The swan dive by stocks this year hasn’t discombobulated Zvi Stepak. A market animal for more than 40 years, he’s been there before and seen crises far worse.
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True, right now the markets are swirling and the United States and Russia are snarling at each other, but nobody wants another Cold War. Nor are the banks about to collapse as everybody feared in 2008 and 2011. The demon inflation is nowhere to be seen, and even oil, which everybody had thought was running out, has been glutting the markets.
But Stepak admits that current developments have taken the markets into totally unfamiliar territory. Nobody could have predicted zero interest rates lasting years, and if anyone had, the assumption would have been that inflation would go insane because that’s what theory taught, Stepak says.
“In practice, interest rates are zero and sometimes even negative, but what most of the West fears now is deflation. This is a new reality,” Stepak says. Investment managers have to develop new ways of thinking.
He doesn’t foresee another global recession, at least not soon, but he does see risk. Altogether, he’s quite optimistic. “The global economy is still recovering from the crisis of 2008,” Stepak says. “I’m not one who thinks the current slow growth is the new normal. Rapid growth will come back.”
Stepak believes that the link between the drop in oil and share prices is illogical; the problem with oil was the speed of the tumble. A 70% retreat in oil prices over years wouldn’t have caused much drama.
Cheap oil is good for countries that import energy like China and Japan, and for the United States, even though it’s a major oil producer. It’s also good for Europe; cheap oil means more disposable income for consumers.
Brazil and Venezuela are among the countries suffering. The market reaction was emotional, Stepak says – pure fear. Anyway, oil prices will probably climb anew, since at $30 per barrel it hardly pays to produce the stuff.
Meanwhile the swings in commodity prices, currencies and stocks are extreme. And they’re confusing – oil plunging to $30 from $100 wasn’t a product of vanishing demand or burgeoning production.
Other things happened too, Stepak explains. From June 2014 to March 2015, the dollar appreciated 20% against the euro – a dramatic change for such dominant currencies.
“In January 2015, when the Swiss central bank stopped supporting the currency and set negative interest rates instead of depreciating, the currency appreciated 20% within seconds,” Stepak says.
“I figured the volatility would migrate to other assets. We did see sharp fluctuations in commodity prices and currencies in emerging markets. Then in June 2015 government bonds started to swing too.”
Ten-year government bonds of AAA-rated countries like the United States and Germany sank 8% in no time; Israeli government long-term bonds also swung. By August, the volatility reached stocks.
“It’s unknown territory. On the one hand, interest rates are at rock bottom and even negative in some places, and on the other hand, the uncertainty is intense,” Stepak says.
“The world economy hasn’t returned to normal since 2008. I feel I’ve been taken to Mars where the economic rules are different and I have to learn everything from scratch.”
This year will be just as strange as 2015, Stepak predicts, because nothing has changed; interest rates remain at rock bottom. Hate volatility? Stay out of the markets, he counsels.
Nor was the retreat by Chinese stocks explained correctly. Chinese stocks have little connection with Western stocks. It’s a local thing, a Chinese casino, Stepak says – like the Israeli casino 30 years ago.
Beijing encouraged the people to invest in shares, partly to cool real estate prices. But most Chinese aren’t in the stock market, which anyway doesn’t represent the Chinese economy, Stepak notes.
The main fear is strange moves by the government like forbidding journalists to write about share-price drops in order to stave off panic, or banning controlling shareholders from selling shares. “Investors wonder if China will have a soft landing or a hard one,” Stepak says.
Is there a similarity between a crisis that could start in China and the global crisis of 2008 that began in the United States?
“In 2009, when world markets sank, the Chinese stock market stayed roughly unchanged, though the Chinese economy continued to grow fast. Then Western markets rose and China went on its horizontal way. That didn’t seem normal. In 2014 the Chinese market shot up 130% in a short time. That was also suspect.
“My main concern about China has to do with the spike in real estate prices and the credit bubble, whose real dimension isn’t known. I think the problems China had in 2009 still exist. China has a bad problem with opacity. Its growth figures don’t mesh with other figures.”
Ghost town blues
So how can we know that it’s a real crisis in China? Crises always start in the banking system and often involve the real estate market – in Japan in the ‘80s, for example.
“If we hear about a major Chinese bank, it will have a dramatic effect on the markets. Chinese banks are government controlled and there is real concern that their loans haven’t been based on economic criteria. We’ve seen plenty of vast real estate projects standing empty; ghost towns.”
But Stepak projects a soft landing for China; the Chinese know how to get things done. When they make a decision, they make it happen. China is also sitting on a ton of cash, gold and U.S. Treasuries.
What if China decides to sell those U.S. government bonds? Stepak shrugs – the world has the capacity to buy the whole batch. And nothing will happen if bond prices fall and yields rise. But if there’s a real crisis in China, the world will feel it. Stocks will tank and U.S. Treasury notes will rise as investors race for a safe harbor.
Are Western economies heading for a lost decade à la Japan? Not in Stepak’s view – he thinks we’re easing back to normality. But it’s an investment manager’s job to be wary, and there are no bargains on the market at the moment. Investment managers have to pick and choose very carefully, especially in bonds. There’s more opportunity in shares, Stepak believes.
So are equity markets still attractive? “The price level of Israeli shares is still low compared with the rest of the world,” he says.
“Take Israeli bank stocks. There’s a market failure there. Even if I’m persuaded that there are big risks in investing in banks because of regulation and mounting competition, including technological ventures, I still think they’re a good investment for the long term.”
Meanwhile, European stocks are reasonably priced, and the European Central Bank is doing what the Fed has long been doing: buying bonds. Nor does Stepak feel U.S. stocks are necessarily overpriced, though they’re not too cheap.
“The problem in the market isn’t stocks, it’s bonds, from which share prices derive. The yield curve of Israeli bonds is lower than the American curve. That indicates that the shekel is a better investment than the dollar, and that Israel is a safer place than the U.S.,” Stepak says, underscoring the absurdity.
“That picture could be misleading. That’s why I maintain that today the better opportunities are in shares, not in the bond market. Especially after the latest retreats on the market.”