2018 — Some Pitfalls to Consider (Partial List)

Even though I don’t like to start the year on a grim note so I will make it short. Every year brings its own risks and pitfalls to consider that could push the markets to unexpected directions. Some issues are in the “known unknown” camp — i.e. issues that we are aware of (even if it’s only a vague idea) that could have an adverse affect on the markets — these include the whole Brexit story and Political unease in the U.S. But then we also have some “unknown unknown” issues that could irrupt this year or issues that weren’t given much media attention and perhaps deserve some attention. As I alluded in the title this won’t be an exhaustive list but it will give you some ideas to keep an eye on as they could unfold this year — or perhaps just continue to develop this year without causing any issues.

In any case, this is my very short and incomplete list in no particular order:

  1. Subprime auto loans: This industry has been running under the radar in part because of its “relative” low market cap compared to the subprime of the housing market a decade back. The subprime loans of this total $1.2 trillion auto loans industry is roughly a quarter; so it doesn’t appear big enough, — even if it’s linked to banks — to cause a major shake up in the markets. But the mere work subprime raises concern among us all. The delinquency rate has been climbing and is at 4% —  the highest level since 2011. So this isn’t a big industry but growing debt and higher delinquency isn’t likely to end well.
  2. Student debt: Over here the shape of this industry is even worse. It too is a 1.36 trillion industry and has soaring delinquency rates that are currently at 11.2% (90+ days delinquent or in default). It’s unclear how, when and if this issue were to develop to a serious systemic problem considering there are a lot of regulations on student debt. But again this issue isn’t getting much coverage and could down the line could cause impediments for the U.S. economy.
  3. Political unease in the U.S.: A lot has been said on this front but two things might not be getting to much attention in the markets (probably there are more than 2 but I’m trying to keep it short): For one, the nuclear unease between the U.S. and N.K. It’s true that the news outlines have given this issue some time but the markets don’t seem to price any possible outcome from this tension. Shouldn’t markets price in even a very small chance of possible deterioration in the relationships. Perhaps the markets are doing this some small extent via the weaker dollar and strong demand for LT treasuries. But at least stocks seem to completely ignore this matter, at least for now. Second, NAFTA – here there is little coverage and the markets don’t seem to price in a possible exit from this deal — a real possibility. The Mexican peso showed some signs of weakness in recent months against the USD but it also likely to be due to Mexico’s economy and natural disasters it had to endure (among other reasons). If there is a pull out of NAFTA this isn’t likely to lead to an immediate recession (at least not in the U.S. but might be for its partners) but it’s likely to shorten production chains and raise prices for consumers. So this could have an adverse impact on the U.S. consumer and corporations.
  4. Crude Oil: The surprise in the plunge in prices back in 2014 is unlikely to this year as the markets are much more wiling to acknowledge oil prices at $30 than they were before 2014.  But the recent rally in oil prices could come to an end if OPEC doesn’t continue to stand by its agreement, U.S. production were to pick up at a faster than expected pace and global demand slows down. Any of these events could lead to a sharp fall in prices and some of them together could result in oil prices going sub-$50 again.
  5. China: The debt levels of China are very high. This also with the unsustainable high growth rate in GDP means something will eventually have to give. For now, China was able to sustain its debt burden, 6.5% GDP growth rate by maintaining capital controls and through high savings. Eventually, there will have to be a transition to a more sustainable growth pace of 2-3%. The question is how will it unfold — how sever the adjustment will be — and when will it occur.
  6. The Fed: The will keep leading the way in moving markets. In 2017 the Fed raised rates 3 times and currently is likely to raise it 2-3 more times in 2018. If the yield curve were to keep flatting, this could indicate the markets aren’t buying that rates will remain high in the coming years. And if the yield curve were to reverse, this suggests a recession is coming in 12-18 months later — at least that was the case for the past 50 years. So keep an eye on the yield curve.

 

And let’s also end on a positive note, overall the global economy is expected to have overall a good year in terms of GDP growth, there aren’t apparent bubbles forming that could lead to a rise in the systemic risk (bitcoin doesn’t count as it’s not linked to banks) and corporate profits are on course to rise by double digits in the U.S. So there are reasons to also remain optimistic (at least on some issues) this year but to maintain skepticism along the way.

Or in short hope for the best and prepare for the worse.