Rabobank: Equity Markets Are Pricing In No Risks At This Moment

Submitted by Michael Every of Rabobank

Scar Tissue

Yesterday UK Chancellor Sunak warned that instead of the V-shape many are still hoping and pricing for, the economy could instead experience “permanent scarring”. Quite. We have long been of the view that the GFC left deep scars on the global economy, most so in developed economies, with lower growth, lower wages, lower inflation, and lower productivity in its wake. We lost strength and stamina even as we gained some kinds of ‘flexibility’; indeed, the flexibility was part of the problem for some key economic muscles.

This process accelerated the already-evident structural gap between winners –in places like London, and doing things like going long property– and losers everywhere else and/or trying to work for a living instead of speculating. It also closed the relative power gap between liberal developed and illiberal emerging markets from both the bottom up and the top down. As was pointed out in ‘Thin Ice’ back in early 2016, the result was the global paradigm most thought was always going to be ‘just the way things are’ was a mile wide and yet an inch deep – and we were likely to fall through ice into the cold waters below.

Well, here we are.

• A world where populism is normal. A Hard Brexit world – as the UK announces the range of tariffs that it will be slashing ahead, a clear signal it won’t be sticking to the EU external tariff barrier, and hence “the negotiations will be short.”

• A world where a US senator asks Treasury Secretary Mnuchin in online testimony how many people have to die in order to raise GDP by 0.5%, or to add 1,000 points to the Dow; and where Fed Chair Powell is asked by another senator why rent relief is not being offered in the US alongside trillions in corporate bailouts, and he mutters something about substantial forbearance already being in place before moving on. (It is for mortgage holders: renters benefit from being protected from eviction –for now, and only in some states– while in some others can pay rent with up to 60-days arrears.)

• A world which no longer has a functional WTO –sorry Australia in your beef and barley beef with China– and soon perhaps no WHO either.

• A world in which the South China Morning Post runs four linked stories: one says this week’s National Party Congress in Beijing will see a 7.5-9.5% increase in defence spending despite a weak economy (all that excess steel has to go somewhere, I guess, but it’s very “guns and butter”); and another also underlining growing risks of military conflict with the US (albeit from a low base). That’s as US Secretary of State Pompeo congratulates the Taiwanese President on her inauguration following an election she won on a rejection of One Country, Two Systems, a further diplomatic red flag to the red-flag bulls; and as it is also reported that US consumers are turning away from Made in China produ­­cts just as Chinese buyers turn away from US goods.

Can you imagine how much worse all this is going to get if Mr Sunak is right –and I fear he is– and global economies, including China, suffer permanent scarring? How do we all deal with it? How do we perhaps distract from it?

Yes, “more liquidity” will be needed. But we had that post-2008 too yet it did not stop 2016 happening. We also had it in the 1930s. That does not mean war looms: but the risks of global supply chains fracturing and related currency/trading blocs emerging are.

Europe needs to consider this deeply as less than 24-hours after news broke that the financial and political Rubicon was finally being crossed as France and Germany proposed a limited new meta-European borrowing facility, it was subsequently reported Austria, Denmark, Sweden, and the Netherlands are all opposed to the idea. It seems very deep scars in the EU body-politic from birth do not allow it the flexibility to turn its head to see just how much deeper the economic and geopolitical problems are about to simultaneously get. How 1930s again.

None of this is being priced by equity markets –just bonds and the strong USD– as those in power do all in their power to divorce from reality. This makes sense if the economy is going to bounce back rapidly: it’s better to prevent a GFC 2.0 and wait for GDP to catch up to where markets have been suspended. Yet if there is no virus vaccine, and yesterday’s Moderna headline was rapidly shot down by one source noting that there was a deficit of data and a surplus of fuzzy, stock-price-ramping words, then where does that leave us? More of the same- until it all goes wrong. I can think of a song that might clarify things:

Scar tissue that at last you saw; Sarcastic market know-it-all

Close your eyes and it’s still true; ‘Cause with the bears I’ll share

With the bears I’ll share this lonely view; With the bears I’ll share this lonely view

Prop up markets up against the wall; bear-market rally in a push-up move

Ah, no fallin’ all over myself; To short your stocks and preserve my wealth, ’cause

With the bears I’ll share this lonely view…

No stop-loss in a bathroom stall; As stocks try to fall

Wave good-bye to real markets Pa; ‘Cause with the bears I’ll share…

Can’t speak truth with a broken jaw; Market-ramping stories full of drawl

Stocks are sweet when they can’t fall; They’ll make it to the moon – don’t put, just call

But with the bears I’ll share this lonely view; With the bears I’ll share this lonely view

With the bears I’ll share this lonely view.