I wonder, when did we lose it? When we missed a warning sign that supposed to alarm us? When did discussions start to transform into arguments and opinions replaced with perceptions? I tried to find answers to these questions and I failed.
Perhaps I could not find an answer because the transformation process was very slow and took several decades to achieve its current stage. The slow speed of this backward journey did not trigger an alarm in our mind until it became apparent that regress has reached an advanced stage.
Today we can notice loudly screaming signs of it almost in every aspect of our life on daily basis, be it social, cultural, economic or political spheres. At times we think that it would be wiser to ignore it. We assume that there is nothing to worry about. We think that if we ignore it, it would just go away.
Initially I thought so too, but lately, I started to suspect that choosing not to pay attention is a mistake. I realized that the true nature of these ugly anti-cultural signs is not as harmless as it might seem.
Naturally, a significant drop in standards has affected the business decision-making process. It is especially well defined when it come to the financial markets. If we listen to what experts say during an interview with Bloomberg and CNBC, it would be convincing enough for us to realize that the further we go the less we are connected with reality.
Before I get into details, I would like to highlight that when a trend leads to a departure from principles of common sense (balance/gold middle), inevitably, it will end up in crisis. I assume that the global financial system began to separate itself from common sense a while ago by making the rules more and more complex. But a high level of complexity does not necessarily mean that high level of efficiency would follow.
The greater the system’s complexity, the less clarity it delivers. Of course, the lack of clarity in combination with the lack of common sense is a recipe to produce an impressive set of manipulation methods which could be the reason for all troubles we face today.
To illustrate what I mean, we may take a look at modern aviation or IT industries. Modern airplanes are very complex and it takes more than a million parts to produce a plane. However, all airplanes have to be designed in line with fundamental and very clear laws of physics. If we do not apply these laws precisely, the level of complexity would be absolutely irrelevant even before the first plane is manufactured.
The same goes when we talk about IT business which has reached the unbelievable level of complexity. But the basis for all of it is 2+2=4. It is not 4 +X% premium or x4 multiples. 2+2 is always 4. It was 4 since forever, it is 4 now and, most likely, is going to remain as 4 in many millenniums to come. If we replace 4 with something else, it would make even the most complex system dysfunctional.
So, with the above in mind, let’s look at numbers.
In May 2017, National Bank of Canada published its Monthly Economic Monitor Report whereby it highlights that the latest IMF’s downwardly revised forecasts for changes in the structural balance were mostly due to the U.S. in anticipation of upcoming tax cuts from the Trump administration, although France and Germany were also deemed to have growth-oriented fiscal policy this year to a larger extent than what was expected back in October 2016.
National Bank of Canada points out that there are significant risks that could derail growth. Of primary concern is the rise of protectionism. Last year saw discriminatory measures vastly outnumber measures aiming to liberalize trade, which eventually led to the weakest GDP growth print the global economy has seen since the 2009 recession. Things could potentially get worse in that regard. While those problems are not new, they are now more destructive than ever given the larger sensitivity of increased integration of global economies.
I agree that protectionism might have worked before but in today’s world, it is no longer relevant. However, I am not sure that 2.2% of the US growth forecast could be qualified as growth. I think it may be the case unless it is adjusted for inflation and interest rates. If it is not, it might be doubtful.
If we consider that 2017 US GDP expected to be at 2.2%, but inflation is 2.3% and the targeted interest rate is 1.5%, in today’s value GDPt could be less than that, if not 0% actual growth.
As far as I understand there is no clear answer whether the adjustments were made. Investopedia explains that the Federal Fund’s rate is the rock-bottom rate at which money can change hands between financial institutions in the United States. While it takes time to work the effects of a change in the Fed Funds rate (or discount rate) throughout the economy, it has proved very effective in making adjustments to the overall money supply when needed.
Please click the link if you would like to read more: The Importance Of Inflation And GDP http://www.investopedia.com/articles/06/gdpinflation.asp#ixzz4gPSFCSPM
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But now we know that, due to its lack of experience and poor organizational skills as well as little understood ties with foreign powers, the current presidential administration brings the whole set of previously unseen risks. The Fed’s rates may not be enough to forecast.
Black Rock in its 2017 Global Investment Outlook indicates that Donald Trump’s plans could be watered down by fiscal conservatives or, conversely, could lead to a surge in debt levels and interest rates that undermine growth. Corporate tax cuts could be offset with measures such as eliminating the deductibility of paid interest. This would be a game changer for equity and credit markets, reducing the incentive for companies to issue debt and buy back shares.
We also shall not forget that due to a continuous process of global economic integration, the number of factors which would influence GDP growth increases proportionately.
Today, China is economy #2 and it has significant downside risks. The monumental debt load is not about to get lighter given a high credit intensity ─ it now takes twice as much credit compared to pre-2009 to generate an additional unit of GDP. China also has to contend with external headwinds such as a potentially less favorable U.S. trade policy. The U.S. takes in a sizable 19% or so of China’s exports. The growth forecast of 6.5% for China this year assumes Beijing is able to successfully manage those risks.
I am not sure how these risks are addressed in 2017 GDP growth forecast. Therefore, the question is whether it is enough to highlight risks? Should there be a formula to translate this factor into a percent? I honestly do not have an answer for it but what is clear to me that investors are likely not to notice it as 2.2% appears attractive.
Although global integration has a lot of positive aspects, it also increases exposure of industries to the outside risks as never before. Oil and gas industry is not an exception. Instead, it is most likely has a greater degree of such exposure than any other industry.
Many investment decisions were made by oil and gas companies before crude oil prices started to decline. Many companies used the opportunity of cheap loans to finance their projects. With almost 80% of lost value of oil and upcoming interest rate hikes coupled with low demand and geopolitical risks, it is not difficult to see what might happen if nothing is changed.
On May 5th, crude oil prices crashed evaporating all efforts of OPEC to find a solution to resolve sustained low oil price environment. The sudden and steep decline resulted in huge losses.
Oil & Energy Insider reports that fears over persistent oversupply, a renewed glut for refined fuels, and the inadequately slow pace of adjustment stemming from the OPEC cuts all forced a selloff. Major oil benchmarks lost 5%. Although the drop in prices underscores the poor market fundamentals, the suddenness of the decline and quick recovery bears all the markers of a technical selloff.
Oil & Energy Insider points out that the refined product glut happened at the end of 2016 and into the early part of this year and it is happening again. Refiners are ramping up their processing, but there isn’t enough demand in the market for all the gasoline and diesel they are producing, leading to another strong buildup in refined product inventories. For diesel, at least, global demand is robust and American refiners will likely have an easy time finding buyers overseas. Preliminary data suggest U.S. exports of diesel hit a record high in April. However, it is the glut of gasoline that is worrying everyone else. The increase in gasoline inventories is especially troubling because this is a time of year in which gasoline stocks typically fall as motorists take to the roads.
According to Reuters, Gulf of Mexico is expected to add another 190,000 bpd before the end of the year. and will reach 300,000 bpd in 2018 from current levels. However, unlike shale, offshore projects are not as flexible.
It is important to remember that a substantial share of investments into stocks of oil and gas companies comes from investment funds.
I would suspect that it became clear to experts that oil is unlikely to recover anytime soon. Therefore, in order to save their funds, they would say anything to convince people to buy stocks. The fact that their statements sound like 2+2= 7 + X% is a clear evidence that I am right.
A couple of days ago Jeff Kilburg, KKM Financials, told CNBC that he is still bullish on crude oil despite the “noise” that there is more pain ahead. It is interesting because the next day it was reported that famed hedge fund manager Pierre Andurand, who has been bullish on crude, liquidated his long positions on crude over the past week.
In my opinion, it shall be no longer a question whether or not it is necessary to have a major revision of the way market functions. Reforms which would ensure that market’s fundamentals are 100% in line with common sense shall be implemented as soon as possible.