Bubbles, profits and debt – look out!

Stock markets in the major economies continue to hit new highs. At the same time, economic growth in the major economies is either slowing down or already at a relatively low level. The UN now forecasts that the global economy, including fast-growing India and high rate China, will expand in real terms (after inflation) by just 2.8% this year. Thus the UN joins the IMF and the World Bank in reducing its growth forecast for this year to around 3% for the world.

And in its semi-annual economic outlook released this week (http://www.oecd.org/economy/strengthening-investment-key-to-improving-world-economy.htm), the OECD has also reduced its forecast for global economic growth.  It warned that weak investment and disappointing productivity growth risk keeping the world economy stuck in a “low-level” equilibrium. The OECD now expects the global economy to expand this year by 3.1%, a sharp downgrade from last November’s forecast of 3.7%. The revision follows a weak first quarter of 2015 for the global economy, the softest since the crisis, led by a sharp decline in the US. “The world economy is muddling through with a B-minus average, but if homework is not done . . . a failing grade is all too possible,” said Catherine Mann, chief economist.

OECD growth

In another sign of a slowdown in US economic growth in the first half of 2015, US factory orders tumbled in April. Orders fell 0.4%, marking the eighth decline in nine months. The key category that tracks business investment plans — non-military capital goods excluding aircraft — slipped 0.3%.

US factory orders

So global economic growth continues to fall well short of the trend rate before the Great Recession began in 2008. The world capitalist economy is unable to return to ‘normal’. This is six years since the trough of the Great Recession.

US weak recovery

The OECD is now forecasting just 2% growth in the US this year, a very sharp downward revision from the November 2014 forecast of 3.1% this year. It also lowered its forecast for Japanese growth to 0.7% (compared with 0.8% in the previous forecast). It has raised its forecast for the Euro area to 1.4% from 1.1%. But most worrying for global growth is the expectation that China will grow even more slowly than previously expected, just 6.8%.

China accounted for 85% of all global growth in 2012, 54% in 2013 and 30% in 2014. This is now likely to fall to just 24% this year, according to the UK bank, RBS. This is pushing the rest of Asia into recession.

China's contribution

Russia, Brazil, Argentina, and Venezuela are all contracting sharply, casualties of the China-driven commodity bust. The UN says the growth rate for the emerging market nexus (ex-China) has dropped to 2.3% from an average of 6.5% in the glory years of 2004-2007.

China is suffering from debt bubble where credit has been ploughed into property and the stock market (in a huge stock market bubble) and less into productive investment. Now there is a vast inventory of unsold property. The country produced more cement between 2011 and 2013 than the US in the 20th century.

China's credit bubble

In my opinion, China is not heading for a big bust, Western capitalist style (see my article in Weekly Worker (http://weeklyworker.co.uk/worker/1058/heading-for-a-crash/), but a slowdown in economic growth is certainly in the cards for this year.

Overall, the basic thesis on the global economy made in this blog on numerous occasions is being confirmed. Global capitalism is not returning to the rate of growth it achieved before the Great Recession. It is now locked into a slow crawl of below-trend growth, because of the failure of investment in particular to recover. And investment has not recovered because profitability in the major economies remains poor and the level of debt built up before the Great Recession, and the ‘trigger’ to the slump, has still not been fully ‘deleveraged’ (https://thenextrecession.wordpress.com/2014/09/30/debt-deleveraging-and-depression/).

In its latest Financial Stability Report (http://www.ecb.europa.eu/press/pr/date/2015/html/pr150528.en.html), the ECB took a relatively pessimistic view about the future: “The highly accommodative monetary policy stance in advanced economies – though showing potential for increased divergence – has continued to provide vital support to the global recovery. While global growth is expected to recover gradually further on the back of lower oil prices and continued policy support, risks to the global outlook remain tilted to the downside. In particular, a sharp repricing of risk with ensuing corrections in asset prices, a potential disorderly unwinding of capital flows and sharp exchange rate movements along the path to normalisation of macroeconomic policies in key advanced economies remain causes for concern.”

In effect, the ECB was suggesting that the policy of ‘quantitative easing’ adopted by the major central banks of the world may have ‘saved capitalism’ from a continued deep slump, but it came with huge risks for the future. The major central banks have been engaged in a massive and unprecedented injection of credit into the banks and corporate sector in order to reverse the slump and restore growth. The balance sheets of the central banks have doubled as a share of GDP and, in the case of Bank of Japan, will have reached near 100% of GDP, when the current round of ‘quantitative easing’ ends.

Yet, as I expected (https://thenextrecession.wordpress.com/2015/01/23/the-ecb-qe-and-escaping-stagnation/), this monetary injection has failed to revive investment or growth. Instead, this credit has just fuelled a new bubble in stock and bond markets round the world.  According to Doug Short, however you measure it, the US stock market is 81% above the mean average, over two standard deviations above the mean (http://www.advisorperspectives.com/dshort/updates/PE-Ratios-and-Market-Valuation.php?WT.rss_f=dshortRSS&WT.rss_ev=a&WT.rss_a=Is+the+Stock+Market+Cheap%3F).

US stock market overvalued

It’s bit less over the top for European stock markets, but the reality of corporate profits in Europe is way out of line with the expectation that investors have, as this graph shows.

Eurozone corporate earnings

Eurozone company (operating) profits (per share) over the past 12 months have just fallen below the bottom reached after Lehman’s failure brought down the global economy!  This tells you that global stock markets are so far out of line with global growth and profits that they are heading for a big fall.

I have compiled a measure of global corporate profits for five economies: the US, the UK, Germany, Japan and China. Annualised corporate profit growth on this measure has dropped to just 2% in the first quarter of 2015. Indeed, in the last four years, annual growth in the mass of profits in these five economies has averaged under 5% compared to 14% in the five years before the Great Recession struck.

Global corporate profits

Corporate profits figures for the US in the first quarter of 2015 were released last week. They showed a mild improvement over the previous quarter, with a 3.7% year-on-year rise. But the average yoy growth for the last four quarters has been just 0.5%.

US corporate profits

It is my thesis that changes in the profitability of capital lead to changes in the mass of profit, which in turn leads to changes in investment, which as the OECD points out, is the key factor in the slow crawl of the global economy (see my post, https://thenextrecession.wordpress.com/2012/06/26/profits-call-the-tune/). There is a high correlation between the mass of profit and investment, (at around 76% since 2000 in the US). So as the mass of profits slows and starts falling, then within a year or less, so will investment.

US corporate profits and investment

And great minds think alike. British Marxist economist, Michael Burke has just done a great piece that makes exactly the same point as I have namely that “The Great Recession was preceded by a decline in profits and the fall in fixed investment followed with a time lag. This was a classic profits-led recession, which was partly obscured by the speculative frenzy that continued until 2007 (but which is a recurring end-of-cycle phenomenon)”
http://socialisteconomicbulletin.blogspot.co.uk/2015/06/declining-us-profits-and-private.html?m=1).

At the same time, debt in the corporate sectors of the main economies remains high and deleveraging has been non-existent or minimal since the Great Recession. To quote the ECB from its report: “The pace of deleveraging has been slow and indebtedness has been hovering well above the levels of past episodes of recession.”

US NFC debt

Up to now, because of central bank QE and very low interest rates, corporations have been able to service their debts with ease. Indeed, low interest rates have encouraged the larger companies to borrow more and use the cash to buy back their own shares or increase dividends to their shareholders. Thus the stock markets have been fuelled with demand.

But US companies are borrowing money faster than they’re earning it — and they’re doing it at the quickest pace since the aftermath of the financial crisis. Stock buybacks reached an all-time high last year and the volume of global mergers and acquisitions announced so far this year would make it the second-busiest ever, according to data compiled by Bloomberg.

For non-financial companies with top credit ratings which have issued debt, the median net leverage in the first quarter of 1.267 was the highest since 2010 and up from 0.927 in the first quarter of 2014. The leverage figure means companies owe $1.267 for every dollar of earnings after subtracting cash on hand. Companies in the S&P 500 will dole out more than $1 trillion, or two-thirds of their cash, buying back stocks and repaying dividends this year, according to Goldman Sachs. That eclipses the $921 billion the firms will spend running their businesses and on research and development, Goldman Sachs wrote.

But global growth remains low and profits, the lifeblood of capitalism, are getting harder to increase. Fictitious capital is facing the real possibility of being found out as just that, fictitious, if the cost of debt rises or the real returns on stock market investment are exposed.

In a previous post, I raised the danger that an end to QE and low interest rates in an environment of weak growth and stagnant profits could provoke a stock market crash and with it a new slump, as happened in 1937 after the brief recovery from the great slump of 1929-32 (see my post, https://thenextrecession.wordpress.com/2014/08/01/the-risk-of-another-1937/).  The US Fed is pledged to hike interest rates later this year. That could be the catalyst. Maybe the Fed will desist because of the very risks being posed by the likes of the ECB in its report. But the end of this stock market boom cannot be far away.

15 Responses to “Bubbles, profits and debt – look out!”

  1. Henryno1 Says:

    Excellent, Michael. Just what I thought and partly saw explained by other analysts but with much less empirical data!

  2. Henry Says:

    this is not me Henry, it is somebody else…..

  3. kyleathompson Says:

    Michael,

    How do you conceptualize China’s massively significant interaction with the world capitalist economy if you do not conceive of it as a capitalist state? Do you see its boom and now massive slow down as operating more or less autonomously of the cyclical movement of the capitalist economy and its profit-lead dynamic, or do you see it as being strongly determined by export demand? In other words, do you see the post-crisis “China Boom” as being essentially an aberration made possible by China’s relative autonomy from the law of value? Thanks for all your analysis.

  4. Tony Walker Says:

    Hello Michael,

    Another excellent and informative article. A couple of typos:

    1. “So global economic [something is missing here] continues to fall well short..”

    2. “Weekly Worker (http://weeklyworker.co.uk/worker/1058/heading-for-a-crash/), but a slowdown in economic growth is certainly in [on?] the cards…”

    A suggestion:
    Could you do an article that graphs the forecasts of various institutions and individual experts – OBR, IFS, ONS, BOE, OECD etc., and compares them to the actual outcome? It would be good to see how wrong the forecasters are and by what margin. I have no evidence to support my suspicions, but I think some of these forecasters (the UK government in particular) are exaggerating their estimates to avoid any political attacks. What do you think?

    Thanks
    tony

  5. mikestasse Says:

    Reblogged this on Damn the Matrix and commented:
    How a non economist like me can see this happen when, people who are supposed to be ‘in the know’ can’t, is truly puzzling.

    As less and less money can be made by depositing in banks, investing in gold, oil, coal, iron ore, you name it, more and more people are investing in the stock market which is the only place left to make a killing. For now. Because the companies whose shares are being bought are only worth the profits they can make from lending out at low interest, selling gold, oil, coal, etc etc, making the shares way overpriced with respect to the no longer profitable companies…..

    That a major correction is overdue is an understatement.

  6. John Doyle Says:

    Don’t you Think we need to learn to manage economies with low to no growth? It is the future, at least a milder version than what is probably more likely.
    Our whole civilization is in its end game. As we consume our way to ruin, economies are set to collapse. Once that starts we will not be able to climb out of that hole.
    No more bubbles after the current ones.
    No plans to cope. Now that is scary!

  7. SimonH Says:

    Having read your China post Michael I have to say it seems like you’ve actually admitted it’s capitalist. Any society in which the law of value prevails, even distorted, is capitalist.

    • Luis Says:

      If by “prevails” you mean “predominates”, then I agree with you. And certainly this is the case in post-Mao China. However, even in a socialist setting, the law of value can still exist. See “The Shanghai Textbook” for details.

  8. Luis Says:

    Anyone who doesn’t think that China is a capitalist state is tripping on acid. Read the pamphlet “Is China an Imperialist Country? Considerations and evidence” by N.B. Tuner et al 2014.

  9. Don Sutherland Says:

    Reblogged this on Don Sutherland's Blog and commented:
    Australia is not mentioned once in this up to date rveiew of the real and severe problems in the global economy. Having said that, the story is as much about Australia’s economy as any of the countries actually referred to. Now, why should we get to grips with this sort of analysis? One important reason: it helps very much to understand not so much the effects of unemployment and underemployment but very much the causes of unemployment and what might be the best immediate and also medium to longer term policies to deal with the causes and also the effects.

  10. vallebaeza Says:

    Reblogged this on Econo Marx 21.

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