Checkpoint: 115 Months of recovery, where are we?

In February 2018 I noted that the recovery had reached 105 months (I must have been off in my count, as the WSJ today calls it 115 months so far, with the longest in US history being 120 months), and asked what could end the recovery. I listed nine possible scenarios that could crack investor confidence sufficiently to cause a sustained market downturn or crash. How have those nine held up over the past ten months, and has the level of risk increased or decreased?

If we should take any lesson from the passage of the past 10 months, it should be that we are closer to the storm, not that we have avoided it.

There has been, with the US mid-term elections, both a reduction in the level of risk and potentially, a major increased risk event. More about that below.

As a recap, the nine potential issues (one removed, one added) that could bring about an end to the US recovery include:

1. Interest Rates;
2. Inflation shock; 
3. Budget deficits;
4. External Shock;
5. Housing market;
6. Automotive Loans default rates; 
7. Credit Card delinquency rates;
8. Environmental event; 
9. Mid-term elections

After years of single-direction trajectory for the markets, the February correction jolted people from their complacency, but concerns were short-lived as the markets recovered and eventually reached new highs in early October. Then there was the October market shock, and now it appears a post-election bump.

Being very clear, I still do not know if the top has been reached, or is there more headroom in this market. I have no idea. None. Also being clear, while the discussion focuses on the US markets, there is nothing in here that either does not have or is not impacted by events and economic situations in other countries.

If the markets continue their advances, how far can they go, and for how long? Is the US in the "demographic sweet spot" that I wrote about in August 2017? I asked if the fall in the US labour market participation rate had been strong enough to create sufficient pools of surplus labour to allow for multi-year growth as that surplus labour drip-feeds into the workforce. If it is, then there may actually be a few more years of growth in the economy and the markets. If not, then the third longest recovery in US history may come to a sudden end.

So having presented all the caveats that matter, the question remains; when will the recovery end, what factors could cause a market rout, and how close are we to that happening?

Interestingly, almost all of the nine catalysts has deteriorated over this year, increasing the chances of any one of these reaching a tipping point, and with contagion, bringing about a multiple Black Swan event stream.

In February I wrote “Most important, there is not one situation that will cause the coming crash, and all are interlinked and interdependent. Each can, and probably will, impact and potentially exacerbate another or multiple others.” That assessment remains true, and the deterioration of each potential catalyst since then has only increased the probability of such contagion.

Below I look again at each, with a potential update on the current situation.

1. Interest Rates: Fed rates hikes have continued through the year, and there is an expectation that there will be another rate hike in December 2018. I predicted that the Fed rate would continue to rise, and it has. More importantly, the 10-year Treasury, hovering then around 2.9% up from a low of 2.06% only six months previously, is now in the 3.2% range, and will go up further with additional rate hikes. Eventually, returns on “zero-risk” assets will move closer to the returns that can be expected (minus the desired margin for risk) from risk assets. When that happens, there may be a flight to Treasuries. There continues to be the additional risk of tipping point in consumer credit growth due to increases in interest rates. Interest rates remain a potential cause of a sudden drop in confidence.

2. Inflation shock: While the years of QE, QEII, Twist, Abenomics, and ECB purchases did not create the inflation shock that should be expected from too much cash chasing too few assets, there are signs of inflation beginning to creep in – in employment costs. Surplus labour is being consumed, and the dearth of skilled workers is beginning to be felt. While demographically the US may have a deep lake of workers waiting to return to work, the decade of reducing participation rate has stripped many of these workers of skills that are required in an economy that has changed so significantly in that decade.

3. Budget deficits: the official 2018 US federal budget deficit is $779 billion, and has jumped 17% since 2017. This, of course, is not the actual US federal budget deficit and total borrowing by the federal government, because it only includes “budget” items, and does not include a wide range of additional spending that has resulted in the US federal government actually borrowing $1250 billion. A Congressional Budget Office projection stating that servicing of the national debt will exceed 8% of the 2019 federal budget (from a current 6% of the federal budget)? As interest rates increase, so does the interest payment obligations of the US government. At some time, there will be a confidence shock related to the budget.

4. External Shock: In the past 10 months there are been plenty of External Shocks, and defying expectations, none seem to have actually impacted levels of confidence in the US economy (and it is the US economy and markets that will crash the rest of the world). Turkey has crashed, as has Argentina, and Venezuela continues to perform to form. Equally unsurprising, there has not been a war with North Korea (not that there ever was going to be a war with the Norks – and yes, The Donald was played like a cheap fiddle). 

Yet potential external shocks remain, and the most “predictable” today include the Italian budget, Brexit, and China. None is a war, but we shouldn’t discount the possibility, with Iran being vocally belligerent (with the threat to Oil supplies and price) after the imposition of the extremely harsh sanction by the US, and an accident could spike tensions in the South China Sea at any time. Extreme but highly unlikely events might include the fall of the current Crown Prince in Saudi Arabia and an associated short civil war.

5. Housing market: The US housing market is turning, even though it has had a very strange 6 months, with months of good starts, contacts and completions for both new and existing homes, and months of badness in the numbers. The latest information suggests that optimism is gone from the market. Optimism drives the market, as without consumer optimism major purchases, and a home is one of the largest purchases most people will ever make, will be postponed. 

6. Automotive Loans default rates: This is one area where the numbers appear to be improving, with auto loan default rates reducing marginally in the previous quarter. Current default rates are increasing, and the total outstanding loan period is also at a record high. In 2018 the most common car loan term was 72 months, and average new car loan monthly payments have reached a record high of $531/month. In addition, over 30% of used car trade-ins are under water. Combine the two, and the consumer is likely to become trapped in the vehicle they are in, and with that trap will come a reduction in car sales, and an expectation of future poor performance by the automotive section.

7. Credit Card delinquency rates: The American binge on consumer credit continues, and in fact never really stopped. Net savings rates are at historic lows of around 2% (average across the entire economy) while credit card debt continues to rise. This is unsustainable. However, so far delinquency rates are not rising, and remain cyclically low at around 2.47%, and in fact remain lower than before the GFC.  None the less, with consumers continuing to splurge on consumer debt, it is only a matter of time before delinquency rates start to climb again. 

8. Environmental event: In a strange twist, the hurricanes and fires that have caused so much damage and misery across the American south and west are now beginning to show up as increased economic activity. The latest retail and home improvement sales have shown a nice jump, probably due to rebuilding activity. Unfortunately, like wars, this is false economic growth, as the country and the people spending the money are paying to return to something less than their pre-event status.

9. And, the Mid-term results: And of course there is now the new situation that could result in longer term (18 months at best) stability, or could result in a US national trauma that spills over into markets and globally; the Mid-term results. It is a given that there will be investigations, indictments, and quite possibly an impeachment, or at least the start of an impeachment process. We will enjoy the drawn-out process of the President attempting to keep his tax returns secret, and fighting subpoenas all the way to the highest court, if he can.

We will also see any market setback being blamed on a Democratic House refusing to go along with his additional tax cuts. A government shutdown is also possible.

One thing is certain, legislative gridlock and a shutdown in the passage of meaningful legislation to help the economy.

Whatever the trigger, when the fall in the markets come, it will be steep and quick, followed by months if not quarters of a cyclical bear market. And while I am writing based on the US economy and markets, the same issues highlighted above are true for so many economies, and any individual large economy could provide the trigger for a global rout.

Inflation Expectations can kill the recovery - soon

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This continues my series of closer looks at the seven areas I think can bring the 103 (now 104?) month economic expansion in the US to an end. The previous articles are here (overview) and here (interest rates).
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Since the onset of QE (Quantitative Easing), also known as the printing of money, by the US, the UK, ECB, BoJ and others in the wake of the Global Financial Crisis, there have been dire warnings that this "new" money would create out-of-control inflation. We have yet to see that, but we will. TARP poured $700 billion into failing banks to prop up the economy, with too much of it ending up as bonuses in the pockets of the very bankers who almost killed their banks, and the economy with them. The FED then created $3.7 trillion more in QE . In Europe, the BoE created £375 billion more, and the ECB has bought €1.1 trillion in assets through the course of their Quantitative Easing (QE) programme.

Much of that money sent to major banks or corporations. The banks were able to take advantage of "cheap money" to rebuild their balance sheets and solvency margins, by passing on only a limited amount of the reduced borrowing costs of Fed (or ECB or BoE) money. In his Bank Performance Outlook for 2018, Chris Whalen points out the "Fed is still effectively transferring $80 billion per quarter from depositors to banks."

Additional stimulus has flowed into global economies in the form of budget deficits piling on debt to record levels. Yet still there is no meaningful inflation, and central banks continue to lament their failure to reach the vaunted 2% level.

Where is the inflation, and will there be an inflation shock? Spoiler alert, yes, but from wages and probably not from the cost of goods and services, although the recent announcement of tariffs may push inflation expectations in other areas.

First, we need to remember what inflation is, and why it occurs. Inflation is the general increase in the cost of goods and services across an economy, or the devaluation of a currency and the associated resetting of the costs of goods and services in that currency. We are told that inflation is caused by an increase in money supply over the increase in the supply of desired goods or services. Where there are too few mangoes (for example) and a high demand for mangoes, the price of mangoes will go up - inflation and good old fashion "supply and demand".

We cannot doubt that there has been significant increase in the supply of money over the past decade. M2 in the US, has almost doubled in the past 10 years, from under $8000 (billions) to just under$14000 (billions). As a reminder, "M2 is a measure of the money supply that includes all elements of M1 as well as "near money." M1 includes cash and checking deposits, while near money refers to savings deposits, money market securities, mutual funds and other time deposits.". Strangely that almost doubling of the money supply has not resulted in inflation in the average cost of goods and services.

Looking at the BLS (Bureau of Labor Statistics) there appears to have been embarrassingly low inflation over the past 20 years. One inflation calculator puts total inflation between 2008 and 2018 at 13.7%, or in dollars, it will cost $113.70 today to purchase what would have cost $100.00 in 2008.

The same money supply and inflation sites tells us that UK money supply, UK M2, has increased by 50% in the past decade, while we are told that inflation has been a "brisk" 29.4% over that decade. So while the money supply has grown from £1600 (billions) to £2400 (billions), it "only" costs £129.40 to purchase today what would have cost £100.00 in 2008.

Certainly the housing market in the UK has been on a multi-year boom, at least in and around London, and in the almost continually expanding London commuter belt. Property price inflation outside of the London catchment has been muted at best, and has artificially moderated the national average inflation.

So if inflation is the result of money supply growing faster than the supply of good and services, then where is the money going, and what does that tell us about what might happen?

We then need to consider a key attribute of inflation; not all goods, service or assets increase in price equally. The first set of US inflation data that I shared above seem to tell us that inflation is under control, or in fact not under control at all, if there is a target of 2% inflation. But over at the American Enterprise Institute, they have a chart that shows inflation broken out quite differently, and they should a roughly 55% inflation over the past twenty years. John Mauldin uses this table in his recent "thoughts from the Frontlines" on 3 March 2018.

What is so interesting about this chart is that the elements that link to a higher standard of living and higher potential income are the elements that are rising the fastest. While it also shows that wages have increased at a rate faster than inflation, there is ample evidence that such wage growth has been skewed to the higher income earners.

It shows healthcare and education growing at well over 100%, and far outpacing most other goods and services. These are the two key areas where potential impact on future standard of living are felt the strongest. Education directly contributes to an individual’s ability to find and retain higher paying work, and without that higher paying work, healthcare becomes less and less affordable. Without good healthcare, and the economic capacity to purchase quality healthcare, the ability to continue to earn at any level of income is impaired.

Which leads back to the original question; will an inflation shock kill the markets?

Not the inflation we have been seeing. The markets do not, and will not care about inflation in costs of goods and services that upper income earners consume. The increases, while nose-bleed levels for some goods and services, the incomes of consumers of those goods and services have risen at pace. This is not where the shock will come from. 

Inflation in almost all other categories has been constant, but as the BLS numbers show in the earlier graph, there has been little inflation in most goods and services. Fundamentally this is because there has been no shortages in those areas, and therefore no supply and demand need for costs to inflate.

However, the market "correction in February has already shown us what inflation can do, when that inflation is in the form of increased wages, when that increase is in lower and middle income wages, not those at the top. We can expect more.

If inflation is too much money chasing too little of a given resource, then the low unemployment rates in the US today, if you believe the 4.1% number reported by the BLS for January 2018, is that "too little" resource. Wages will need to increase to attract that resource, reducing future expected incomes for employers.

The name of the business function has said it all for the past few decades: Human Resources. Resources just like copper and wood, cash, electricity and fuel. Humans are now a commodity, and have been for decades, and that commodity price is about to rise. Inflation in the cost of this now theoretically scare "resource" will push up prices across the board.

Fourth Quarter 2017 (US) numbers should give us any comfort, with Productivity growth at 0%, yet Labor Unit Costs and Hourly Wages both being revised upward. This is not sustainable without real wage inflation, and inflation moving beyond the human commodity and into the wider economy. These number tells us that we should expect lower corporate profitability, lower free cash, and lower expected returns in appreciation of already overpriced shares.

So watch the monthly unemployment rate (with ADP projecting a 235,000 increase in payrolls for February 2018) and an announced 313,000 BLS-reported increase for February, and watch the wage data from the BLS.

These two provide an indicator of future inflation in the one major commodity area where the only way to "mine" new resources is to pay a higher price. The mangoes in case are humans, and there are not enough to go around. This means the mangoes (humans) will cost more - the classic definition of inflation, and the warning of problems to come across the economy.



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Next week I aim to tackle another of the seven areas that could kill this recovery.
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Will Interest Rates kill the recovery?

In my "103 Months" post last week, I specifically mention seven areas that could bring about the end of the Bear market, and result in the end of this business cycle. First on the list was Interest Rates. I also specifically stated that none of the seven areas could take sole credit for a fall in the markets (and flow on negativity and economic contraction), and that each may be impacted by others, and impact others. Which will come first, an Interest Rate hike generated collapse in house sales, or a collapse in house sales spreading uncertainty resulting in an interest rate spike?

Markets exist to facilitate the effective application of capital. As such, capital will flow to the markets in which capital can be expected to deliver the greatest return to the owners of the capital. Capital will flow to assets with the greatest probability or generating the highest risk-weighted return. And while markets do not get this right all the time, generally markets sense where returns will be achieved, high or low, and move capital to those asset classes. The result has been capital allocation distortions. (It was interesting to write that first sentence, then to google the exact words - first place returned was the SEC) 

The mythical Rational Market Hypothesis tells us that open access to information ensures that capital will flow efficiently. This or course does not and cannot happen, as there is not free and open access to all information relevant to investment decision making. Different players have and always will have access to market moving information that is not available to all investors. In addition, a range of human and even algorithmic factors will ensure a different weighting of information by different market participants, ensuring a less than efficient market.

What does this have to do with interest rates?

Each time the Fed or the BoE talks rate hikes, the markets pause (for milliseconds sometimes) and asks if the higher rate will have a negative impact of economic activity, and thus on market value, or if Treasury Bills will deliver a higher capital growth, and therefore, is it time to leave one market and enter another (leave stocks, enter treasuries or other bonds). Business and investors have become so numbed to ZIRP (Zero Interest Rate Policy) that they have come to see any hikes as potential speed bumps on the economic highway.

Continued ZIRP has resulted in behavioural distortions, with a new set of assumptions, including current market reactions reinforcing self-delusional assumptions of market rationality. In the middle 2000s we were convinced that we had become expert at managing risk, now we believe in the power of monetary policy to ensure ever-expanding market value. This cannot end well.

In the UK, the change in the "Ogden rate" (the discount rate applied to large insurance claims, predicated on the assumption that large claims will be invested in the most conservative manner) in early 2017 provides a wonderful example of a political decision designed to reinforce the "end of boom and bust" narrative. A change in a long term discount rate from 2.5% to -.75% both boosted insurance pay-outs and imposed massive loses on the insurance industry (The rate is now under review). The political nature of the decision was in effect a reiteration of the UK government’s assumption or expectation that interest rates would remain in the ZIRP range for the foreseeable future.

ZIRP ensured a limiting of the range of options for capital, be effectively removing treasuries, US, British Gilts, Japanese, from the portfolios of available return generating assets.

The end of ZIRP has seen a steady increase in the retail cost of money. At some stage, that increase will be perceived as reaching a point at which users of credit will begin to make decisions to not invest, or not spend. Owners of capital will begin to ask if the markets will therefore continue to increase at a rate significantly higher than "safe haven" investments.

So what is that interest rate number that will move the markets?

Only this past week the Chairman of the Federal Reserve presented to Congress for the first time, with his upbeat assessment of the US economy having quite a strange impact. The Wall Street Journal reported: "On Tuesday, Mr. Powell made his first Capitol Hill appearance since taking over as Fed chief this month, where he underscored the improvement in economic prospects, which many investors took as a suggestion that the central bank will lift borrowing costs four times this year. “It now looks more likely that the Fed is going to tighten more quickly,” said Peter Elston, chief investment officer at Seneca Investment Managers."

The markets seem to be at a point where positive economic news itself causes concerns about interest rates, upsetting the fragile balance between shares as the probably area of best return on capital, and fear that shares will fall resulting in negative returns.

That fragility could tip either way, although the messaging would suggest a greater probability of a negative shock. Bad economic news (such as the reported fall in new housing starts) could hint at a slower pace of rate hikes while at the same time undermining confidence. Alternatively, stronger economic news could cement more rate hikes sooner, again undermining confidence in the markets as the source of future capital appreciation.

Further, that fragility is all about perceptions and perceptions of perceptions. Will rates increase? If rates increase, will shares fall? If shares fall, will that force rates higher, or will a continued fall in shares erase gains. Should gains be "locked in" by selling now and putting the capital into "safe" options, and ride out a fall in share values, while earning more interest on the bonds / treasuries?

The Fed rate after all flows through into mortgage rates, auto loan rates, student loans, and credit card interest rates. All of these have a direct impact on individuals' economic behaviours and choices.

So if we game this situation, it looks something like:

1. Fed increases interest rates, reaching an eye-watering 2.5% by mid-2018.
2. Following a Fed rate rise event, markets expect reduction in mortgage lending, increase in credit card interest, reduction in auto loans.
3. Market data is released showing a drop in new mortgage applications.
4. Home builder and real estate stocks hit.
5. REITs drop on expectation that housing prices will stabilize or fall.
6. Contagion across industries creates further falls in equities.
7. Holders of capital determine that treasuries will provide a "no loss of capital" position and that shares have created a "capital at risk" situation.

As the "rational" market distributes and creates information with an inequitable and non-transparent distribution, individual market participants reach widely different conclusions, ultimately coalescing into a consensus that the stock markets are no longer the best place to hold or invest capital for a time long enough for stable bottom to be found.

In this way Interest Rates may provide one of the catalysts for a substantial and sustained drop in market values. This is only one of the seven situations that I discussed last week. Next week we'll look at another of the seven.

What remains clear is that in a world with so many potential contributors or drivers of a change from Bull to Bear, there is no single non-interconnected economic or political situation that will be "the cause" of the coming end of this expansion. The big question will be which, through the lens of history, will carry the "blame".

Whalen on CDOs, OBS, Fraud and Europe - I suggest you be very afraid

In 2006, after reading one of my friend Chris Whalen's articles in which he discussed the size and dangers of the Synthetic Collateralized Debt Obligation (CDO) market, I picked up the phone and rang him. "Chris, I have to admit that I simply do not understand what you've just written. Could you please explain it to me in small words?"

To his credit he did, and he took his time, and used small words, and at the end of our call, the only thing I could say was "Chris, based on what you've just taught me and what you are saying, you are now the scariest person I know."

Not long after came the collapse of Lehman Brothers and the slide into the Global Financial Crisis (GFC). Everything Chris had written seemed to come to fruition, as if he had written the play-book for the crisis, or at least the reasons for the processes creating the crisis.

Fast forward to 2017, and over the past two weeks Chris has again written two very alarming articles. Last week focusing on CDOs and OBS risk, while this week's article sheds light on why Europe should worry us.

Last week Chris wrote a piece, this time called "CDO Redux: Credit Spreads & Financial Fraud". Read this article from Chris. It is as scary as anything he wrote in 2006. Toward the end you'll find the following statement:

The fact that Citi, JPM and GS are now pushing back into the dangerous world of off-balance sheet (OBS) derivatives just illustrates the fact that the large banks cannot survive without cheating customers, creditors and shareholders.

He points out that the very largest banks, like retailers, cannot be profitable by selling a greater volume at a lose, but only by, in effect, cooking the books. This suggests that systemic fraud is part of the natural business cycle, and he seems to be saying that we are nearing the end of this cycle.

As we note in "Good Banks, Bad Banks," larger institutions suffer from a fatal lack of profitability that ultimately dooms them to commit fraud and, eventually, suffer a catastrophic systemic risk event.

How big is this problem? Chris has a nice chart. Sure, it looks like the problems were in the past, but look at the re-growth to today. Notional Off Balance-Sheet Derivatives (OBS) are, between the three largest (Citi, JPMorgan, and Goldman Sacks) over $140 Trillion, not far from the GFC peak of around $130 and a later peak of possibly $175 Trillion.

Now, I seem to remember that "OBS" - Off Balance-Sheet, is bad. I seem to remember that it was the Off Balance-Sheet manipulation via the use of Special Purpose Vehicles (SVPs) that distorted their true debt position, and lead to the crash of Enron in late 2001.

Imagine a bank for which a 30BP (Basis Points: 100 PB = 1%) move in the OBS book would wipe out the bank's capital. Imagine wiping out a bank's capital with a .07% move (7 basis points). Imagine any entity leveraged 8000:1.

Note too that the relatively small GS has a notional OBS derivatives book of more than $41 trillion, almost as large as that of Citi and JPM.  More alarming, a move of just 7bp in the smaller bank’s OBS derivatives exposures would wipe out the capital of Goldman’s subsidiary bank. This gives GS an effective leverage ratio vs its notional OBS derivatives exposures of 8,800 to 1.

Worried yet?

Jumping forward to this week, and he has nothing comforting to say about Europe (or again, the American situation). This the following is not a surprise, the clarity of statement leaves no doubt:

Zero rates and QE a la Yellen, Draghi and Abe is not about growth so much as it is about subsidizing debtors, especially governments and other public obligors who are beyond the point of recovery in terms of ability to repay debt.

Meanwhile we continue to see the Rape of Greece, with bailouts primarily intended to subsidize European banks and governments, with Germany seeming to take the lead. All this as European banks continue to record interest "income" against non-performing loans. Many of those loans will never be repaid, and a haircut is inevitable. Chris points out that "more public sector debt has been incurred and the banks – which admit to some €850 billion (6%) in non-performing loans – are essentially insolvent as a group."

The big question will be whether Cyprus becomes the model for Europe, and if so, how long can the banking sector survive a run, or at least a slow walk, on deposits by individual savers. So far, QE in Europe has been used to avoid this, but not forever.

Europe is drowning in debt and there are a number of large EU banks that are demonstrably insolvent.

This continued pretense by the Europeans, coupled with the CDO & OBS situation in the US points to two of the three major economic blocks (counting China & ROTW {Rest of the world} as the third) piling on higher and higher levels of systemic risk. And not matter what anyone says, it will not be different this time.

Chris is being scary again. and again, we should listen to him.

Risk Managers in Uncertain times

Over the past few weeks I have been thinking about the world as we move into 2016. Most of that thinking is not about daisies and pixey dust, but about the changes over the past few years, many of which seem to be leading either to crisis, trouble, or the slow boiling of the frogs. Personally I'm hoping for a few crises that will, although probably fairly terrible at the time, actually bring about some fundamental changes that will create real change and improvement, at least in the medium term.


What's a Risk Manager to do? Below I contrast "the Usual Suspects" that we are (or should be) watching every day as Risk Managers, and then "the Big Stuff" and implications for Risk Managers now.

We are going to see the world change through 2016 and 2017, potentially dramatically - and not necessarily positive change. That is my view. Of course, I could be very wrong, and we could see a world that "muddles along". At heart are our individual answers to the question "how do we best help our businesses manage the coming risk world?"

I am not confident, but that is my view.

So let me suggest, based on my view, the potential impacts on Risk Managers for the coming couple of years. Two years is a very short time in a world of potential regulatory change and economic cycles. Anything shorter than two years would fail to consider the potential impact of major business and economic cycles such as the current commodity depression, the US (and China) manufacturing recession, and the very serious systemic debt and migrant issues that Europe may or may not manage through the coming year.

The Usual Suspects:

Of course the world of Risk will be both immediate and longer term, local or specific as well as systemic and international. We'll start by reminding ourselves of some basic risks that have no direct link to the wider situation.

1. Cyber threats. This category of risk continues to be on the rise, and can be an existential threat to companies from a data-loss or damage perspective, while civil and regulatory sanctions continue to increase. This is a threat that has been growing, and increased access and growth in skill sets will increase the number of hackers and the breadth of tools and techniques they will use. Companies will be taken down by Cyber attacks. Companies can prepare for and attempt to limit the impact of Cyber attacks, but can do little to reduce the likelihood of such attacks (as exogenous threat likelihood is not subject to risk reduction activities on the part of the company). Reducing the impact requires planning, careful review of the potential threat (what are the data-crown jewels, and how are these protected?) and remediation where infrastructure is not adequately protected. Reputation damage limitation if an element of planned responses, and finally, consideration should be given to Cyber Insurance.

2. Fraud, Bribery and Corruption. If the economy continues to grow and unemployment continues to fall, there will be little impact on the likelihood of Fraud, internal or external, though of course these risks remain. However, if we see a degradation in economic conditions, this will probably lead to an increase in fraudulent activity, starting with external fraud and followed by an uptick in potential internal fraud. Of course, some fraud, bribery or corruption is simply due to greedy people, and has no linkage to economics. Exercise skepticism.

3. Solvency. For the insurance industry in Europe, this is the year Solvency II fully comes into effect, and insurers across the continent are getting their reporting houses in order. Yet the risk is not simply that companies may or may not be solvent, it is a question of the quality of internal processes supporting production and maintenance of the ORSA (Own Risk and Solvency Assessment). As risk managers we can learn from companies that have been through the process, such as the importance of the quality of documentation of the process, effectiveness of systems of control (nothing new there), and the ability to demonstrate how the ORSA contributes directly to business decision-making.

4. All Your Risks. Every risk on your Risk Register will remain as critical (or otherwise) through 2016 and 2017 as they are today. Some will increase in potential impact, many will eventuate in actual issues or problems. These risks will become incidents, and you will manage them through to resolution - or not. There will also be a host of issues and incidents that will result in you reviewing the Risk Register, and probably adding risks to the Register.

You can never go wrong keeping your eyes on the day-to-day risks, and ensuring that the business either has effective controls in place, or is building a control environment that can actually be monitored to indicate areas of existing or emerging risk.

Now for the Big Stuff:

A global correction may be underway, with no sign of a low for some time to come. Certainly there may be up days or weeks, but it appears that there is more likelihood of a longer down trend for the coming months. The questions now are "how far, how fast, how long, and how much stimulus"? There are no serious commentators calling for a near-term renewal of a global bull market. The IMF recently downgraded their expectations for global growth from 3.8 (July 2015 forecast) to 3.4 (January 20016) with developed economy growth downgraded from 2.4 to 2.1, the same level as 2015.

The US markets are down 15% from their highs (DJIA - 15,900 from 18,200 in 2015), and China is at 2014 levels (Shanghai is at 2750 from a high of 5100 in 2015). [as at 26 January 2016]  Where will they go?

Total global debt has continued to rise all through the supposed deleveraging after the Global Financial Crisis (GFC), increasing by $(US)57 Trillion since 2007 to almost 200 $(US) Trillion. The majority of this increase has been government debt, yet corporate debt (and personal debt) has also risen through that period. This also cannot continue without impact.

At the same time in developed countries we see a close to stagnation in growth in real incomes. Personal income in the UK has finally (May 2015) caught up with where it was before the GFC, and the strong employment growth has been reflected in falling unemployment and increased wages. The introduction of a "living wage" will also increase personal incomes (although some worry that imposed minimum wages reduce employment growth). All good news, but will the UK continue to grow as the rest of the world slows down, if the UK votes to leave the EU, or if markets continue to fall (the FTSE is now at 5800 from just over 7000 in 2015, and continues to fall). [as at 26 January 2016]

In the US, employment growth appears to be strong, at the same time that the labor participation rate continues to fall. The unemployment rate is around 5%, a level that is close enough to full employment that we should be seeing serious upward pressure on wages. Yet the continued fall in labor participation indicates that there remains a (growing) untapped pool of labor. The picture remains murky.

Recommendations for Risk Managers

The current economic situation is, in my view, as scary as it has been since the GFC. Fear has an impact on risk and companies' and individuals' perceptions of appropriate levels of acceptable risk. How do we translate this into meaningful decision-making by companies, and counsel from Risk Managers?

1. Risk Appetite. There should be no better time than now to review (or write) the Risk Appetite for the business. Risk Appetite will provide a construct for decision-making by management that is in line with the level of risk that is acceptable to the Board and through them the shareholders. Risk Appetite is not a single statement, but needs to be broken into key business activities or processes, and potentially high level business units / companies. When reviewing (or writing) the Risk Appetite, speak directly with the directors and in private companies, with the key shareholders.

2. Identify your Key Risk Indicators (KRIs). These are the indicators whose movement provides insight into the potential increase or decrease in the likelihood of the materialization of any particular risk. For example, this may include items such as average days receivables (expanding may indicate deteriorating customer business conditions), or less obvious indicators such as unplanned staff turnover rates (with falling unplanned turnover being a surrogate for a degrading jobs market for your employees).

3. Stress tests (EKRIs). Build the models, and then test them beyond what your CFO/Finance Director thinks are possible. Build in extremes such as cost of fuel for distribution networks, cost of capital, internal project huddle rates. Stress until the model breaks, then look at why the model broke. That will give you a strong indication of the most important factors to be watching on a daily basis - your External Key Risk Indicators (EKRIs). I know of a very large manufacturing company that failed to hedge fuel costs, resulting in significant business costs when oil did spike. While that may not be the case today, if cheap oil turns out to be transitory, will cost-reduction based profits evaporate?

4. Outside-In. Having built or reviewed the Risk Register, the KRIs and the EKRIs, how are the risks identified reflected in the Risk Registers and risk reporting? Is the current risk environment too inward looking, focusing on the specific risks, controls, actions and people that are within the organization and therefore "observable" to management? How strong is the monitoring of external factors, and how can this be built into risk reporting?

5. Regulation Watch. Times of crisis almost always breed new regulation, or changes to existing regulation. I'm not going to opine on the benefits or otherwise of regulation, but as Risk Managers we must ensure that our organizations has fully considered the potential impact of such changes. When SOx (Sarbanes Oxley) and the section 404 requirements were passed, who predicted $170/hour for bulk standard Internal Auditors spending thousands of hours documenting mundane financial reporting processes and identifying controls - followed then by the massive increases in compliance costs to test those controls? Something like this is in our collective futures.

These are a few of the considerations for Risk Managers today. Are these different from what Risk Managers should be doing or concerned with in good times or steady global growth? No. And that is the rub, and the message; times like today provide strong reminders of what we should be doing every day. The increased fear do however provide us with the energy to get this done.