Tuesday, January 21, 2014 - Real Risks

Real Risks

by Sinclair Noe

DOW – 44= 16,414
SPX + 5 = 1843
NAS + 28 = 4225
10 YR YLD unch = 2.82%
OIL + .67 = 95.26
GOLD – 13.00 = 1242.70
SILV - .41 = 20.01

Wall Street’s attention this week will mainly focus on earnings reports given the dearth of economic data. There are only a few important economic reports this week, all of which will be released on Thursday. Thursday’s reports include the November FHFA housing price index (expected +0.3% m/m), December existing home sales (expected +1.0%), and December leading indicators (expected +0.2%). The Treasury on Thursday will sell $15 billion of 10-year TIPS. The markets will be looking to next week’s FOMC meeting where the consensus is that the FOMC will taper QE3 by another $10 billion to $65 billion per month.

Global stocks found support as Chinese money-market rates dropped after the People’s Bank of China added funds and expanded access to a lending facility after the 7-day repurchase rate had surged 153 basis points to a 1-month high of 6.32% on Monday. In an attempt to alleviate a liquidity squeeze, the PBOC added more than 255 billion yuan ($42 billion) into the financial system and will allow small and medium-sized Chinese banks to access its Standing Lending Facility for loans of up to 2-weeks on a trial basis before China's Lunar New Year holiday begins on Jan 31; this was in addition to a liquidity injection made just yesterday for an unspecified amount.

The yield on Portugal's 10-year government bond fell below 5.00% for the first time since Aug 2010, reducing concerns about sovereign debt. Gains in European stocks were muted. The German January investor confidence unexpectedly dropped for the first time in 6 months. Japanese Economy Minister Amari warned that his country still faced the risk of falling back into deflation, which undercut the yen on speculation the BOJ may press ahead with additional stimulus.

The International Monetary Fund is slightly more optimistic about the world’s economies this year than it was three months ago.  The IMF updated its forecasts that the world economy will grow 3.7% in 2014 and that the US economy will grow 2.8%. The global forecast is 0.1 percentage point higher and the US forecast 0.2 point higher than the IMF's October forecast.

After a sluggish start, global economic growth picked up in the second half of 2013. As a result, growth amounted to 3% last year. The IMF expects it will be even stronger growth this year.

The IMF forecasts that the US economy grew 1.9% last year, and they are forecasting 2.8% growth for this year, which would match US growth in 2012. Part of the anticipated improvement is based on expectations for less drag from higher US taxes and across-the-board spending cuts. By 2015, the IMF forecast the US economy will grow 3%, or 0.4 percentage point lower than its October forecast. So, 2014 revised higher and 2015 revised lower. The IMF reduced its outlook because a recent budget agreement left in place most of the spending cuts. The IMF had expected most of those cuts to have been eliminated by next year.

The IMF forecasts stronger growth for the Eurozone as it tries to emerge from recession after a lingering debt crisis.  Economic activity shrank 0.7% in 2012 and 0.4% in 2013. But this year the IMF projects 1% growth and 1.4% in 2015. Germany, the biggest economy in Europe, will grow 1.6% this year it projects, up from 0.5% growth in 2013.

China is expected to grow 7.5% in 2014 and 7.3% in 2015. Both 2014 and 2015 projections were slightly higher than the IMF's October forecast, but lower than the 7.7% growth reported for 2013.  The IMF said that growth in China, the world's second-largest economy, had rebounded strongly in the second half of 2013 due to acceleration in investment. But the IMF said the growth will moderate because of actions by the government to slow growth in credit.

For Japan, the IMF forecast growth of 1.7% this year, the same as 2013, but a slowdown to 1% growth in 2015.

Citing high unemployment and low inflation, the IMF said that the United States and other major economies should be careful not to pull back prematurely on the economic support being provided by the Fed and other central banks.

A survey finds that CEOs around the world are more confident in the global economy. Accounting and consulting firm PricewaterhouseCoopers, which conducted the survey, said the world's corporate leaders are "gradually switching from survival mode to growth mode." That improved optimism could lead to more investment, growth and jobs.

Activists, however, warn that wealth inequality is a growing and pressing concern that needs to be addressed. PwC's findings came as political and business leaders gathered in the Swiss ski resort of Davos. Each year they got together on a mountaintop to congratulate themselves, network with each other and confer about how best to bring order and prosperity to humankind; and of course, how they can profit.

Nobody at Davos will come right out and say that they are trying to rule the world; that would be far too crass; especially in light of the World Economic Forum’s most recent publication, Global Risks 2014. The study, issued by the charitable organization Oxfam concludes that the “the chronic gap between the incomes of the richest and poorest citizens” is the greatest threat to stability that looms in the next decade.

The study revealed some remarkable statistics. The 85 richest people on Earth have the same amount of wealth as the bottom half of the population. Those wealthy individuals are a small part of the richest 1% of the population, which combined owns about 46% of global wealth. The study found the richest 1% had $110 trillion in wealth -- 65 times the total wealth of the bottom half of the population. Seven out of 10 people live in countries where economic inequality has increased in the last 30 years.

That bottom half of the population owned about $1.7 trillion, or about 0.7% of the world's wealth. That's the same amount as owned by the 85 richest people. It is a little crazy that more than 3.5 billion people own less than 85 people, roughly the number of people who could comfortably sit on a bus – not that they would actually sit on a bus. Nowhere is inequality more pronounced than the United States, where the very greatest amount of resources are owned by the very fewest people. In the US, the wealthiest one per cent captured 95% of post-financial crisis growth since 2009, while the bottom 90% became poorer.

The Oxfam report says that the global economy has become so skewed in favor of the rich that economic growth in many countries today “amounts to little more than a ‘winner takes all’ windfall for the richest.” The report warns that democratic institutions are being undermined as an increasing amount of wealth is concentrated in the hands of the richest, making it ever easier for them to influence policy to enrich themselves further. The report calls this process “political capture.”

Oxfam sees a risk to both democratic institutions and to social stability in these trends. The report does recognize that “some economic inequality is essential to drive growth and progress, rewarding those with talent, hard earned skills, and the ambition to innovate and take entrepreneurial risks.”; but “the extreme levels of wealth concentration occurring today threaten to exclude hundreds of millions of people from realizing the benefits of their talents and hard work.”

Pope Francis challenged business leaders assembled in Davos to put their wealth at the service of humanity instead of leaving most of the world's population in poverty and insecurity. The Pope’s message said, in part: "I ask you to ensure that humanity is served by wealth and not ruled by it," and it went on: "The growth of equality demands something more than economic growth, even though it presupposes it. It demands first of all 'a transcendent vision of the person'."

The World Economic Forum is looking at other threats, not just inequality. The recent hack of Target merely reinforced the possibility of “Cybergeddon” in the online world, and that possibility, taken to just a little extreme could result in a frozen neural network which controls, among other things, the global financial system. Once again, the Masters of the Universe gathered at Davos will talk about the challenge of climate changes and the related hurricanes, floods, polar vortexes, droughts, and other extreme weather. Once again, the Masters of the Universe will face the reality that they can’t control the weather. And there will be a bunch of people guessing who among the 85 is in attendance.

Maybe that guy, maybe that guy, maybe some other guy. There are lots of guys in Davos this week; not many women; only about 15% of the 2,500 attendees. Organizers say it’s simply the reality of today’s world.

So back to the real concern for the Davos attendees – how to make more money. For the answers we turn to the global central bankers. After an unprecedented bout of experimental monetary policy and money printing, the Federal Reserve wants to reset policy to the pre-crisis mode to avoid another credit bubble. Meanwhile, China is trying to implement financial sector reforms to bring a credit bubble to an end. So, the real risks look  like slower than forecast US growth, possible Eurozone deflation, not enough structural reforms in Japan, and bad loans in China; there will doubtless be other risks that crop up.