Bears beat Trump and Brexit drum

Seasoned hands are warning that a Trump victory could tip Europe’s banks over the edge and of a looming UK recession.

US presidential candidate Donald Trump speaks during a campaign rally, Wednesday, Nov. 2, 2016, in Miami. (AP Photo/ Evan Vucci)

Global sharemarkets are nervous as a series of investment and economic analysts with good track records warn of dangers ahead.

That why last night the S&P 500 in New York staged its sixth successive decline (albeit small) and London and Germany were both down around 1.5 per cent.

There are two separate but connected bearish forces, one closely linked to Brexit and the other to a possible Trump win. So, let’s look at what the bears are saying and then test the validity of their analysis.

For a Brexit bear I have chosen Crispin Odey, founder of Odey Asset Management and a backer of the Vote Leave campaign. Odey is telling his clients to prepare for a British recession and higher inflation in the wake of the Brexit vote.

Odey has been behind some of the most successful market plunges in the last decade but right now his fund is at the bottom of the performance tables because he shorted stock believing the market was too high — but he got the timing wrong and at this stage the direction.

Nevertheless, Odey’s past wins make him well worth quoting.

Odey says the FTSE 100 share index is now up 30 per cent over five years, while earnings have fallen by 80 per cent.

“The Bank of England is proud that they have engineered such a pleasant result but there is now increasing evidence that this is unsustainable … the current account deficit is ballooning and the budget deficit is following.

“Mark Carney, the Governor of the Bank of England, has responded by flooding the money markets with more cash, QE, and in the process supporting the government 10-year bond at a current yield of 1.2 per cent.

“However, as sterling falls against all its trading partners’ currencies, it is mechanically ensuring that inflation rises up through 3.5 per cent. Traders have been buying into sterling weakness on the back of an 18 per cent fall in the trade weighted index since the Brexit vote, but do they not understand that the further the pound falls, the greater the difference between next year’s inflation rise and today’s interest rates.

“Sterling is getting more expensive, the further it falls. Carney is really under pressure and should be raising interest rates, but it now looks as though a rise in interest rates will be over his metaphorical dead body. We are now destined to have a recession in the UK as well as inflation”.

The argument against Odey is that the depressed currency will create a lot of UK economic activity, so there will be no recession unless the UK is frozen out of Europe.

But that UK Brexit nervousness spills over into weakness in the European banking system and fears of what impact a Trump victory in the US would have on global markets

My second choice of bears is MIT’s Simon Johnson who was the IMF’s chief economist until 2008. Johnson says eurozone banks have never fully recovered from earlier losses, and their equity capital levels remain low relative to international competitors (like the US) and to what investors regard as reasonable.

“These banks are clearly too big to fail — no European government in its right mind would allow a default on bank debt. But there is no agreement on how to share bank losses across countries.

“Taken as a whole, the eurozone has enough fiscal capacity to stand behind its banks. But, unfortunately, doing so is still a country-by-country decision — the collective mechanisms for recapitalising European banks remain partial and far too weak,” Johnson says.

Johnson believes a Trump win in the US would provide the trigger to bring on a European banking crisis, partly because of the big fall in markets that would result from a Trump Presidency and secondly because of his trade policies.

Johnson says Trump promises to boost US growth immediately to between 4 and 5 per cent, but add that “this is pure fantasy” and that’s far more likely that his anti-trade policies would cause a sharp slowdown.

Trump is determined to curtail imports through a variety of policies, all of which are well within the power of a president.

“Trump’s trade-led recession would tip Europe back into full-blown recession, which would likely precipitate a serious banking crisis … the effects on emerging markets and all lower-income countries would be dramatic”.

I am not advocating a Trump Presidency but, in his defence, we should not forget that whereas Hillary Clinton is talking about lifting the taxes on “the rich” Trump is going to reduce taxes.

Trump is a businessman and is likely to seek to negotiate with China, Mexico and others about exporting to the US.

Moreover, given rising world tensions, the US and Russia need to establish an accord to avoid war. Given his Russian connections, Trump is much more likely to reach such a power accord than Clinton.

The level of pre-poll voting in the US is much higher than Australia, so this latest swing towards Trump only influences part of the US electorate — those that haven’t voted yet.

The US markets understand this which is one reason why, to date, they have not fallen as dramatically as observer markets like London, Germany and Australia.

But if the swing to Trump continues …