Global stock markets ended mostly unchanged in November after the sharp rallies in October following the downturns in August and September. Stocks sold off sharply during the first two weeks of November but then rallied despite the increasing geo-political risks emanating from the terrorist attacks in Paris and elevated tensions in Syria.  It was almost as if investors started to incorporate the idea that the U.S. Federal Reserve would be less likely to raise interest rates in December if the global situation suddenly deteriorated again.  Further comments from the ECB’s Mario Draghi that he would do ‘whatever it takes’ to remove deflationary risk in Europe also emboldened investors to believe that another round of stimulus and even more aggressive Quantitative Easing (QE) was going to be announced soon.  Stock markets rallied once again on the ‘bad news is good’ syndrome, with Europe leading the charge as the Euro currency suffered through more depreciation against the U.S. dollar, falling another 4% in November and 12.7% so far in 2015.  Commodity markets were also weighed down by the renewed strength in the U.S. dollar and the continued deterioration of economic growth, particularly in the emerging economies.  The CRB Commodity Index fell 6.7% in November and has fallen over 20% so far in 2015.  Many metals moved to multi-year lows as copper, nickel and platinum fell 11.6%, 15.5% and 15.8%, respectively, last month.  Oil prices also lost another 10% in November and have fallen over 60% over the past 16 months!

Canadian stocks continued to suffer last month, falling another 0.4% for a year-to-date loss of over 7%.  Resource stocks were once again the culprit with the gold stocks dropping 6.2% and the metals stocks plummeting 17.8% as metals prices sunk to multi-year lows.  The overall decline in the index, however, was mitigated by the 1% gain for the heavyweight Financials sector, the 6.6% jump in the Info Tech sector and the whopping 21.7% gain for the Health Care group, as both Valeant Pharmaceuticals and Concordia Health Care recovered some of their substantial September-October losses.  Emerging market stocks were also weak in November, with the MSCI Emerging Markets Index losing another 4% for a year-to-date loss of over 15%.  Economic weakness in China, combined with a strong U.S. dollar, has resulted in trade deterioration and capital outflows in the developing markets.  Brazil and Russia have both slipped back into recession.  U.S. stocks had marginal gains last month, with technology stocks leading the way.  European stocks were the biggest winners last month as optimism about more aggressive monetary easing by the ECB pushed the German Dax Index ahead by 4.9%.

The other strong stock market in November was Japan, where the Nikkei Dow jumped 3.5%, following a whopping gain of almost 10% in October.  But despite decades of spending beyond their means in attempt to stimulate their economy, printing 1.6% of their GDP each month and using it to buy assets of all types including government bonds and public equities; and despite aggressively devaluing their currency in an attempt to gain a competitive advantage for their exports, the Japanese economy has once again gone into a recession as the economy contracted in Q3.  The 0.8% contraction in GDP marks its second recession since Prime Minister Shinzo Abe took office in December 2012.  Clearly it is the expectation that we will see more stimulus out of the Bank of Japan very soon is what has been sending stocks higher, just as it has in Europe and China.

Questioning the Chinese Miracle!  We spend a lot of time on Chinese economic data but the growth in that economy has been the source of most of the world’s marginal growth over the past decade.  So it seems worth looking closely at how sustainable the growth is, particularly with the data continuing to deteriorate.  Our biggest concern in China is not the economic growth but the debt in the banking system.  Bank credit in China was about US$2.1 trillion in the year 2000, or about 121% of GDP (total output) at that time.  That credit surged to US$7.4 trillion (158% of GDP) by 2007 and stands at US$28.2 trillion (282% of GDP) today.  This lending boom was used to finance capital growth projects that are projecting very little return to the lenders.  Estimates of the money put into projects with ‘zero efficiency’ are as high as 47% of China’s total capital formation (McKinsey Global Institute).  Clearly there must be massive levels of non-performing loans growing throughout the banking system and that is our key worry as it impacts both the Chinese and global economies.  Although the government has almost US$3 trillion of reserves to backstop these losses, they are running down the value of those reserves to protect the currency and stop outflows of capital.  While China might be moving towards a consumption economy and away from a capital spending economy, the trail of bad debts that could be left in the wake of their prior spending boom will weigh on the banking system.  This is the big risk in China in our view!

The massive ‘easing’ in the U.S. has been a part of this credit binge.  Between 2009 and 2014, when the Fed generated some $4 trillion in QE, credit provided overseas in US dollars through bank loans and bonds hit $9 trillion according to the BIS (Bank of International Settlements).  The result of all of this is that the leveraging of QE money has resulted in piles of debt around the emerging world that are very hard to measure or even detect but that have also built up huge overcapacity in many industries.  The excess capacity created by these companies has become more apparent as China’s economy has slowed triggering a collapse in global commodity prices, hurting companies around the world and sending economies like Brazil into deep recession.  Some believe the QE policies have left a legacy of oversupply from which it will take years to recover.  To make things worse, the rising $US is now putting pressure on all of this debt and effectively cutting off credit to these companies and markets.  This explains why global monetary institutions such as the IMF and the World Bank are going out of their way asking the U.S. Federal Reserve ‘not’ to start raising interest rates.  Could a further rise in the U.S. dollar be what finally brings down this ‘house of cards?’

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