On the World Stage: Political Posturing and Economic Nuances

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July witnessed the latest talk-fest of the G20, held in Hamburg, and the first attended by Donald Trump. He marked the event by affirming his decision to remove the US from the 2015 Paris Climate Accord. The other G20 members immediately affirmed their intention to continue without the participation of the US – even going so far as to declare the Accord “irreversible”.

Mr. Trump met one-on-one with many world leaders including China’s Xi and Russia’s Putin – both seasoned and wily performers on this stage. In familiar fashion he declared the meetings a great success. He ensured that his “America First” strategy was well broadcast but this insular stance distances the US from one of the key themes of G20 meetings. At the final press conference of the summit Mr. Trump was notable by his absence.

The IMF has released its latest economic outlook report (previous publication was April) and has left unchanged the world growth forecast for this year and next – at 3.5% and 3.6%. The country growth “mix”, has, however, changed subtly with the Eurozone, Japan and China up a bit but the US down. The biggest US mark-down occurs in 2018 where the forecast has been reduced from 2.5% to 2.1% as a consequence of less expansionary fiscal policy than previously anticipated. The Eurozone is now expected to grow by 1.9% in 2017 and 1.7% in 2018 (up from the April forecasts by 0.2% and 0.1%). Japan is forecast to grow by 1.3% in 2017 and 0.6% in 2018 – not exactly rubber-shredding performance.

The IMF expects advanced economies to grow by 2.0% in 2017 and 1.9% in 2018 whilst emerging market and developing economies are forecast to grow by an average of 4.6% and 4.8% over the same period. The IMF comments that growth remains below “pre-crisis” levels and adds the now-familiar phrase that “risks are still skewed to the downside.”

Trying to decimal-point growth rate forecasts over the relatively near-term is a no-win game so we have no issue with any of the IMF figures but its warning about risks being skewed to the downside resonates strongly given our oft-repeated views about deteriorating demographics, rich equity and bond valuations, debt levels and central bank manipulations.

Charging ahead with electric vehicles
In a surprise announcement Volvo shook the auto industry by advising that all new models from 2019 would be equipped with an electric motor – either pure-electric or hybrid. Volvo is a tiny player on the world auto-stage (little more than 500,000 vehicles a year) but under Chinese ownership since 2010 it clearly has big ambitions. China has an overall target of 2 million electric cars, or 20% of all auto sales, by 2020.

The march towards electric vehicles seems irresistible although it will be many years before they account for more than a few percent of the world’s total vehicle stock. Government subsidies and targets will play a significant role in this growth but let’s not ignore the manufacturers of traditional engines as they will fight back by offering increasingly efficient and cleaner units.

The Tesla Model 3 is due to hit the roads about the same time as this missive reaches your hands – it will sell for around US$35,000 – pitching it squarely, as intended, into the mass-market. Elon Musk, Tesla Chief Executive and marketer extraordinaire, hopes to produce and sell a total of 500,000 vehicles next year (including the Models S and X). This seems a little ambitious given that total sales in 2016 amounted to 84,000. The share price has already reached the stars but the company is a long way from being profitable. This is going to be a fascinating (electric) ride.

Central banks change their tones
In the UK, Brexit negotiations and political in-fighting continue to provide plenty of headlines with every view known to man (and woman) being expressed at one time or another. The media clearly revel in the “this will be a total disaster” viewpoint so that tends to dominate the airtime. We are depressed by the political opportunism and short-termism on display but remain confident that it will be fine in the long term. It will, however, be a tortuous two years before we finally reach “exit.” In the meantime, Theresa May has gone off on her annual European hiking holiday. Good for her.

When we view both British and US politics we are constantly reminded of episodes of Yes Minister (and Yes, Prime Minister) as well as Veep and House of Cards. It must be tough for satirists these days as the real politicians are pinching all the best story-lines.

In Canada the central bank has lifted its key rate from 0.5% to 0.75%. This is a reflection of solid employment growth and a strong housing market although the rate is still lower than the central bank rates in the US and Australia. Nevertheless, it is quite a bit higher than rates in Japan, the Eurozone and UK. The low-point plumbed by the Bank of Canada was 0.25% in April 2009.

And so, bit by tiny bit, the central banks are starting to nudge rates and subtly change their tone. There is even speculation that the European Central Bank will soon end its asset purchase program and consider a small increase in rates. Possibly even Japan? – perhaps that is a bridge too far. One way or another, sooner or later, “normalization” will have to occur. We would most definitely be champions of “sooner”.

Greece has passed a significant milestone by selling 3 billion euros of government bonds at a yield of 4.62% with a five-year term - this is its first bond sale in three years and it did not involve any contribution from the IMF. It is reported that about half of the buyers were existing holders who received “financial encouragement” to swap their 2019 bonds for this new issue. We admire the courage and optimism of these investors. We will not be joining them.

One of the curiosities of economics since the end of the “crisis” is that improving employment trends have not been accompanied by rising real wages and inflation. In fact, in several countries, precisely the opposite has occurred. Back in the 1950s William Phillips developed the “Phillips Curve” which supposedly explained the relationship between employment and inflation. It now seems safe to consign that theorem to the ever-expanding economics dustbin.

Poor productivity growth over recent years is undoubtedly playing a major role in this enigma but, infuriatingly, no-one is quite sure why productivity growth is so weak. Perhaps it is the “mix” of jobs – many more hamburger flippers and cappuccino frothers. Perhaps technology isn’t making the profound difference as in decades past. Perhaps capital investment growth is on a permanent downward shift. Or perhaps it’s just a temporary aberration.

We have views on this subject, like all prognosticators, but in the meantime prefer to act on the basis of “it is what it is”. Productivity growth is poor, output growth sub-standard and inflation, whilst up from the levels seen during the financial crisis, seems likely to remain relatively subdued. Inflation in asset prices? – now there’s another story!

Here’s some good news – a report published in Annals of Internal Medicine cites two observational studies (one European and one American) that suggest that coffee drinking (regular or decaffeinated) is associated with better health. One of the studies cited lower instances of heart disease, cancer, strokes, diabetes, respiratory and kidney diseases. The studies make no attempt to analyze cause and effect as they are merely observational. So we don’t really know what’s going on here. A bit like economics!

At the time of writing (July 25) equity markets are generally up for the month – not massively (most less than 1% based on MSCI local currency price indices) but this modest appreciation contributes to a healthy run in 2017. The US and UK indices are both up more than 1% month-to-date. The latter may surprise some observers given the extremely negative press the UK economy keeps receiving.

In keeping with the generally positive tone to recent economic news bond yields in most countries (10- year maturity) firmed slightly over the month. Yields remain tiny (Japan 0.07%; Germany 0.56%; UK 1.26%; Canada 1.99%; USA 2.31%; Australia 2.69%) but we will applaud any slight uptick. In our book they still have some distance to go.

Pyrford International
26 July 2017


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