The Downside Of Davos - Fear

Includes: SPY
by: David White


Davos has brought many brewing "serious" economic problems to the fore. Russia is in dire trouble.

There is refocus on the PIIGS. These are still having significant banking problems and other economic problems.

There is focus on China. This is looking ever more troubled. Roubini is now saying he expects something between a hard and a soft landing.

There is focus on the energy price crisis. The feeling now seems to be moving central banks toward more QE.

Some are now entertaining the thought that the EU could break up.

Hopefully this article will help you grow and retain your wealth.

The World Economic Forum that meets for a week each year in Davos, Switzerland is intended to allow all of the great business, political, and economic leaders to get together to discuss the state of the world economy. This includes the good and the bad. However, this year it seems to include a huge number of serious problems; and that is feeding the fear in the world's stock markets.

I have prepared a partial list below of some of the more important problems being brought to the forefront at Davos.

  • The energy crisis is causing a terrible recession in Russia and a lesser one in Brazil. The Russian GDP was $2.079T in FY2013. It was $1.861T in FY2014. In 2013 energy related exports (mostly oil, natural gas, and coal) accounted for 50% of Russia's Federal budget revenues and 68% of Russia's total exports. If the Nymex price for a barrel of light sweet crude has fallen from roughly $100 per barrel to a closing price of $28.35 per barrel on January 20, 2016, Russia is now gleaning less than 70% of its former oil revenues. For oil alone at a FY2015 production rate of 10.7 million bpd that amounts to a loss of approximately 365 days * 10.7 million bpd * $70 = $273.4B; and that is without even considering the lost revenues from natural gas. For a roughly $2T per year GDP, that is more than a 10% loss. When you add in all of the other forms of energy, that has to amount to roughly $400B+ of energy related losses. In other words Russia has effectively seen its GDP cut by about -20% in two years due to the cut in energy prices. Some might argue that we are not talking about "real GDP". However, economic speak will not get you around the fact that those dollars have been lost. This is devastating the Russian economy. When you consider multiplier effects of these losses, you can really appreciate how bad things might be (or may get soon) in Russia. The fall in the Russian Ruble shows just how much the fall in the price of oil has hurt Russia's ability to buy other items (see the chart of the USD vs. the Russian Ruble below). In the last two years the ratio has gone from 33.92 rubles to the USD to 83.50 rubles to the USD as of this writing January 21, 2015. In other words the ruble buys about 60% less. Now that's inflation. This double whammy of oil selling for 70% less and the ruble buying 60% less virtually has to decimate the Russian economy in 2016.

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  • Brazil has a similar problem. However, oil is a lesser, but still large part of that country's GDP. Therefore the problem is smaller there. However, it is still a very bad problem. The list of oil troubled countries includes Saudi Arabia, Venezuela, and Iraq among others.
  • The US has many crises of its own that it will face in FY2016. First will be the souring loans of the energy exploration and production companies. There has been huge growth in US oil production in the last 5+ years. Companies were happy to borrow from the banks for the development monies, when oil prices were $90-$110 per barrel for WTI crude. Banks were happy to lend. With WTI oil prices now below $30 per barrel, many companies cannot afford to pay the interest on those loans. This problem will get worse as 2016 progresses. The companies with oil and gas hedges will see many of them expire. The companies have no way of replacing them with oil hedges in the $80-$110 per barrel range. Many oil companies will likely fail. Many banks will take huge losses. According to regulators, US banks have syndicated leveraged loans totaling $276B. 15% are now regarded as distressed. By the end of 2016, when many of the small and medium sized oil companies are largely without good oil and gas hedges, that percentage may go up to the area of 50% distressed or more. On top of that housing and even commercial real estate in the areas of the Bakken, the Eagle Ford, etc. may suffer severe reverses. According to Graves & Co. -- an oil industry consultant, the oil and gas companies have laid off roughly 250,000 employees around the world. US development has been especially hard hit. Both commercial and residential real estate in such areas may be hard hit. This could multiply the amount of the additional distressed loans. More layoffs are expected in 2016. Many expect the medium sized banks in these areas to be especially hard hit.
  • The US has a substantial subprime auto loan problem. Approximately 80% of General Motors' (NYSE:GM) auto loans are subprime; and some are for very long terms. This means a buyer could have an accident. The he/she could just let the car go since there would be little equity in the early years. Remember autos depreciate quickly in the first few years. Santander (OTCPK:BCDRF) is another auto loan maker with a lot of subprime loans. Total auto loans outstanding in the US are $900B+.
  • The US also has a student loan debt problem with over $1T+ in total student debts that many cannot afford to pay on. Much of this debt is securitized and packaged into securities. This presents still another problem.
  • Although not discussed at Davos (that I know of), the US has to worry about a projected $127T in unfunded federal liabilities. This is about $1.1 million per taxpayer. The state and local liabilities add in on top of this. For instance in Texas in 2013, the total unfunded liabilities were $7.2B (about $54,000 per active member). The far majority of states have grossly unfunded pension funds. A Daily Caller article on July 1, 2015 estimated the state and local government unfunded pension liabilities at $4.7T. Many pundits believe that in a recession this could lead to a crash in many muni bond funds. That in turn could lead to crashes in many other areas.
  • The Davos goers are focusing on the banking crisis in Italy. Italian banks have about $218B in non-performing loans; and many Italian banks have extremely weak balance sheets. The Italian banking index is down -17.7% so far this year; and it is still January. This issue has the potential to explode at any time. Additionally Portugal and Spain are showing weakness too. Will the PIIGS economies become a dire issue again in 2016?
  • There is significant speculation that the UK will leave the EU soon. People seem to be viewing this as mostly a distraction at this point. However, other countries are adding to the distraction by positing that the EU could fall apart soon. We all know how much equities markets hate political uncertainty.
  • There is a lot of speculation about the Chinese economy. Some are saying it could be caught up in a perfect storm. Roubini has estimated that China could see 6% GDP growth in 2016. He is now calling for something between a soft and a hard landing. Not long ago he was calling for a soft landing. Importantly the 6% GDP growth figure is getting frightfully close to the 5%-6% GDP growth figure that I posited some time ago would likely bring the overextended credit problems in China crashing down. This is such an involved topic that I cannot possibly do it justice in this article about all world economic problems.
  • Many other Asian economies are facing much the same problems as China.
  • I could go on; but readers should get the idea that there are huge and uncertain forces in play in world markets.

In counter to the above, ECB President Mario Draghi implied in his talk Thursday January 21, 2016 that more QE would be forthcoming for the EU. He stated that the economic situation in the EU has gotten worse; and the fall in oil prices is leading to deflation. Some are now speculating that the ECB will announce a move from €60B in QE per month to €80B in QE per month at its March 2016 meeting. This should provide a near term boost to equities markets, even in the US. Such an action should lead to the euro weakening. That in turn will make European investors want to invest in US equities, since the USD will likely rise versus the euro based on the above action. Therefore in spite of all of the above bad news, I am now changing my SELL call on the SPDR S&P500 ETF (NYSEARCA:SPY) to a HOLD.

The SPY did bounce off the roughly $180.50 fair value line intraday recently. That could be a signal that the markets may move up near term. I don't have much faith in the long term good effects of the ECB actions indicated so far. There are huge economic problems brewing. However, investing is often about reading the tea leaves as they are currently. The central banks of the world have controlled the markets for much of the last few years. I am hesitant to believe they are not going to do so again.

The US Fed's Bullard (a voting member) has also said the December 2015 Fed Funds rate raise may have been a mistake. We could see a significant weakening in the US Fed's tightening policy. The US Fed could even join the QE parade soon. With all of this in mind it makes sense to change to a "wait and see" stance. Thus I am changing my SELL call on the SPY to a HOLD call for the near term.

Good Luck Trading/Investing.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.