Saxo Bank Quarterly Outlook: End of a Cycle Like No Other

Saxo Bank provides an ominous economic outlook in its second quarter report.

What follows below are snips from a 35-page report by Saxo Bank. I condensed the report for readability. Any emphasis in italics is mine. Until the final paragraph what follows are snips from various Saxo Bank analysts.


End of a Cycle Like No Other - Steen Jakobsen - CIO

We are nearing the end of the largest monetary policy experiment of all time, and ascendant nationalism, staggering inequality, and a widespread loss of hope among the younger generation are among its varied fruit. The good news? Things only change when they absolutely must.

Q1’s brief volatility spasms notwithstanding, today’s capital markets are in a zombie-like state, with low volatility and extreme valuations in all assets with no net increase in growth and productivity, and a massive increase in inequality.

The benefits from the globalised system and particularly from the central bank’s asset-pumping response accrued near-entirely to the already wealthy, while the average economic participant lost out. This is the process that drove the advent of Brexit and Trump.

So now we have our first great new showdown since the Cold War, which saw the victory of capitalism over communism. Now comes the fight between nationalism and globalism. Nationalism is winning big, as country by country the outlook is turning inwards, with an increase in placing the blame on external forces from immigrants to the real and imagined misbehaviour of trade partners. Talk of trade policy and protectionism is now labelled “trade wars”.

What we are forecasting is that technology will move from app-creation and data harvesting to becoming compliant with new data regulations – again, a cost. The US economy will get no big upside from the tax cut; housing prices have already dropped 15-20% in New York and inflation still will not materialise as net lending demand, or the velocity of money, continues to be depressed and will soon enter negative territory.

The geopolitical scene will be driven by nationalistic agendas, meaning less and more expensive trade and – in the worst outcome – a world split into China versus the US, with the rest of the world having to decide which side to join.

For yet another angle on how this cycle is different from anything in recent or even distant memory, see the chart above (courtesy of my fellow Dane Torsten Sløk of Deutsche Bank in New York), which I deem to be the most negative I have ever seen.

Please explain to me how a 35-year-old can be less optimistic about the future than a 55-year-old! It defies logic, nature, and reasoning. It is a case of young people feeling the pain of the present economic reality: it’s hard to find a decent job and or even interview for a job when you need a PhD to start with. The young are increasingly indebted by education costs and priced out of getting onto the house ownership ladder.

Equity Burnout - Peter Garnry - Head of Equity Strategy

With the MSCI World Index valued above the average and multiple key macro risks on the horizon, the risk-reward ratio is no longer all that attractive for equities on a two-year horizon. Global rates have risen, thereby improving the alternative to equities. With a recession likely coming with the next two years, the outlook does not support an aggressive stance and overweight position in equities.

Dollar is a Time Bomb and the Fuse is Burning Faster - John Hardy - Head of FX Strategy

When the Fed tightened policy starting in late 2013, the supply of printed US dollars started drying up and the USD exchange rate went increasingly vertical. Many forget just how bad a year 2015 actually was for global asset prices, particularly in emerging markets, and it was the lucky timing of the European Central Bank’s extreme QE starting in early 2015 and China’s eventual massive stimulus starting later that year that likely kept the world from dipping into recession.

But now, most of the policy punch bowls around the world have been removed or are nearly empty. China’s growth priorities are changing to priorities centred on the standard of living for everyone, as well as environmental policy, and Beijing also faces the onerous task of addressing its own credit bubble.

The Fed, meanwhile, continues to tighten policy and supposedly intends to shrink its balance sheet at an accelerating pace. Elsewhere, the ECB has promised to cease expanding its asset purchases entirely by late this year. Only the Bank of Japan continues to drag its heels, though it has also tapered its rate of asset purchases over the past year.

The removal of global policy stimulus has naturally come about as the world economy finally managed a couple of quarters of synchronised growth in 2017. But our view is that this growth is tenuous and very late-cycle, particularly in China and the US, as the credit cycle has already turned. And the next challenges for markets are just around the corner.

First, the escalation of US protectionist rhetoric, most pointedly aimed at China, sets in motion a whole host of potential responses from the Chinese side. Undoubtedly, among these will be an effort by China to reduce the sway that the US dollar holds over global trade and financial markets.

Second, Trump’s freshly minted tax regime has guaranteed unprecedented new fiscal shortfalls during an expansionary phase of the US growth cycle – as much as a trillion USD for the next budget year already. The US actually dipping into a recession over the next 12 to 18 months (as we suggest) is an underappreciated risk, tax cuts notwithstanding; the fiscal gap will stretch beyond even the extremes seen during the financial crisis of near 12% of GDP.

As the US runs a large current account deficit, it will have to fund that deficit with foreign capital – likely at a far lower USD value. Providing added urgency to the search for an alternative to the USD is the need to devalue the world’s stock of USD-denominated debt – which has only increased by leaps and bounds in the offshore USD system that got global finances in such a pickle back in 2008-09.

Last September, the Bank for International Settlements estimated that there was a net $25 trillion in USD-denominated debts and derivatives in the offshore financial system. The world can ill afford another USD funding mishap, one that has already partially been set in motion by Trump’s corporate tax cuts, which are encouraging US corporations to repatriate hundreds of billions of USD from outside the US and draining liquidity from the offshore USD system.

Recession The Evidence Piles Up - Christopher Dembik

At the end of last year, the consensus eagerly embraced the “synchronised global growth” narrative and no one dared question the strength of the United States economy. Optimism prevailed among the financial community. As we enter the second quarter of 2018, the hopes of synchronised growth are vanishing quickly as the global economy suffers a loss of momentum (global PMI has plunged to a 16-month low) and warning signs of an imminent slowdown are popping up in the US.

Credit Impulse Heading South

In a highly leveraged economy like the US, credit is a key determinant of growth. Lower credit generation is expected to translate into lower demand and lower private investment in the coming quarters. There is a high 0.70 correlation (out of one) between US credit impulse and private fixed investment and a significant 0.60 correlation between credit impulse and final domestic demand.

So far, there has been no sign that Trump’s tax cuts could mitigate the negative effect of a lower credit impulse by lifting companies’ investment spending plans. In the last NFIB survey, the proportion of respondents planning to increase capital spending even decreased to 26%, which seems to indicate that there is more to consider than tax alone when running a business.

Spectre of Recession

The main risk for investors is the increasing mismatch between the optimistic view of the market that considers the risk of recession as being less than 10% and what recession indicators are saying about the economy. These indicators suggest that the US is at the end of the business cycle – which is not much of a surprise – and hint that recession is just around the corner and Trump’s economic policy does not seem able to avert it.

Evidence Piles Up

Even unconventional indicators are sending warning signs. Product sales by paper and paperboard mills, which reflect the evolution of sales and therefore give a signal about the future evolution of production, have been falling since the beginning of the year. Although this indicator is certainly less reliable than in the past due to the digitalisation of the economy, there is still an obvious correlation with the economic cycle.

US consumer confidence has returned to a high level but households’ financial situation remains gloomy. Household debt is at a new record of $13 trillion and the most fragile households are starting to face serious difficulties due to higher interest rates and tightening credit conditions.

Even though we agree that history does not always repeat itself, it is interesting to note that historically, such levels of consumer confidence have been followed by recession and a lost decade. This is too much of a coincidence, is it not?

Delinquencies have increased considerably over the past few months, especially in subprime auto loans where serious delinquencies have reached ‘Lehman moment’ proportions, as well as in credit cards.

Commodities Go Their Separate Ways - Ole Hanson - Head of Commodities Strategy

Gold is one of a few metals that has managed to hold onto a positive return this year. However, after several failed attempts to break through the $20 band of resistance above $1,355/oz, many investors have for now adopted a wait-and-see approach.

Despite the fading focus on inflation, which was a key driver at the beginning of the year, we believe that investors will continue to seek diversification and protection against trade and geopolitical tensions as well as increased volatility across global stock markets.

Recent history does tell us that the impact of geopolitical risks and events tends to be transitory unless they lead to a significant change in the economic outlook.

An escalated trade war could be a situation where growth is negatively impacted. That could lend support to precious metals as the speed of future US rate hikes slow and bond yields reverse lower. On that basis we maintain a bullish stance on gold above $1,280/oz and view a break above $1,375/oz opening up for a move towards $1,480/oz. Silver has the potential for making a comeback based on continued support for gold. This is because hedge funds hold a record and now squeezable short due to the lack of lower price action to support, as well as the fact that compared to gold, silver is relatively cheap with the gold-silver ratio trading near a two-year high.

Mish Comments

Thanks to Saxo Bank for an excellent and comprehensive 35-page report. I touched on what I believe to be the highlights. Unfortunately, I do not have a link to the full report. It came from Saxo Bank by email and is not yet posted online.

Mike "Mish" Shedlock

The lack of optimism among the young might be a sign that they are starting to seen the inevitable failure, but I don't think that's it at all. I think it's the exact opposite. I think they are not optimistic because government is not following the full Bernie Sanders style socialistic approach. They still see more government as the answer, not the problem. Thus, that indicator also is a warning to me that the end is growing closer, not further away.

I appreciate seeing the highlights of this report. Thanks Mish. It appears that slow growth will continue in the US and worldwide for the next year or two, provided there is no shock to the system such as a trade war.

It’s interesting to read the comments section. I enjoy it almost as much as the articles. When the article clearly says, the US is at the end of the business cycle yet people’s interpretation is everything is going to fine.

I find your last statement about the lack of a Bernie Sanders style of socialism being the pessimism of the "under 35" crowd to be a challenging insight. I don't disagree that many people expected a Utopian society to be the natural course after 2008-2016 and that was rather upset by the not-to-Utopian POTUS.
Which raises a question: does the lack of optimism have a legitimate economic component or are we just looking at a general misunderstanding that economics are not correlated to social progress and negatively correlated to government intervention?
Maybe the "optimism" being measured isn't one of economics but of the ideal of a Utopian Society that has been getting promoted over the last ~6 years. The fact that people have a very hard time getting real jobs that can justify their education debt isn't the fault of economics or career choices but one of society not providing them with the opportunities necessary for their choices to be successful.
Similar to this is the idea that a zero-skills job should provide for an idealized Middle Class lifestyle (which is well beyond the Middle Class of the 1950-1970s) and that it's the fault of society & government to provide that and since they haven't granted a $15/hr minimum wage there's no hope. Again, nothing to do with actual economics.

This is the beginning of the end of Wall Street capitalism and the beginnings of Main Street capitalism. Expect Wall Street lackeys like Mish to keep on whining every step of the way, writing their "the-sky-is-falling" stories every other day. What they don't realize (or more likely, don't care about) is that the sky has ALREADY fallen on hundreds of millions of Americans and billions of people the world over during the last 40 years of Reagan and Thatcher style neoliberalism.

I'm guessing that the 35 year olds grew up in the households of the now 55 year olds. And they suddenly realize that their parents lived better at 35 than they do at 35. What they don't understand is that their parents lived on the residues of government policies and corporate governance styles of the '50's and '60's. While they live on the residues of government policies and corporate governance styles of the '90's and '00's. There are consequences to the choices we make.

So they are predicting a global downturn and USD crash? This seems to lack internal consistency. Also, they don't seem to bring it all together to a clear view other than the general pessimism that they begin with.

Goren, my advice is not to concern yourself overly with the conclusions that "they" reach. Simply take their information, and glean from it what you can, and reach your own conclusions. Articles like these are a starting point for discussion, not the end of one.
Whirlaway, indeed it is possible that, in the economic changes ahead, Wall Street Capitalism will be replaced by something new, but it won't be "main street capitalism", because there is no such thing. If it falls, it will most likely be replaced by anarchy, and confiscation, and ultimately by some sort of dictatorship, either a military one, or a populist one. While those two are extreme opposites, either way the people that will suffer the most will be middle income Americans because today they may not have all that they would like, but they have quite a lot, and in a dictatorship, only those in power will have anything, and living conditions in America will become like those in other dictatorships. Be careful what you wish for, as you may get it.

Good to hear this Dane Banker has it all figured out. Guess I'll need to apply for a Saxo credit card.

When will these knuckleheads figure out that an economy is a self organizing structure, the more official meddling in it, the greater the distortions in it's efficiency.

“Things only change when they absolutely must”, which for govt that means after the crisis, when they can conveniently point the blame at someone else and pretend to save the day.

As noted, the “massive increase in inequality” has been due to the rise in assets, not income. So why doesn’t the govt allow the average Joe to participate in the asset appreciation by investing Social Security in stocks (private sector) instead of govt bonds?

Nationalism does NOT have to mean trade wars and more expensive trade. These negative consequences are the result of globalist that impose more govt and taxes, which slows global growth because govt can never down-size. Since there are no mirrors in the halls of govt, foreign boogeymen and minorities are always blamed for the economic malfeasance of govt. Politics, not individuals or small businesses, forced the refuge crisis that also contributed to the anti-establishment movement that has swept through Europe. After imposing inhumane austerity on Greece, Merkel wanted to pretend to be human by unilaterally opening the refuge floodgates.

Looking at the MSCI World Index and global rates to make a determination on stocks is confusing at best. What if rates rise much faster abroad, and a sovereign debt contagion causes global capital to seek the relative safety of dollar-based assets?

“It was the lucky timing of the ECB’s extreme QE … that likely kept the world from dipping into recession”. Lucky for who – Draghi and captured banksters? The ECB already owns 40% of all member country debt, and Draghi will TRY to keep buying until the end of his term to avoid being blamed for the pending crisis (he will be unsuccessful in running out the clock).

Virtually everything that John Hardy (head of FX Strategy) says, and you highlighted, is upside-down. Higher interest rates will be much more devastating to foreign entities holding the $25+ Trillion in dollar-based debts, and since the big money knows the problem, does he really think the dollar will decline and the US will have a hard time attracting foreign capital? It is a RISING dollar that will cause the crisis, not a falling dollar, as the amount of dollar-based debt grows in relation to the declining home currency, compounding the debt problem abroad.

Uncertain and high corporate tax rates, coupled with govt taking an ever-increasing chunk of people’s incomes is naturally impacting global growth. Yet, govt’s solution is more bloodletting. The mere insinuation that Trump’s tax cut is bad demonstrates how upside-down the “thinking”.

Gold and silver will eventually rise, but not until govt confidence collapses, which will occur when govt reneges on promises (i.e. pensions) over the next few years. However, because the big money does not park in PM’s, stocks will outperform. The bubble is in govt, not the private sector. This economic reset process will also be very bullish for cryptocurrencies, which provides optimism for the younger generation, as they see some light out from under the oppression of govt. Why wouldn’t the younger generation be depressed with the rampant lying by govt and the media, as well as seeing their parents and grandparents milk the system dry and sending them the bill?

This comparison of under 35/over 55 attitudes is absolutely stunning. If a quant pitched it to me in a PowerPoint, I'd first want to see the source data to determine if it's been folded, spindled, mutilated, mined, spun and/or distorted, to serve an agenda. I.e., was it taken from apartment dwellers next to a recently closed Sears store and dying shopping mall, and maybe four blocks from an up-scale retirement community where the over 55's were taken? If not and the data and use are legit, I'd round up the usual suspects and control for them: 1.Student debt, now $1.3T of $13T consumer debt. 2.Credit card balance, the working middle class's last grip on living standards. 3.Car payment delinquencies 4.Personal job situation, e.g., are you working a plan to outsource your job to India in 18 months? 5.Have you tried and failed to find a house you can afford in your area? Very interesting.


"the younger generation, as they see some light out from under the oppression of govt" Youngsters tend to be more "progressive" than old grumpies, and seek more government controls, not less. This will be true if and when any kind of crypto solution gets real traction: the majority of voters will WANT it to be regulated/owned by the government.

While I have a bias towards these viewpoints, first thing that bothers me: "housing prices have already dropped 15-20% in New York" - I live in the NYC metro, and I don't know how such a statement could be made. Unless the context is, since the peak in 2006? Or does he mean update NY and not NYC metro? No support for the statement is given. Second thing is: I have three children ages 32, 30 and 25; all are working, happy, and self sufficient. And they have plenty of friends who are likewise. True, they don't have any college debt. Then again they weren't called for the survey.

More pointless rants against neoliberalism. Politics and policy have done a fraction of the damage to our economy and social fabric that monetary policy has. Our monetary system is front and centre the single biggest cause of our woes. Do yourself a favour -- take your ignorance and bury it in a deep hole. You know the one ...

Of course, there is such a thing as "Main Street capitalism". You see it in parts of Western Europe from Scandinivia to Spain. Do those countries have economic problems? Yes, they do. But wherever they do, it is caused by the instances where they fell prey to (or were arm-twisted into accepting) aspects of Wall Street capitalism.

A wonderful and insightful read. i learned a few things to. God help us all.

Thank you for posting this.