This year, 2016 has the potential to be a down year again for commodities, bonds and stocks. As usual, market analysts are not pessimistic but that can change. Only real estate is expected to show a good return. Interest rates will probably go up, but only by a fraction of 1%. The U.S. will likely see overall economic growth of 1% – 2% with slightly rising profits ex oil companies, high employment, though many workers are under-employed.
Reasons for Lower Prices Starting Out 2016
What is depressing prices across all asset classes, but especially stocks and commodities? I think the Randall Forsyth column in this week’s Barrons’s got it right. Forsyth explains that during the boom years of the early 2000s, and then again after a break for the 2008-09 crisis the sovereign wealth funds of oil exporters Norway and the Middle East, plus China, Singapore and the city of Hong Kong built up large amounts of money as a result of large trade surpluses their countries ran with other countries.
What is a sovereign wealth fund? It is simply the money that is set aside by central banks as the result of running trade surpluses with other countries. A trade surplus arises from simply selling more to other countries than you buy from them. For example, if Saudi Arabia sells more to the US than it spends on American goods, the Saudis will receive more money than they send out. That money is invested. We’re talking serious money here – China alone has roughly $3 trillion in its fund. Norway is the next largest at just under $1 trillion.
Before, China spent a lot of that surplus money to buy its own currency to keep it at a stable price, exactly contrary to Donald Trump’s mistaken populist opinion. Sorry Donald, you just don’t know what you’re talking about. China also bought resources like oil and copper to build up inventories, both for security and industrial purposes. Other countries just invested where they thought they could get good returns and relative safety. Mainly that was in bonds and stocks, of which the US had the best performing and easy to invest in markets overall.
Since China has spent and borrowed so much money on its currency and for domestic spending to goose its economy since 2009 and since invested it so poorly into things that didn’t produce further growth, like the famous empty cities, airports and freeways, not to mention bloated and inefficient state-owned companies, its currency reserves are now down to the minimum level China likes to see.
Because of that, China is no longer spending large amounts of money to defend the currency or buy stocks, bonds and commodities overseas. That removes a lot of demand for those investments that you and I like to invest in. Once that ball gets rolling downhill, other sovereign wealth funds start pulling back too because prices are falling. Remember Economics 101 – when you reduce demand, prices fall. That doesn’t just apply to things like oil, it also applies to stocks. That assumes supply remains steady, and in fact, the supply of oil, stocks and bonds has stayed steady, so their prices are falling.
That’s a good question to which no one knows the answer. Many stocks have already declined much more than people know, as I mentioned at the outset. Usually the last to fall are the high fliers. In this case, that would be health care stocks, especially biotechs, and companies like Apple and Amazon and Netflix that had tremendous years in 2015. Those areas are now down 20-30%. Since we have now seen that and since stocks are only valued slightly above the long-term average and since oil looks set to bottom out in the next month, I would say that decline has largely run its course.