Forces continue to unfold evidencing a slowing global economy. Chinese exports show little signs of growth. Imports are down. Industrial commodities have suffered as a result. Abenomics has yet to turn around the Japanese economy. The policy has successfully depreciated the yen and inflated the Bank of Japan’s balance sheet. Progress on structural reform has been missing in Japan, much as it has in most of the developed world. Europe continues to languish, with Greek problems resurfacing and some countries slipping into outright recession. Quantitative Easing (QE) has improved asset prices, but not underlying economies. Even in the United States, the one global success story, the Purchasing Managers’ Index for manufactured goods was down 1% from last year. Production was -2.9%, and new orders were -7.1%.
We have discussed in recent commentaries the dramatic declines in oil prices. Lower oil prices will benefit oil consuming regions, like much of Asia and Europe and hurt others. Countries such as Iran, Russia and Venezuela that depend on high energy prices to meet budget requirements are clearly disadvantaged. Booming areas within the U.S. will have to adjust to the new reality, while the consuming public will enjoy broad relief. But, such significant moves as we have witnessed in recent months will have consequences beyond the obvious. We do not know what will happen. A possible breakdown in credit markets could have serious repercussions.
The Swiss National Bank (SNB) surprised world markets last week by abandoning the Swiss franc peg of 1.20 to the euro. With the European Central Bank possibly pursuing QE to stimulate economic growth, the Swiss came to the realization that they could no longer afford to expand the SNB’s balance sheet to maintain the currency peg, fearing the creation of asset bubbles at home. As stresses continue to unfold, we may see more countries act in their own self-interest.
Although there are a lot of risks in the global market place, it is important to recognize that most of the significant market downturns in the U.S. have had domestic causes. The severe 1973-1975 recession was due largely to excess inventories. The Arab oil embargo and rising commodity prices aggravated the recession. The dot com bubble that culminated in early 2000 was purely a domestic phenomenon. A lot of us remember that, after a parabolic rise, the NASDAQ dropped a painful 78% to its low in October 2002.
The 2007-2008 credit crisis had its origin in the securitized subprime mortgage paper that was sold globally. Housing prices collapsed in the worst recession since the 1930s, spawning bank bailouts and monumental fiscal and monetary stimulus. The crisis had global repercussions because real estate prices had risen to speculative levels in many countries, and banks were over levered.
When the Japanese juggernaut of the 1980’s collapsed in 1989, it barely caused a ripple in the U.S. The 1990-1991 recession, with a minor dip in the S&P 500, may have had more to do with Iraq’s invasion of Kuwait than to Japan’s woes. The Mexican peso crisis in the 1990s had little effect on the U.S. stock market. The Asian financial crisis began in 1997 when Thailand devalued the baht. It spread though the region with Malaysia, Indonesia and the Philippines being forced to devalue significantly. Several large brokerage firms and banks in Japan and South Korea collapsed. In August 1998, Russia defaulted on its debt and devalued the ruble. The crisis even spread to Brazil and Argentina. Long-Term Capital Management (LTCM), the U.S. hedge fund, was forced into an orderly liquidation. Partners and investors lost 90% of their money. Volatility did increase during this period, but the U.S. economy remained strong and the S&P 500 advanced to new highs.
Although there is little evidence that international disturbances have had a major impact on U.S. stock prices, slow economic growth and increased globalization have not made us complacent. Deflation is a new challenge for western economies. Competitive devaluations, zero interest rates and QE have not revived economic growth in any major country. It will take several years for the deleveraging cycle to come into balance. While we are constructive on U.S. equities, we expect increased volatility and currently favor defensive sectors.
John Hess 
Falgun Jariwala 
Managing Principal Managing Director
jhess@nsinvestors.com fjariwala@nsinvestors.com
www.nsinvestors.com www.nsinvestors.com
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