The Royal Bank of Scotland (RBS) has advised clients to brace for a “cataclysmic year” and a global deflationary crisis, warning that the major stock markets could fall by a fifth and oil may reach $US16 a barrel.
The bank’s credit team said markets are flashing the same stress alerts as they did before the Lehman crisis in 2008. “Sell everything except high quality bonds. This is about return of capital, not return on capital. In a crowded hall, exit doors are small,” it said in a client note.
Andrew Roberts, the bank’s credit chief, said both global trade and loans are contracting, a nasty cocktail for corporate balance sheets and equity earnings, and uncharted waters given that debt ratios have reached record highs.
“China has set off a major correction and it is going to snowball. Equities and credit have become very dangerous, and we have hardly even begun to retrace the ‘Goldilocks’ love-in of the last two years,” he said. Mr Roberts expects Wall Street and European stocks to fall by 10pc to 20pc, with an even deeper slide for the FTSE-100 thanks to its high weighting of energy and commodities.
“London is vulnerable to a negative shock. All these people who are ‘long’ oil and mining companies thinking the dividends are safe are going to discover that they’re not at all safe,” he said.
Brent oil prices will continue to slide after breaking through a key technical level at $US34.40, with a “bear flag” and “Fibonacci” signals pointing to a floor of $US16. The bank said a paralysed Opec seems incapable of responding to a deepening slowdown in Asia, the swing region for global oil demand.
RBS forecast that yields on 10-year German Bunds would fall in time to an all-time low of 0.16pc in a flight to safety, and may break zero as deflationary forces tighten their grip. The European Central Bank’s policy rate will fall to minus 0.7pc. US Treasuries will fall to rock-bottom levels in sympathy, hammering hedge funds that have shorted US bonds in a very crowded “reflation trade”.
RBS issued a dire warning for the global economy in November but events have move even faster than feared. It estimates that the US economy slowed to a growth rate of 0.5pc in the fourth quarter, and accuses the US Federal Reserve of “playing with fire” by raising rates into the teeth of the storm. “There has been severe monetary tightening in the US from the rising dollar,” it said.
RBS said the epicentre of global stress is China, where debt-driven expansion has reached saturation. The country now faces a surge in capital flight and needs a “dramatically lower” currency, a fresh leg of the rolling global drama that is likely to play out fast and furiously. “We are deeply sceptical of the consensus that the authorities can ‘buy time’ by their heavy intervention in cutting reserve ratio requirements (RRR), rate cuts, and easing in fiscal policy,” it said.
Mr Roberts said the tightening cycle by the Anglo-Saxon central banks is already over. There will no rate rises by the Bank of England before the downturn hits, and the next action by the Fed may be a humiliating volte-face and a rate cut.
RBS is not alone in fearing trouble. UBS issued what it called a “significant change” to its house view late last week, saying policy chaos in China had unsettled markets. It cut exposure to equities from overweight to neutral on a “six-month tactical horizon.” It went underweight emerging markets.
Yet there is something strange about the latest events. Austerity is finally over in Europe and fiscal policy in the US this year will be expansionary.
Pessimists warn that unless there is a batch of irrefutably good data from China over the next two or three months, the sell-off could become self-fulfilling and quickly metamorphose into the next global crisis.
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The last time we saw significant financial institutions starting to make noise like this was just prior to the Global Financial Crisis, which gripped the entire globe thanks to the sub-prime lending practices of the Wall Street.
The potential risk in the above to Australia is somewhat alarming; it is no secret the size of China’s trade has buffered Australia from almost all the world’s financial issues. It was this buffer that underpinned the $900 Tax Bonus and the School Building Projects.
As China’s economic growth slows down, and combined with the lack of cash we have available (massive surpluses prior to the GFC meant government stimulus spending was somewhat easy), 2016 could prove a highly volatile time for all Australians.
It’s time to buckle up and prepare for a bumpy ride.
Until next time,
Mark @ Marked Focus
At Marked Focus, your business matters to us.
Mark Peterson is the Director of Marked Focus and leads a network of financial industry professionals to help you know your numbers and make the best possible financial decisions for your professional and personal life.
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