Chief economist Steen Jakobsen at Saxo Bank believes it's important for investors to consider a range of possible risks to their portfolios, no matter how left of field they may seem.
“This year’s edition has a unifying theme of ‘enough is enough’. A world running on empty will have to wake up and start creating reforms, not because it wants to but because it has to,” he said.
“The signs are everywhere. We think 2019 will mark a profound pivot away from this mentality as we are reaching the end of the road in piling on new debt and next year will see us all beginning to pay the piper for our errant ways.
“The great credit cycle is already showing signs of strain in late 2018 and will rip through developed markets next year as central banks are sent back to the drawing board. After all, their money printing efforts since 2008 have only dug a deeper debt hole, and it has now grown beyond their mandate to manage.”
He said although these situations are unlikely to come to pass, it is important for investors to consider both the risks and opportunities macro-events such as these could have on markets.
“If some of these outrageous predictions see the light of day, we might finally see a healthy shift toward a less leveraged society, with less focus on short-term gains and growth, and a new focus on productivity and new economic revolution back toward globalisation with a fairer playing field after the immediate moment of crisis,” he said.
“On the negative side, we could see considerable worsening of central bank independence, a credit crunch, and big losses in the asset where everyone is too long: real estate.”
Here are Saxo Bank’s 10 most outrageous scenarios for 2019:
Scenario 1: The EU announces a debt jubilee
As another year goes by with Europe’s bond markets feeling the effects of Italy’s rising debt, Saxo Bank’s economists predicted what could occur should the crisis spill over across the rest of Europe.
“In 2019, the unsustainable level of public debt, a populist revolt, rising interest rates from European Central Bank (ECB) tapering/lower liquidity, and sluggish growth reopened the European debate on how to get ahead of a new crisis,” the bank suggests.
“Italian contagion sickens Europe’s banks as the EU lurches into recession. The ECB resorts to new targeted longer-term refinancing operations and forward guidance to limit the carnage, but it’s not enough and when contagion spreads to France, policymakers understand that the EU faces the abyss.”
Should this unlikely series of events occur, Saxo’s economists predict the EU will have no choice other than to back monetisation or watch as the Eurozone crumbles.
“The Economic and Monetary Union (EMU) extends a debt monetisation mandate to the ECB for all debt levels over 50 per cent of GDP and guarantees the rest via a Eurobond scheme while moving the controversial growth and stability goalposts,” Saxo Bank speculates.
“A new fiscal rule allowing the first 3 per cent of GDP in deficits to be mutualised in 2020 is adopted by EMU countries, with everything beyond subject to a periodic review by the European Commission linked to the state of the EU economy.”
Scenario 2: Apple moves in on Tesla
With Apple stocks taking a pretty big hit this year, Saxo Bank’s economists wonder what it would take for the tech giant to move into the next digital space – cars.
“Apple realises that if it wants to deepen its reach into the lives of its user base, the next frontier is the automobile as cars become more digitally connected. After all, the late Steve Jobs showed that a company needs to bet big and bet wild to avoid complacency and irrelevance,” the bank imagines.
The bank suggests that Apple, fuelled by the innovative legacy of Jobs and its desire to dominate all aspects of the consumer tech market, makes a bid for booming Tesla.
“Acknowledging that Tesla needs more financial power and Apple needs to expand its ecosystem to the car in a more profound way than that represented by the current Apple CarPlay software, Apple goes after Tesla,” Saxo Bank envisions.
“It secures funding for the deal at a 40 per cent premium of $520 dollars a share – acquiring the company at $100/share more than Elon Musk’s errant “funding secured” tweet.”
Scenario 3: Trump shows Powell the door
As the Federal Reserve raised interest rates yet again at the December 2018 Federal Open Market Committee meeting, Saxo Bank considers what could occur could Federal Reserve chair Jerome Powell have issued one too many rate hikes for the economy to handle.
“At the December 2018 Federal Open Market Committee meeting, Federal Reserve chair Jerome Powell signs on with a slim majority of voters in favour of a rate hike — one too many and the US economy and US equities promptly drop off a cliff in the first quarter of 2019. By the summer, with equities in a deep funk and the US yield curve having moved to outright inversion, an incensed President Trump fires Powell and appoints Minnesota Fed President Neel Kashkari in his stead,” the bank imagines.
“The ambitious Kashkari was the most consistent Fed dove and critic of tightening US monetary policy. He is less resistant to the idea of the Fed serving at the government’s pleasure and is soon dubbed ‘The Great Enabler’, setting President Trump up for a successful run at a second term in 2020 by promising a $5 trillion credit line to buy Treasury Secretary Mnuchin’s new zero-coupon perpetual bonds to fund Trump’s “beautiful” new infrastructure projects and force nominal US GDP back on the path it lost after the Great Financial Crisis."
Saxo Bank says US savers could be left high and dry as the Fed’s rate is held at 1 per cent, despite actual inflation rising to six times that level.
“Inflation reaches 6 per cent, is reported at 3 per cent, and the Fed policy is stuck at 1 per cent. That’s deleveraging you can believe in via financial repression to the great detriment of savers,” it suggests.
Scenario 4: Britain sees a Corbyn become PM and GBP/USD on par
As Britain’s voters become increasingly despondent over the back-and-forth Brexit negotiations between Prime Minister Theresa May and her conservative party, Saxo Bank wonders what could occur should Jeremy Corbyn and his party take out the 2019 British election on the back of promises to re-do a Brexit referendum.
“Labour sweeps to a resounding victory and names Jeremy Corbyn as prime minister on the promise of comprehensive progressive reform and a second referendum on a “to-be defined” Brexit deal,” the bank considers.
“With a popular mandate and strong majority in Parliament, the Corbyn Labour government embarks on a mid-20th century style socialist scorched-earth campaign to even out the UK’s gross inequalities.”
The bank wonders the extent to which Corbyn will move forward with a socialist agenda and the affect this could have on the value of the pound.
“New tax revenue streams are tapped into as Corbyn brings the UK’s first steeply progressive property tax into being to soak the wealthy and demands the Bank of England help finance a new “People’s quantitative easing”, or universal basic income,” Saxo Bank envisions.
“Utilities and the rail networks are re-nationalised and fiscal expansion sees deficits yawn wider to the tune of 5 per cent of GDP. Inflation rises steeply, business investment languishes, and non-domiciled foreign residents run for cover, taking their vast wealth with them.
“Sterling is crushed on the double trouble of ugly twin deficits and lack of business investment on the still-unresolved Brexit issue. Cable goes from the 1.30 area where it spent most of the second half of 2018 and all the way down to parity at 1.00, a move of over 20 per cent — with one dollar being equal to one pound for the first time ever.”
Scenario 5: Netflix falls out of favour
With Netflix still reigning king of the content streaming market, Saxo considers what it would take for investors to push the entertainment giant into volatile waters in 2019 due to concerns over its debt rate.
“2019 proves the year of credit dominoes toppling in the US corporate bond market,” Saxo Bank hypothesises.
“It starts with General Electric losing further credibility in credit markets, pushing the credit default price above 600 basis points as investors panic over GE’s $100 billion in liabilities rolling over in the coming years at the same time as the firm sees deteriorating cash flow generation.
“The carnage even spreads as far as Netflix where investors suddenly fret the firm’s fearsome leverage, with a net debt to EBIDTA after CAPEX ratio of 3.4 and over $10 billion in debt on the balance sheet. Netflix’s funding costs double, slamming the brakes on content growth and gutting the share price,” the bank adds.
In this scenario, the downturn hitting corporate bonds causes volatility in the high-yield bond market, which in turn triggers a massive fallout in the ETF market.
“To make things worse, Disney’s 2019 entrance into the video streaming industry trims Netflix growth further still,” the bank suggests.
“The negative chain reaction in corporate bonds sets off massive uncertainty in high-yield bonds leading to a Black Tuesday for exchange-traded funds tracking the US high-yield bond market where ETF market makers are unable to set meaningful spreads, forcing a complete withdrawal from the market during a tumultuous trading session. The fallout in the ETF market becomes the first warning shot of passive investment vehicles and their negative impact on markets during turmoil.”
Scenario 6: Australian Reserve Bank is forced to engage in quantitative easing due to housing market collapse
Although we have seen APRA release the breaks on interest-only home-loan lending, Saxo Bank considers what could happen should property investors continue to sit on the sidelines and the drop in housing prices takes its toll on Aussies households.
In 2019, the curtains close on Australia’s property binge in a catastrophic shutdown driven most prominently by plummeting credit growth,” the bank imagines.
“In the aftermath of the royal commission, all that is left of the banks is a frozen lending business and an overleveraged, overvalued mortgage-backed property ledger and banks are forced to further tighten the screws on lending.
“Australia falls into recession for the first time in 27 years as the plunge in property prices destroys household wealth and consumer spending. The bust also contributes to a sharp decline in residential investment. GDP tumbles. The blowout in bad debt squeezes margins and craters profits," says the bank.
Saxo Bank suggests that the only means of recovery would be in the form of an RBA bailout, potentially recapitalising and securitising mortgages onto the RBA’s balance sheet.
Scenario 7: A German recession
Based on slow car industry growth in 2018, Saxo wonders how the German economy would be affected should German car sales be stifled by the increasing demand for electric vehicles (EV) and strong US tariffs.
“A global leader for decades, Germany is struggling to upgrade its leveraging of modern technology,” the bank proposes.
“The crown jewel of the German economy, representing a cool 14 per cent of GDP, is its car industry. The German car industry was supposed to be a growth juggernaut, registering 100 million sold cars in 2018. In the end, it only managed to unload 81 million cars, a mere 2 per cent more than 2017 and well down from the 5-10 per cent yearly growth rates from 2000s and forward.
“By 2040, 55 per cent of all new global car sales and 33 per cent of the stock will be EVs. But Germany is only just starting the transformation to EV and is years behind, and stiffer US tariffs won’t make things any better for German supply chains or exports," says the bank.
Saxo Bank suggests the trends of anti-globalisation, the leveraging of big data and sustainability could have an adverse impact on the industry that was once the stalwart of the German economy.
“2019 will be the peak of anti-globalisation sentiment and will create a laser-like focus on costs, domestic markets and production, and the further use of big data and reduced pollution footprint – the exact opposite of the trends that have benefited Germany since the 1980s. As such, we see a recession arriving as early as the third quarter of 2019.”
Scenario 8: Solar flare causes $2 trillion of damage
Few people would be aware that we are entering the 25th solar cycle and the potential exists of a subsequent solar storm inflicting trillions of dollars of damage on vital satellites located in the western hemisphere.
Saxo Bank envisions what would happen should a major solar event take place in 2019.
“As solar astronomers are well aware, the sun is also a seething cauldron of activity capable of producing incredible violence in the form of solar flares, the worst of which sees the sun vomiting actual matter and radiation in the form of Coronal Mass Ejections, or CMEs,” the bank highlights.
“In 2019, as solar cycle 25 kicks into gear, the earth isn’t so lucky and a solar storm strikes the Western hemisphere, taking down most satellites on the wrong side of the earth at the time and unleashing untold chaos on GPS-reliant air and surface travel/logistics and electric power infrastructure.
“The bill? Around $2 trillion, which is actually some 20 per cent less than the worst-case scenario estimated by a Lloyds-sponsored study on the potential financial risks from solar storms back in 2013.”
Scenario 9: Climate change sparks a Global Transportation Tax (GTT)
As the impact of climate change becomes increasingly felt around the globe, what could happen should an international transportation tax be agreed upon to put pressure on the aviation and shipping industries to lower their carbon emissions?
“The world suffers another year of wild weather with Europe again experiencing an extremely hot summer, setting off panic alarms in capitals around the world,” the bank hypothesises.
“With the international aviation and shipping industry enjoying substantial tax privileges, they become the targets of a new Global Transportation Tax (GTT) that introduces a global ticket tax on aviation and a capital “tonnage” tax on shipping with the price linked to carbon emission footprints. The new tax charge is set to $50/ton of CO2 emissions which is twice previous proposed levels and significantly above the 2018 average of €15/ton under the European Union’s Emissions Trading System."
In order to offset the impact of the tax, Saxo Bank suggests the tax would have to be passed on to consumers, further exacerbating US and China relations and sending markets into worsened volatility.
“The new GTT pushes up air travel ticket prices and maritime freight, increasing the general price level as the new tax is passed on to consumers,” the bank suggests.
“The US and China have previously contested fuel taxes on aviation, citing the 1944 Chicago Convention on International Civil Aviation, but China changes its stance as a natural progression of its fight against pollution. This forces the US to reluctantly join forces in a global transportation tax on aviation and shipping. Stocks in the tourism, airline, and shipping industries plunge on increased uncertainty and lower growth.”
Scenario 10: IMF and World Bank turn their attentions to productivity
Finally, Saxo Bank looks at what could happen if two of the globe's leading financial institutions turned their attentions away from GDP and instead focus on ‘productivity’, or each nation’s output per hour worked.
“In a surprising move at the International Monetary Fund and World Bank spring meetings, chief economists Pinelopi Goldberg and Gita Gopinath announce their intent to stop measuring GDP,” Saxo imagines.
“They argue that GDP has failed to capture the real impact of low-cost, technology-based services and has been unable to account for environmental issues, as attested by the gruesome effects from pollution on human health and the environment in India and elsewhere around the world."
Productivity is certainly one of the most popular, and yet least understood, terms in economics. Simply defined, it refers to output per hour worked.
The bank suggests a move such as this would allow both the IMF and World Bank to better monitor the true standard of living per country and also would indicate central banks no longer possess dominant control over each nation state’s economy.
“In the real world, however, productivity is a much more complex notion. In fact, it can be considered as the greatest determinant of the standard of living over time,” the bank says.
“If a country is looking to improve people’s happiness and health, it needs to produce more per worker than it did in the past. This unprecedented decision by the IMF and the World Bank also symbolises the transition away from the central bank-dominated era that has been associated with the collapse in global productivity since the global financial crisis.”