- I am not actively looking to short India.
- Capital expenditure is falling globally. Global PMI is below 50.
- I deal in probabilities, not certainties
I deal in probabilities, not certainties. There is a lot of leading indicators that suggest that there is trouble ahead, say Raoul Pal, CEO & Co-Founder, Real Vision Group. Excerpts from an interview with ETNOW.
Your first prediction is that forget about contraction, there is a recession which is coming and one should fasten the seatbelts because turbulent times are coming and the fall could be bigger than what we have seen even in 2008?
I deal in probabilities, not certainties. I am looking at an increasing probability that we are going to enter a difficult period, based on a number of things. Firstly, it is US and global economic growth. As we know we are seeing economic growth on the decline everywhere. Many nations around the world are already in recession. The US looks like it is following suit and my belief is that it is going into recession as a result of the Fed tightening rates a year or so ago. On top of that, there are the trade tariffs and the Chinese slowdown which put together has created a big problem for the global backdrop. We have seen it with India slowing down as well.
Now the question is, does it fall into something that can get more complex and difficult? It probably does and the bond market is telling us that in Europe and the US in particular, bond yields have been falling sharply and kind of screaming that recession is a big risk.
We understand that the Federal Reserve is slowly cutting rates but my view is that they probably would not do enough. I think there is an issue with the US dollar; there is a shortage of dollars offshore and that is driving emerging market currencies and other currencies down versus the US dollar. The most spectacular of all has been the break of the Chinese RMB against the US dollar at that seven level and that is driven by this dollar shortage. We are about to enter a period from September, October, November where we are going to start taking out even more dollars from the system and there is a complicated part to the financial plumbing of the system where the US treasuries get issued a lot more bills, a lot more debt to start replenishing the savings account that they sent when the debt ceiling was in place.
That plus the extra spending means that the government has to raise something like $600 billion of new capital from the markets and that will be a $600 billion tightening of money coming out from the financial markets. The problem is, there is not enough dollars around globally to deal with that. We have a structural problem in a cyclical slowdown and there is a catalyst out there as well and it makes one really nervous.
Which are the lead indicators pointing to a recession around the corner?
I have seen it coming for sometime. It has been my core thesis. In March 2018, I saw China slowing down dramatically. Then the trade tariffs came in and we started to see the US slowdown and the bond market yield started falling dramatically. We have started the next part of the cycle — the rate cutting cycle. We have had only 25 bps cut in the US but the bond market is pricing in a lot more. I have a fear that the Federal Reserve is not reading the situation well enough and that they might underperform. If they do that, then that is likely to ignite the dollar and the bond market again. Maybe we will see more inversion of the curve.
I am expecting us to go into recession globally because I do not see anything to counteract this. Even if there is no more escalation and there is more tariffs to come and most corporates around the world are looking at the global supply chains and making adjustments because they cannot trust the US government stance with regards to where certain nations lie, in terms of favourability: can they manufacture in India or not? Can they manufacture in Mexico or not, we do not know. If you are a corporation, you are not going to make investment decisions. So, that is a recessionary situation, globally.
I do not think we have seen all of that start to flow through yet. Capital expenditure is falling globally. The global PMI is below 50, which would suggest that the world is headed towards recession. We are seeing the US ISM fall below 50, which increases the probability of recession significantly. We are also seeing Germany, China essentially in recession. We are seeing manufacturing, global trade contract everywhere. All major countries are seeing global exports decreasing. We are seeing big ticket items decreasing as well. This is a lot of leading indicators that suggest that there is trouble ahead.
A look at global prices over the last two years suggests that things are going to get worse as is the business cycle at least till the middle of next year. Any optimism seen in the markets currently is probably misplaced. Again I do not deal in certainties, I deal in probabilities. But the balance of evidence suggests that we should continue to see a slowdown and the majority of US data will prove that overtime.
Your view is that even though history may not repeat itself, it certainly rhymes and the importance of the dollar index in the near term positioning of risk and emerging markets cannot be dismissed.
Generally 80% of all of the performance in emerging markets is explained by the weakness or strength in the US dollar. When the US dollar is strong, emerging markets do badly which is why most emerging markets have not done well over the last few years, as the dollar supply has shrunk. When the dollar is weak, emerging markets tend to do well. Within that, different countries have different cycles and different strengths, etc. The one that worries me the most, would be South Korea. I think South Korea is getting caught up in the global trade situation. They are already in a trade dispute with Japan, one of its largest trading parties. China, the largest trade counterpart of South Korea, is slowing down dramatically. There is a reasonable amount of debt within South Korea as well and that makes me worry that the South Korean currency is going to weaken significantly and that would see the stock market fall as well.
India may fall into that zone. I am structurally long term a very big India bull but I worry that there is a little too much exposure to India still and there is some disappointment in the economic cycle. I would rather own India from a cheaper place. Although I am not actively looking to short India, I never bet against my structural view. My structural view is much longer term bull.
Your view on India is centred around the fact that you expect that Indian markets to benefit. What is your understanding of other sectors, especially the banks because Indian banks are in unique position right now?
I have been very long on India for a period of time. I closed out most of my longs about eight-nine months ago when I started getting concerned about the bigger picture. I was long on the banks, telecom companies and the Nifty overall. I still think longer term they are okay, but short term, you can see the price action is much choppier and complex and it just feels like there is a rotation. The Indian government bond market offers great returns in comparison to equities right now and much more surety. You can see that kind of rotation going on. It is the right thing to happen for India. I don’t really have any chart patterns that I am aiming for within India, but I do know that I think bond yields fall significantly over time.
Is the bear market in oil here to stay and we may not see $70 or $80 of oil for a really long time?
Yes I think that is right. We are in that most positive seasonality for oil now. It is bouncing around a little bit. There is always news out of Iran, always news out of OPEC. But if you think of the story that I have been telling, the narrative in the market that is explained by the charts, it is one of deflationary and global demand destruction. If that is the case, we should see it in copper, we should see it in oil. Copper broke a big head and shoulder’s top and looks to be suggesting there is further downside and oil looks like it has fallen some sort of wedge pattern that would allow for a fall down to somewhere around $45 which will be larger support level in a neckline of a much bigger head and shoulder’s top.
If that breaks, which I think it will, because it will be consistent with the dollar and all the other charts, I think oil could go to $30 or if not $20 a barrel which I do not think people are prepared for. Again if you are thinking in Indian terms, that is pretty constructive for India to have one of its largest import costs reduced so dramatically. So that will be a stabilising effect.