But the overall tone has been bullish, as investors had been holding large cash positions in front of the election which they now seem more comfortable in shifting back into stocks.   Moreover, the recent collapse in the bond market has initiated a substantial asset mix shift from bonds to stocks.  TrimTabs data showed $44.6 billion moving into exchange-traded stock funds in the seven days following the election.  That was the second-largest surge in its records, exceeded only in July 2007, not long before the peak in the U.S. equity market.  The outflows from bonds, meanwhile, was the largest since the taper tantrum of June 2013, a term that describes how the debt market spiked yields higher at the hint that the Federal Reserve was contemplating the end of its bond-buying program.  The flight from bonds made for the biggest two-week loss in more than a quarter-century.  It’s tempting to believe this is the beginning of the so-called Great Rotation theory, which first gained widespread currency several years ago.  That theory predicts that, as the multi-decade bond bull market comes to an end, investors will shift their hundreds of billions invested in the bond market into the equity market, thereby propelling stocks massively higher.  Only time will tell on that call but it hints at a ‘greater fools theory’ that someone will always there to buy your shares at an even higher valuation.  I would rather be buying stocks because they were inexpensive and their earnings were rising.   Although we hear comparisons to the early Reagan years, this is not 1982 again!  At that time stocks were trading at record-low valuations, interest rates were coming down from all-time highs and government debt levels were low.  We are at a diametrically opposed position to that today!

Elsewhere in the world, we started to see the fallout from the ‘Brexit’ vote last June.  Britain cut its official forecasts for economic growth for the next two years, announced during the delivery of the country’s first budget statement since voters decided to leave the European Union.  The weak public finances leave little room to ramp up public spending or make big cuts to taxes.  The government will need to borrow billions of pounds more over the next five years, with net public sector debt forecast to rise to a peak of 90.2% in 2017/18, up from a projection of 81.3% in March.  Britain’s independent budget forecasters, said gross domestic product would grow by 1.4% in 2017, down from an estimate of 2.2% made in March, before voters decided to leave the EU.  Britain’s economy has so far largely withstood the shock of the Brexit vote, contrary to what the Bank of England and almost all private economists expected.  The sharp fall in the British Pound may have given a short-term ‘kick-start’ to the economy that may now be wearing off.

China’s debt load is still one of the biggest ‘potential market bombs’ out there, in our view.  The country’s debt load has expanded from 150% of GDP before the onset of the 2008 global credit crisis to about 300%.  That is $30 trillion of debt sitting precariously atop a $10 trillion economy.  That ratio could rise to more than 330% by next year, well above what most rating agencies view as ‘crisis levels.’  The real problem is that China has become a very ‘inefficient economy’, which is best illustrated by looking at its capital-efficiency ratio, or the number of yuan of new credit it takes to produce one yuan of GDP growth.  China’s credit bubble exceeded even that of the U.S. in 2007, on the cusp of the subprime mortgage meltdown that set off the global credit crisis, as the authorities resorted to stepping hard on the monetary accelerator to revive growth.  In this year’s first quarter, Beijing pumped almost one trillion dollars into the economy, a quarterly record for monetary stimulus.  That did help to stabilize economic growth in the 6.8% range, although skeptics abound about the accuracy of those ‘official’ numbers.  The bigger problem may be that all this liquidity lead to a bubble in housing prices, which has worked its way into the inflation numbers.   As shown in the chart below, there is a strong link between Chinese inflation and that in the rest of the world, given that economy’s strong impact on global growth and commodity demand.  Rising inflation in China, if it were to trigger a similar turn in global inflation, would undermine the ability of the world’s central banks to continue with their low interest rate policies that have been a key support for financial markets. Rising prices in China; signs of global inflation?

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