For many years, I have written quarterly economic comments as Chairman of Wasatch Advisors. Recently I left Wasatch to help start up a new firm, Seven Canyons Advisors, with my two sons, Josh and Spence, my son-in-law Eric Moessing and Wes Golby. I made this change not due to any dissatisfaction with Wasatch but for the opportunity to have a new adventure in my life after the 42 years I spent at Wasatch.
Change is good, but some things shouldn’t—and one of those is quarterly publication of my overview of the economy and the markets. I always like to start this commentary with an overview of the economy, as most stock market events are driven by economic events. Rarely does the market encounter “clear air turbulence” during which the market reacts without any economic prodding.
As we look over the global economy today, we note there is substantial bifurcation between what is occurring in the U.S. and what is occurring in many other countries around the globe. In the U.S. everything seems just fine. Our economy is humming. Employment is overflowing as there are more jobs than job seekers. Wages are rising yet inflation remains contained.
However, as we expand our horizons to view the global economy, the picture is not so rosy. Europe is troubled by Brexit and Italian woes. Japan is plagued by mounting debt. China seems to alternatively step on the brake and then on the gas as it tries to navigate towards a growing consumer-led economy. And many emerging economies are suffering from inflation and weak currencies.
One explanation is unanticipated effects of the strange economic brew post-global financial crisis (GFC). The classic prescription for a financial crisis is easy money to halt the panic, followed by fiscal stimulus to get the economy going. Instead of following that pattern post the GFC, central banks around the world continued easing monetary policy in the absence of fiscal stimulus. Normally fiscal and monetary work in tandem with fiscal gas and monetary brake. However, post the GFC most economies relied on continued easing from central banks to stimulate the economy. Perhaps the absence of fiscal policy was a side effect of an overly debt-laden world.
Central banks, led by the U.S., are now finally withdrawing liquidity as the global economy appears strong enough to withstand diminished liquidity. However, as liquidity is the grease to the global economy, less grease is causing “hot spots” to develop (most notable in Argentina and Turkey).
Unlike the rest of the world, the U.S. is adding a large dose of fiscal stimulus at a time when it would normally be backing off the gas. Fiscal ease rarely occurs near the peak of a cycle. So far the U.S. has benefited from the very late application of fiscal stimulus. Tighter money has so far prevented inflation from expanding. This policy has led to expanding debt levels, which in turn has led to higher rates. Higher rates have led to a stronger dollar.
A strong dollar is often cited as the cause of emerging economy woes, especially if a country has high levels of debt. A strong dollar makes high levels of dollar debt more difficult to service as the dollar liabilities are now more expensive relative to the local currency. Also, efforts to repay the debt exert a depressing effect on those economies. This is because the now more expensive debt has the same economic impact as tighter credit.
The role of Chinese currency weakness should not be overlooked. As the Yuan shifted from appreciating in the early part of this year to depreciating, emerging economies seemed to take another leg down. China, with an economy of a similar size to that of the U.S., appears to have a major impact on emerging economies. This is because China is a large market for many emerging economies. When China reversed course this spring from supporting a stronger Yuan to encouraging a weaker Yuan, many emerging economies turned on a dime due to suffering from a more competitive currency.
To summarize, even if it causes short term pain, a strong U.S. economy with rising rates and a strong dollar will benefit emerging economies in the long run. In contrast, a sputtering Chinese economy with a weak currency will hurt emerging economies. It is China, rather than the U.S., which bears much of the responsibility for problems in emerging economies. However, Chinese weakness will come to an end as China’s global aspirations require it to keep its currency in line with that of its major trading partners.
Despite the headlines, during our visits to emerging economies, we are not detecting excessive concern about their progress. Business seems more normal than anything else.
This blog is for informational purposes only and does not constitute investment advice or a recommendation of any particular security, strategy, or investment product. The expressed views and opinions presented are for informational purposes only, are based on current market conditions, and are subject to change without notice. Although information and statistics contained herein have been obtained from sources believed to be reliable and are accurate to the best of our knowledge, Seven Canyons Advisors cannot and does not guarantee the accuracy, validity, timeliness, or completeness of such information and statistics made available to you for any particular purpose. Past performance is not indicative of future results.
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