originally thought the market would be weak in 2017 as the central bank policies unwound. This didn’t happen. Therefore, I became more cautious about predicting weakness as a result of this policy change continuing in 2018.
However, there’s a way to rationalize the market’s behavior while maintaining the notion that the QE unwind will be bad for risk assets. It’s important to recognize that in the first quarter of 2017, QE was still strong. The ECB started its tapering in April. The Fed started its unwind in October. While the total bond buying was lower in the 2nd half, stocks may have been boosted by the prospect of tax cuts.
Then in January 2018, the ECB tapered its bond buying by €30 billion and the Fed increased its total unwind to $20 billion per month. With the stock market’s vertical leap higher in January, I was ready to throw in the towel on the thesis that this new monetary policy would pressure risk assets. Now with the recent decline, I’m open to switching back to thinking this global tapering is bearish for stocks. My thinking is that the stock market went up in January largely because retail investors went all in. I don’t think that record retail sentiment will be matched for many years. Therefore, now that the market is back to normal, we’re seeing a decline. I wish I could say with certitude how these new policies will affect stocks, because it would make predicting the next two years become very easy: stocks would plummet especially in 2019.
Therefore, I’ll maintain my hybrid perspective on QE which is that the Fed’s unwind and the ECB’s tapering will cause more volatility in stocks. So far, this has been correct. It’s worth noting that being open to both sides of the argument was advantageous. However, I think the situation will be made clear in the next 6 months. Just saying volatility will increase won’t be enough if stocks are about to enter a bear market because of this policy change. The chart below maps out the bearish case for stocks now that the era of QE looks to be over, at least temporarily.
Don Kaufman: Trade small and Live to trade another day at Theotrade.
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