Global Crisis 2.0? Not So Fast

February 03, 2016

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Tyler Mordy, president and chief investment officer of Toronto-based Forstrong Global.

In a much-celebrated quote on his 50th birthday, the late David Bowie boldly declared to an audience at Madison Square Gardens, “I don't know where I'm going from here, but I promise it won't be boring.”

Recent financial markets carry echoes of those immortal words. In the opening days of 2016, action has been anything but dull, and investors are once again disoriented.

Where to from here? At panic points like this, it is useful to revisit the role of the portfolio manager: Why do clients pay us to manage their wealth? It is not for flawless clairvoyance. Rather, we are paid to anticipate probable risks, prepare for opportunities and, importantly, not proverbially lose our minds when everyone else has lost theirs. That requires a disciplined, unemotional process. In that spirit, let’s proceed with rational faculties intact.

The Market That Fell To Earth

To be sure, markets are reacting to some legitimate macro fears. The Fed has taken a step (albeit, a baby one) away from ultra-accommodative policy, China’s longer-running agenda has been poorly communicated and global demand remains structurally deficient.

Yet, apparently no one—not even the usually bullish chorus from mainstream media—can find a positive catalyst. Not even one. Really?

Consider the following factors, all of which argue that a global recession with an attendant bear market is not yet in the cards:

Stop Worrying (Or, How You Can Learn To Love Low Oil Prices)

Investors have been treating the decline in oil prices as a leading indicator of weakness in global demand, even though it is much more of an oversupply story. This view is reinforced by the always-immediate appearance of the downside of collapsing oil prices in the regions and sectors that experience difficulties. And, it is evident in market action. Incongruously, correlations between oil prices and the U.S. stock market are the highest in years.

Consider The Flip Side

Cheap oil is a very powerful stimulant for global growth. This will become more apparent as the positive impact on global consumption, investment and liquidity materializes over time. In fact, falling oil prices have never correctly predicted an economic downturn.

On all recent occasions when the oil price has at least halved, faster global growth followed. Conversely, every global recession in the past 50 years has been preceded by a sharp increase in oil prices.

Huge Wealth Transfer Is Now Underway

Because the world burns 34 billion barrels of oil every year, a $10/barrel decline in oil shifts roughly 340 billion from oil producers to consumers.

Thus, the enormous price fall since August 2014 will easily redistribute more than $2 trillion annually to oil consumers, providing a bigger income boost than the combined U.S. and Chinese fiscal stimulus in 2009.

‘Sell Everything’ Sentiment

Since 2008, we have argued that post-financial crisis periods are a different animal. Investors, still carrying crisis-made scar tissue, tend to cling close to shore. Endless financial crisis fears prevail. Yet markets continue to scale a “wall of worry.”

This time has not been different. Recent stock market losses have again brought out bearish voices announcing an imminent crisis 2.0. (prompting one colleague to wryly observe that, if the bears are right, this would be the “most forecast crisis of all time”).

Our behavioral models paint a different picture. Whether measuring retail fund flows, futures positioning or investor sentiment, all point to maximum pessimism. That argues negative views are already discounted in markets, paving the way for positive surprises ahead. Here, a number of catalysts exist—a firming eurozone recovery, a clearer agenda communication from Beijing or, even, better-than-expected U.S. corporate profits due to topline revenue gains.

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