OPINION: Gray Rhinos put stocks at risk

JOHANNESBURG - While the term Black Swan event, coined by the contrarian risk manager Nassim Taleb, refers to a low probability but high-impact event, The Gray Rhino has been coined by Michele Wucker in her book The Gray Rhino; How to Recognise and Act on the Obvious Dangers We Ignore - the best-selling English book in China.

She terms a Gray Rhino as a highly probable, high-impact yet neglected threat, which when it charges can cause severe damage.

In simple terms she means “why do we ignore problems when the costs and consequences of failing to act are obvious?” She cites the bursting of the housing bubble in 2008 and the rising vulnerability to cyberattacks that were all foreseeable and could have been avoided.

It is best to identify the Gray Rhinos domestically and globally to get some idea when we consider the economic and investment outlook for 2018. Most importantly, inflation and inflation expectations are the most important Gray Rhino.

The labour markets in developing countries are very tight. In the US the unemployment rate is at 4.1% and at the lowest level since October 2000, when it reached a level of 3.9%.

Germany experiences full employment with 3.6% unemployment. France’s unemployment rate still sits at 9.7%, but is at the lowest since 2011. The Eurozone’s unemployment rate is currently 8.8% - the lowest since February 2009 - near post-2008 crash level’s figure.

Given the current trend, it is likely that the Eurozone’s unemployment figure is likely to reach the pre-2008 crash levels by the fourth quarter of next year.

Japan is also experiencing full employment with an unemployment rate of 2.8% - the lowest since 1995.

The tight and tightening of the labour markets are likely to spill over into higher prices - yes, the honeymoon is over. The normalisation of monetary policies, especially the euro zone, may therefore be brought forward as full employment is likely to fuel higher compensations and contribute to higher inflation and inflation expectations.

While protectionism is likely one of President’s Donald Trump’s strategies, the US is unlikely to escape the inflation spiral and could lead to a tighter monetary policy than is currently expected by the financial markets.

Sustained global economic growth is likely to lend support to commodity prices, resulting in further upward pressure on global inflation rates.

Political fragmentation came to the fore with Brexit, but is likely to gain momentum as a result of the upcoming normalisation of monetary policy in the Eurozone.

Reform

Angela Merkel, Germany’s chancellor, is already struggling to forge a coalition government and needs to get France on her side to reform the EU.

The monetary policy pursued by the European Central Bank (ECB) will become increasingly difficult and fraught with friction due to the employment inequality between the two nations.

The fragmentation is likely to escalate, especially in regard to the so-called “problem” countries.

Greece’s unemployment rate, while down from a high of nearly 28%, is still at about 21%. Italy’s unemployment rate is 11.1%compared to a high of more than 13%, while Spain’s unemployment rate is 16.7%, down from a high of nearly 27%.

The normalisation of monetary policy, which is likely to lead to higher interest rates, may cause significant discomfort in the said countries, resulting in them exiting the EU.

The negative impact that Britain’s exit from the EU had, and still has, was well telegraphed, while the exit of some of the “problem” countries could cause serious doubts about the EU going forward.

Yes, Brexit’s impact on the UK and the global economy does still need to take effect.

The tension on the Korean peninsula is another Gray Rhino. In fact, the Korean situation can be viewed as a potential Black Elephant - a combination between the Black Swan and the proverbial elephant in the room which does something no one predicts.

The persistent provocation by North Korea could lead the US into preventive strikes and the key aspect thereof is that South Korea, Japan and China will be more directly hit economically than the US.

An all-out war may bring about an abrupt end to the current global economic upswing.

Stocks, and especially economically cyclical equities, in developed markets are at risk due to the Gray Rhinos. Rising interest rates will undoubtedly threaten the rich valuations of equities, especially in the US markets.

While a cut in company tax rates in the US is likely to underscore earnings growth, the big question is whether the global economy will catch up with the current levels of global equity markets. Just as a matter of interest - collectively a group of rhinoceros is called a “crash”.

Although emerging market equities are facing the same Gray Rhinos they are likely to benefit from higher commodity prices.

The main driving forces are likely to be China and India.

The ECB’s large-scale bond-buying programme presented investors and banks a freebie through positive carries in the sense that they could borrow euros for next to nothing or use their own euros, which earned close to zero interest and invest in high yielding emerging market debt.

Quantitative Easing

The eventual ceasing of the ECB’s quantitative easing and bringing forward the normalisation of monetary policy are likely to exert upward pressure on long-dated bonds, especially in the Brics countries later in the year as the gap between the Brics and eurozone yield spread curves will narrow.

Apart from facing the same Gray Rhinos as the rest of the world, South Africa is also facing two highly certain events.

At the ANC’s conference from the 16th to December 20 a new president will be elected. Added to that, Moody’s review period for a downgrade runs until the 2018 budget is known in February next year.

If the downgrade happens, South Africa’s economy may suffer a major implosion. In an interview, Nassim Taleb described a White Swan as: “A White Swan for me would be a bridge that can only handle these (two-ton) trucks, of course, and you are certain because you have seen from a helicopter a few big six-ton trucks coming on the highway, and so you know the bridge is going to collapse, it’s only a matter of time.”

Will the upcoming events be White Swans?

Ryk de Klerk was co-founder of PlexCrown Fund Ratings and is currently a consultant for PlexCrown Fund Ratings.

The views expressed here are not necessarily those of Independent Media.

-BUSINESS REPORT ONLINE