Although markets seemed to really quieten down ahead of the long Easter weekend, there was still enough happening and enough on the near horizon to keep us on our toes. Rather than dive into a long essay like we did last week, we will just have a look at a couple of things that have caught our eye.
First, the third revision to fourth quarter US GDP was released on Friday, and with that came the calculation of corporate profits, as measured on a national accounts basis. As expected, corporate profits on this measure were horrible, falling more than 11% year on year. We have said many times that declining corporate profits leads the US into recession as shown in chart 1 below. The only major false signal in the last 45 years was in 1986, which interestingly was the last time that the oil price collapsed at a time when US oil production was close to current levels.
Chart 1 – US Corporate profits (year on year % change) and Real GDP
Companies’ own pro forma results are expected to decline by about 9%, year on year, in the first quarter of 2016 so we will just have to wait and see whether the corporate sector finally starts dragging the economy into recession or whether the consumer (who is still keeping the US economic engine sputtering along) will be strong enough to keep the US just above stall speed. The start of the US quarterly results season is only a couple of weeks away, and it feels like it could be a very important quarter for US companies, particularly the message they give to investors about the outlook for the year ahead.
Second, we came across an analysis from Horseman Capital linking the performance of the Japanese equity market to the US. The thought process is that the US has run a persistent current account deficit in recent decades, and this needs to be funded by someone else’s capital. The world’s biggest saver continues to be Japan who has been funding the US for years. Of course, all current account deficits will be funded, but at what price? In the words of Horseman Capital, “My view is that the Japanese are the world’s biggest net savers and investors, and it is the movement of Japanese investments that cause the biggest moves in currencies and equities.”
The point of the notes is to illustrate that the Japanese equity market has peaked 3 to 6 months ahead of the S&P 500 at the last two peaks in 2000 and 2007, as can be seen in chart 2 below.
Chart 2 – The US and Japanese equity markets
The chart also shows that the Japanese equity market peaked last summer. So far, this looks to be coincident with the peak in the US although clearly Japan has underperformed in recent months, perhaps leading the way as in 2000 and 2007.
This begs questions over capital flows in general, and the increasingly disappointing performance of Japanese equities despite massive QE from the Bank of Japan (same for European equities after a year of QE from the ECB). To keep this note short this week, we won’t delve into this any further; simply leaving this out there as an interesting thought. We would point out that we have looked at global liquidity in recent weeks and in particular the change in global FX reserves and how they rise and fall with asset prices. Needless to say, when global FX reserves are falling, and domestic asset prices of the world’s largest savers (Japan and Germany) are falling, then perhaps it’s only a matter of time before even the mighty US equity market stumbles. (FX is the focus of the RMG FX Strategy – our recently launched UCITS compliant fund – see HERE for details).
For many months now, we have been trying to articulate how we feel that equity markets, the US in particular, are overvalued. With corporate earnings now declining, economic growth stalling, central bank credibility falling and global liquidity tightening, we find it very difficult to be bullish and all too easy to be bearish. Add in geopolitical concerns and structural headwinds like demographics (Japan and Europe in particular), poor productivity and high and rising inequality and our bearishness only increases.
Stewart Richardson, Chief Investment Officer
