Many of us get nervous as we approach the year 2018. Some people are expecting “the big restart” which is believed to occur every 10 years. Whether or not this is coincidence, those who believe in the so called 10 year cycle has quite a strong reason to believe that it exists. We have Asian crisis in 1998 which starts from Thailand and then spreading throughout Asia and eventually, all over the world. In 2008 we have the GFC (global financial crisis) which is caused by sub-prime mortgage crisis in the US. Let’s start firstly from the perspective of a technical analyst.
CHART 1 : MSCI World Index
If you are a technicalist, you would argue that the world’s equity market is going to correct soon as it touches its resistance suggested by the trendline (red line). There is, however, a possibility that we will enter the new trend once the index pass the resistance level. I am personally more interested in the 7-8 year cycle.
1998 Asian Crisis : It takes 5 years for the index to go up more than 100% before it crashes and declines for 52% in 3 years time.
2008 GFC : It then takes another 5 years for the index to increase approx. 100% before it reverses and suffers from 60% loss in 2 years time.
In my personal opinion, the 2015 crisis is the big restart people have been waiting for. The Fed enters into normalization of extreme accommodative monetary polity by tapering off the 3 times QE and raised interest rate for the 1st time in almost 8 years. To worsen the situation, China devalues its currencies which indirectly forces other currencies to weaken against USD. These adjustments by the leaders of the world bring the world to the new equilibrium, although we don’t see 50%-60% correction like we see in 1998 and 2008.
Now let’s take a look from fundamentalist (macroeconomic) perspective.
CHART 2 : Manufacturing PMI
This is one of the most important leading indicators in macroeconomic perspective. What is PMI? Let’s take a look on below explanation by Investopedia ( http://www.investopedia.com/terms/p/pmi.asp ).
“The Purchasing Managers’ Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment. The purpose of the PMI is to provide information about current business conditions to company decision makers, analysts and purchasing managers. A PMI of more than 50 represents expansion of the manufacturing sector when compared to the previous month. A PMI reading under 50 represents a contraction, and a reading at 50 indicates no change.
PMI is a critical decision-making tool for managers in a variety of roles. An automobile manufacturer, for example, makes production decisions based on the new orders it expects from customers in future months. Those new orders drive management’s purchase decisions about dozens of component parts and raw materials, such as steel and plastic. Existing inventory balances also drive the amount of production the manufacturer needs to complete to fill new orders and to keep some inventory on hand at the end of the month.
Suppliers also make decisions based on PMI. A parts supplier for a manufacturer follows PMI to estimate the amount of future demand for its products. The supplier also wants to know how much inventory its customers have on hand, which also impacts the amount of production its clients must generate. PMI information about supply and demand affects the prices that suppliers can charge. If the manufacturer’s new orders are growing, for example, it may raise customer prices and accept price increases from its suppliers. On the other hand, when new orders are declining, the manufacturer may have to lower its prices and demand a lower cost for the parts it purchases.”
The chart shows that in 2015 it’s very clear that the world is in a very bad shape. There are many red squares which indicates contraction (slowing business activity) especially in the EM (emerging market) section. It seems that 2016 is the early stage of recovery, more green circles which indicates expansion (growing business activity) especially in the DM (developed market). In 2017 there is no red squares any more, this indicates that the world is moving towards the next stage of economic recovery.
CHART 3 : Bloomberg Commodity Index
Generally speaking, commodity is one proxy we can use to gauge how hot the economy is. Here is the argument; if the economy is going well then more energy is needed, vice versa. It’s quite clear that in 2008 the world’s economy is running hot. At that time people are extremely bullish on US property market, even world’s greatest and oldest banks ignore the risks which then lead to a wound that has yet been healed until today. As we can see from the chart, the black dots shows that in late 2015 we are approx. at the same level as when 1998 crisis hit. Judging from this indicator, I say we are too cold for a meltdown.
CHART 4 : Inflation
Source: World Bank
Inflation is also very flattish and arguably low. So low that in 2015-2016 majority of central banks all around the world reduce interest rates aggressively. BOJ (Bank of Japan) & ECB (European Central Bank) even introduced the NIRP (negative interest rate policy) driving yield to the negative territory. The world is so desperate for inflation which in many times indicates economic growth. Trumponomics bring the animal spririt (higher growth & inflation) to the world for almost 9 months since Trump wins the 2016 US election, but now it’s no more than just a rhetoric promise. As oil price goes back to $45ish, it’s very difficult to expect inflation to go up significantly any time soon.
CHART 5 : GDP Growth
Source: World Bank
Painting pretty much the same picture as inflation does, GDP growth stops declining in 2012 but remain sluggish to the next 3 years. Although not shown in the chart, in 2016 & 2017 there is some improvement. 2015 seems to be the inflection point or simply the bottom of this down trend.
I always believe that as long as the world is spinning, the “mean reversion” theory applies. Anything that goes too high must come down, and anything that goes too low must come up. Although chart 1 (MSCI World Index) shows that we are on a high level, chart 2 to 5 shows that we are somewhere below the mean, if not way below. So who will prevail in 2018? The bull or the bear?
Disclaimer : This note is not a research report. It doesn’t represent any company, institution, or individual. This is not a recommendation or suggestion. Information and data are collected from various public sources. Reader should be able to distinguish between fact on opinion.