WTF in Chaos, Switzerland!

Well, it wasn't exactly WTF(!) , but quite similar. It was WEF (World Economic Forum). It was held in Davos, Switzerland and it was a chaos!

The left hand has no idea what the right hand does. Other than schmoozing around, having newly elected heads of state show up and folks talking about "Lean In" (no offence), nobody has a clue on the state of the world economy.

It has been a tumultuous start to the year thus far. Markets have plunged in Asia, Europe and dragged down the US indices with them. Major companies have posted solid 4Q15 earnings, however, with a disappointing forecast for the year ahead and this has made matters worse. The FED had its most recent meeting last week and came out looking stupid. They have no idea on what is going on around them. The economy typically posts higher employment numbers in summer through fall. This is driven largely by seasonal workers employed by major companies. The Fed relied on this rosy picture and ignored the fact that wages aren't rising as well as inflation is tepid. Wages typically tend to raise when jobs are filled with full-time workers. Employing a bunch of part-time workers does not raise wages.

The FED is so focused on the monetary policy, they have essentially boxed themselves in after a disastrous statement in the 3Q15 FOMC meeting, essentially committing to the markets to raise interest rates in 2015. This was a huge mistake.

Central banks around the world have been reducing interest rates. Even countries such as India which are considered a rare bright spot in the world economy have reduced interest rates in 4Q15. China has been slowing down and will end up being like Japan. Brazil is going nowhere except being mired in corruption scandals, slowing growth and raising inflation of 15 percent. Most of Latin America is slowing down due to a reducing appetite for commodities in China. The plunge in oil prices has been disastrous. Venezuela has an inflation of one hundred forty percent last year. Japan even introduced negative interest rates the past week.

The market crash of August 24th made us realize how dependent our economy has become on that of the world and especially China. Given the uncertainty and dismal outlook, I have been a strong advocate of not raising interest rates unless there is data that supports inflation above two percent. It makes no sense for the FED to increase interest rates, when the central banks across the world are reducing it.

FED is under a disastrous assumption that this economy can sustain itself at higher interest rates.. Let me explain.

Let's consider a scenario where you are the central bank i.e. FED. Let us also assume you are in a town where there is one and only one store. Now, you (i.e. FED) turn up there one fine morning, take a wad of ten dollar bills and throw them in the air, while at the same time yelling "Finders Keeper". What happens next? Folks would scurry to collect the money. They would then go to the only store in town and spend in there. What does this lead to? Increased revenue for the store.

Now, lets say you do this every day and soon the entire town knows you are showing up at the store and throwing wads of bills in the air. To keep up with the increasing crowd, you print more money and show up every day to throw the bills. Now, what happens? Two scenarios.

First scenario, people are awash with cash and there is only one store to spend. The store owner realizes this and raises prices i.e. inflation.

Second scenario, another two stores open and they each employ two part-time employees and cater to the entire town.

What you see in the above example is that the FED created artificial growth. In addition, just because two more stores opened and employed people, the FED would say the GDP of the town has increased as well as reducing unemployment rate.

This is exactly what is happening in the US economy. The FED has been printing money and essentially distributing it at near zero interest rates. Suddenly raising the rates and expecting growth to sustain itself is very risky. Especially, when you don't live on a desert island !!!!!

Looking ahead, it is a no-brainer that the markets will rebound, albeit, at a slower pace. The price of oil is sure to stay low in the near future. Unless there is a catastrophic event in Middle East, production of oil will not slow down, leading to  a glut of supply (~9 to 10m b / d). It will be interesting to see China Central Bank respond to slowing growth. While they have been open to not manipulate the currency value, I believe they will continue to do so to support the manufacturing sector of the economy. Will Mario Draghi finally end QE? Will Latin America be able to survive slowing demand for commodities? Will Canada get out of a recession? And what about the African economy and it's dependence on China?

With all of this uncertainty and love in the air (Valentine's day is fast approaching), will the investors fall in love with the markets and ignore the dangers lurking ahead?

But then again, love is blind !!!

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