Category Archives: World Bank


As The S&P 500 Reaches New Highs, Asset Inflation Continues

  • All factors are indicating an artificially created asset inflation.
  • Earnings are expected to decline with economic outlook being constantly revised downwards.
  • Gold is gaining alongside stocks which confirms that all assets are inflated.


Amidst all the turmoil from BREXIT, negative interest rates and global downward economic growth forecasts, the S&P 500 has reached a new high. On Monday it closed at 2,137.16 points, overtaking the previous high of 2,130.82 from May 21, 2015. The Monday record was surpassed again on Tuesday and Wednesday, with Wednesday closing at 2,152.43.

figure 1 s and p 500
Figure 1: S&P 500 in the last 5 years. Source: Bloomberg.

This new high isn’t significant in terms of real returns as the market hasn’t really gone anywhere in the last 14 months, but it is significant from a psychological and confidence perspective. In this article we are going to look for the breakout reasons and fundamentals, and analyze potential risks.


It’s pretty straightforward: if earnings grow then the S&P 500 is also supposed to grow, if earnings decline and the S&P 500 grows we can assume we are in a bubble. At the moment, earnings are not growing and this earnings season will probably be the fifth consecutive quarterly earnings decline. In total, net income is down 18% since its 2014 high.

figure 2 earnigs
Figure 2: S&P 500 index and earnings. Source: Bloomberg.

The 18% decline isn’t that bad when compared to the average 36% earnings decline in recessions since 1936, but currently we are not even close to being in a recession.

Investors seem optimistic and willing to pay a hefty premium for stocks. The current S&P 500 PE ratio is approaching 25 and it has been higher than 25 on only two occasions in the last 100 years, in the dotcom bubble and in the midst of the Great Recession when earnings plunged.

figure 3 S&P 500 pe ratio
Figure 3: S&P 500 PE ratio. Source: Multpl.

As earnings are not growing and fundamentals are deteriorating, there must be something else that creates investor optimism.

Economic Data

As stock prices reflect future expectations, a look at GDP forecasts will give a good perspective on the rationality of the above valuations. In June, well before the BREXIT vote, the World Bank lowered its global growth forecast from 2.9% to 2.4% indicating more trouble for corporations. The International Monetary Fund has cut its forecast for the U.S. from 2.4% to 2.2% for 2016 but expects a pickup to 2.5% in 2017, while the FED expects moderate and stable economic growth at 2% for the next few years. In greater detail, the media highly promoted the 287,000 new jobs added recently but failed to focus on the increased unemployment rate from 4.7% to 4.9%.

One might wonder if the above mentioned data is enough to sustain a PE ratio of 25 as historically the economy has grown faster than 2% and the S&P 500 has had lower PE ratios, again an indication that asset prices are inflated.

Low Bond Yields 

The inflation in asset prices is especially visible in fixed income investments. With 30% of global sovereign debt charging a negative yield, investors push bond prices higher and higher in a desperate search for positive yields. This is further enhanced by the central banks of Europe and Japan actively buying corporate bonds on the market, and even stocks for the latter. As long as central banks relentlessly continue buying securities, it is very difficult for stock markets to experience substantial declines which means that small risks are being smoothed out by monetary policies while the big black looming risk grows bigger and bigger.

Not only that, but capital flows toward fixed income funds are reaching record highs.

figure 4 etf flows
Figure 4: Cumulative fixed income ETP flows in billions. Source: Bloomberg.

S&P 500 Sector Performance

One could argue that the above mentioned corporate earnings decline is mostly the result of lower commodity prices and declining earnings in the energy sector, but only 4 of 10 sectors will see earnings growth in the coming earnings season.

figure 4 earnings per sector
Figure 5: S&P 500 expected earnings growth per sector. Source: FACTSET.

Despite that the energy sector is expecting the worst decline in earnings, its performance in the last 6 months has been the best as things have stabilized a bit. On the other hand, the fact that utilities, energy and materials were the best performing sectors in the last 3 months shows that investors are looking for investments that protect against inflation and have constant, recession-proof yields.

figure 5 sector spdr
Figure 6: S&P 500 sector performance in the last 6 months. Source: Sector SPDR.

The same conclusion related to the search for inflation protective assets can be reached by the looking at the continuing surge in gold prices.

figure 6 gold prices
Figure 7: Gold prices in the last 12 months. Source: Bloomberg.

Gold is usually not correlated with stocks, but from the chart above we can see that both gold and stocks are increasing which again leads toward the conclusion that all asset prices are inflated.

What To Do

It is difficult to be smart in such an artificially created situation, but stock picking and “stick to what you know” might be the best option. You must evaluate the companies in your portfolio and identify how they will perform in the uncertain times that are ahead as asset inflation, possible real inflation in the future, and higher rates will wreak havoc among securities.

Now is the time to be smart. Investors should grasp the opportunities given by the high liquidity but at the same time think of the potential risks if anything changes in the current financial monetary easing system.



Negative Yielding Debt: A Party for Investors or Pure Stupidity?

  • Almost 30% of global sovereign debt comes with a negative yield.
  • The situation is much worse in Japan and Europe than it is in the U.S.
  • Investors should enjoy the asset inflation party while it lasts but also be prepared for the worst.


Negative yielding debt seemed impossible and illogical for a long time, but it suddenly became a reality a few years ago and now we are seeing it slowly become the new normal.

This isn’t just strange, it’s dangerous as risk averse investors—like pension funds and insurance companies—are forced to invest in assets that have traditionally been considered safe but that have now become risky, and their returns minimal. Those low returns will result in lower pensions and lower savings which will create new troubles in the future.

This article will analyze how we arrived negative interest rates, what the current situation is globally, and what the long term implications will be for your portfolio.

History and the Current Situation

Negative interest rates started with a few European central banks cutting their interest rates below zero in 2014 (Switzerland and Sweden), followed by Japan in 2016. The EU is not far behind with its 0% interest rate. Apart from central banks’ negative interest rates, high demand for bonds also pushes the yields below zero. With the European Central Bank buying 169 billion of bonds per month with its asset purchase program, it also distorts the markets, and pushes bond prices up, creating negative yields.

It is now estimated that 30% of global sovereign debt has a negative yield.

figure 1 negative yielding debt
Figure 1: Global debt by yield. Source: Wall Street Journal.

Per country, the worst situation is in Switzerland where the complete yield curve is negative, even for bonds maturing in 2049. Germany and Japan have negative yields on debt maturing in 10 years with yields of -0.17% and -0.28% respectively, while The Netherlands and France are not far away with yields at 0.02% and 0.12% respectively. The situation is much worse for debts with shorter maturities.

figure 2 euro yield curve
Figure 2: Euro yield curve. Source: Financial Times.

For perspective, it is wise to compare this to how the U.S. nominal yield curve looks as it is much healthier. If economic news from the U.S. continues to be similar to the latest job news, we could expect an interest rate rise in one of the next FED meetings, which should normalize the U.S. yield curve even more.

figure 3 us curve
Figure 3: U.S. yield curve. Source: U.S. Department of the Treasury.

With longer term yield being above inflation, the U.S. debt market looks much healthier and more rational than the EU or Japanese markets.

Economic Reasons and Implications

Many of the World’s most renowned investors have warned that this negative interest rate experiment in Europe and Japan will backfire. Pimco’s Bill Gross stated that a new supernova is being created and BlackRock’s Larry Fink has warned that it will have huge repercussions on the ability investors have to save and plan for the future.

The main goal central banks had in mind by lowering interest rates was to stabilize the economy and increase employment. However, given the length of time yields have been at zero, or even negative, without the accompanying benefits to the economy, one could conclude that the experiment has not worked. In fact, the World Bank has now trimmed global economic growth prospects from 2.9% to 2.4%.

One of the reasons why it may not have worked, is because the whole world is pushing for liquidity by lowering yields, and the positive effect low yields should have on an economy has been diluted and the only thing that has been inflated are asset prices, which isn’t bad if you are fully invested.

Since central banks were unable to create a healthy inflation rate of 2% with what they deemed the appropriate amount of liquidity, they then flooded the global economy with too much liquidity. And instead of having the desired effect of raising prices, it has actually increased competition with more goods and services being offered, which has lowered prices.

We might now start to see some inflation in the U.S. as the unemployment rate is getting close to the natural unemployment rate but Europe is still far from it with unemployment at 10.1%. Until consumers increase spending and create inflation this negative interest environment will persist and we cannot know when it will change, what we can is prepare for when it will change and analyze the current risks.

Implications for Investors

The most painful consequence of negative yields is that savers are penalized and that investors desperate for any kind of yield pay a high risk premium for low yields. A global snap back in interest rates, or a fall in credit quality, would put the financial world under extreme pressure as investments that are usually considered the safest could lose a substantial amount of value depending on how high interest rates rise, since bond prices move inversely to yields. Goldman Sachs estimates that an unexpected 1% increase in U.S. treasury yields would trigger $1 trillion of losses. If you are highly invested in bonds please be aware of the risks you are running if interest rates rise and ask yourself if the low yield is worth the risk.

Inflation would put pressure on interest rates and companies which cannot transfer increased financing costs onto customers would have huge difficulties in refinancing their debt. The current S&P 500 debt pile is the largest in history and companies are taking advantage of the low interest rates in order to borrow as much as they can.

figure 4 net debt
Figure 4: Net debt issuance/reduction. Source: FACTSET.

Investors should take advantage of the situation as most of the corporate debt is used for repurchases that further inflate asset prices but be careful for the moment when the party stops. At some point, the party has to come to an end someday because corporations are not using the fresh capital to invest but instead are only using it mostly for repurchases and dividends, thus not thinking that much about the future.


As there is no historical precedent to the current situation, all that one can do is make an educated guess as to when it will end. We all know that this situation is artificial and we also know that it has not been that beneficial to the global economy in the last few years.

As the more mature investors reading this will know, the economy works in cycles and we will see this asset inflation end but we cannot know when. When it does turn, it will certainly be an ugly scenario as investors will sell inflated assets in panic, corporations will find it difficult to refinance debt and central banks will not have maneuvering options with interest rates already negative.

But, as central banks continue to hope that more of the same—which is clearly not working—will eventually work, and which according to Albert Einstein is the exact definition of stupidity, let us enjoy the party while it lasts, hope that it will last for a long time, and always stay prepared for an eventual change.



Forget About The November Elections – This Will Impact Your Investments Even More

  • Slower global growth will have a much stronger impact on corporate earnings than interest rate increases.
  • US productivity is declining and GDP growth is based on increased consumption amidst cheap financing.
  • Corporate earnings are the source of your investment returns, and the picture is not one of growth.


Amid all the fuss around interest rates, Yellen, jobs, Clinton and Trump there is one piece of information that is very significant for investors but is often disregarded.

The World Bank has revised its 2016 global growth forecast down to 2.4 percent from the 2.9 percent pace projected in January. The cut comes mostly due to sluggish growth in emerging markets, weaker growth in developed economies, stubbornly low commodity prices and lackluster global trade and capital flows. A faster growth rate is expected only in 2018 and it’s still not spectacular as it will be only 3%.

There are more downside risks coming from the limited use of monetary policies at this point as rates are already close to zero, worsening conditions among key commodity exporters and softer than expected activity in advanced economies. On the upside, hope lies in structural reforms as space for fiscal and monetary policies is narrow.

This article is going have a look at what the World Bank says about US growth in order to get a FED-independent opinion and to discuss how slower global growth affects a portfolio, the economy and corporate earnings.

The World Bank’s Look at the US Economy

This a different analysis than the FED’s as it looks from a structural perspective and has no political goal attached to it.

Softer than expected activity since January has led to downward revisions of growth projections. Low oil prices led to a collapse in capital expenditures, while a strong US dollar and weakening demand from emerging markets contributed to stalling exports. The current growth is mostly a result of higher disposable income due to lower commodity pricing and cheap financing that increase consumption.

1 figure invesments US
Figure 1: Non-financial investments in the US are down. Source: World Bank.

In relation to labor, the trend is one of declining productivity amidst low corporate investments and most of the growth comes from services which do not contribute to sustainable GDP growth as much manufacturing does.

2 figure consumption
Figure 2: Consumption is the biggest driver of GDP growth. Source: World Bank.

The World Bank revised its US GDP growth forecast from 2.7% to 1.9% due to rising external risks and the inability of monetary policies to reach their set targets. In the longer term it forecasts US GDP growth at around 2% as investment growth remains modest, demographic pressures are intensifying, and a significant turnaround in productivity growth is unlikely in the short-term.

An interesting thing which is not commented on but is of great importance is that the US economy has reached its natural rate of unemployment which means that further employment or growth will come with increased costs. That should spur inflation which would leave the FED no choice on interest rate increases, no matter the state of the economy.

3 fiugre labor force
Figure 3: US labor force. Source: World Bank.

To sum up the situation in the US we can say it is fragile. The FED is not increasing interest rates as is knows that it would hurt the economy. Such a long period of quantitative easing and low interest rates should have had a much stronger influence on the economy, so the missed targets have the FED navigating in uncharted territory.

From an economic perspective, productivity is the main contributor to long term growth and it has not been increasing. Typically in the US, productivity has grown by an average of 2.2% since World War II, but has been growing at only 0.5% in the last 5 years and even fell by 0.6% in the second quarter of 2016.

Global Outlook

The global economy still hasn’t reached the growth rates from before the Great Recession.

4 figure globa growth rate
Figure 4: Global GDP growth rate. Source: Trading Economics.

The global economy typically was growing at levels around 4%, which would fall to 2% under the influence of a global shock like the 1970 oil crisis. Currently there is no shock in the global economy and central banks are stimulating the economy as never before. Any shock would therefore soon resend global growth into negative territory as we saw in 2009. A risk to keep in mind.

Impact on Corporate Earnings

As about 50% of S&P 500 corporate revenues come from abroad, global GDP growth is essential for earnings. The US is reaching full employment any growth potential will be subdued by increased hiring costs, and abroad growth is subdued by lower growth rates as countries like Russia and Brazil are still in a recession and China is slowing down.

5 sandp 500 earnings
Figure 5: S&P 500 corporate earnings. Source: Charts.

There is a high probability that corporate earnings are going to continue on their declining trend as companies are investing less and less while wage expenses are increasing and demand from abroad is weakening due to a strong dollar.


The above described structural trends bring to a conclusion that more investing activity than just buying the S&P 500 is required in order to reach satisfactory returns. As productivity decreases and global growth decreases, companies dependent on exports or with larger parts of their revenue coming from abroad should become underweight in a portfolio. Also companies that base their business model on services should have more difficulties in keeping their margins as the economy has reached natural unemployment level and wages are bound to go up.

As the economy still looks fragile, it is also opportune to look for companies that can withstand shocks, like a potential inflation shock coming from prolonged low interest rates or an interest expenses shock coming from inevitable future FED rate increases.