International and Global

Impeachment, coronavirus, brushfires...who would be in the forecasting business?

January threw up more than its share of hurdles but, until the last week of the month, stock markets shrugged and just kept rolling along.
February 2020

January threw up more than its share of hurdles but, until the last week of the month, stock markets shrugged and just kept rolling along. The Trump impeachment trial commenced; the deadly coronavirus launched itself upon a nervous world; tensions in the Middle East ratcheted up yet another notch; the UK exit from the EU finally became a reality and the IMF and World Bank trotted out their (now) customary cautionary tales and lowered their near-term growth forecasts. In Australia, tragic (but not unprecedented) bushfires ravaged thousands of square miles whilst the excitable world media reacted by inferring that virtually all of the country was ablaze. And the Australian stock market? – it delivered a gain of 5.1% over the month (MSCI price index in A$) – second only to Portugal among developed markets. Who would be in the forecasting business?

IMF slightly lowers world output expectations

Let’s start with the IMF. Relative to its October 2019 forecasts world output expectations in 2020 and 2021 have been nudged down by 0.1% and 0.2% – to growth of 3.3% and 3.4% respectively. The US is forecast to grow at 2.0% and 1.7%; eurozone by 1.3% and 1.4%; Japan 0.7% and 0.5%; UK 1.4% and 1.5% and Canada 1.8% (in both years). Emerging and developing Asia is where the most significant growth is expected to occur: 5.8% in 2020 and 5.9% in 2021. The IMF expects China’s growth to slide below 6% in 2021 (to 5.8%) whilst India’s is expected to top that with a growth rate of 6.5%.

Striking a muted but marginally positive note the IMF comments: “…market sentiment has been boosted by tentative signs that manufacturing activity and global trade are bottoming out, a broad-based shift toward accommodative monetary policy, intermittent favorable news on US-China trade negotiations, and diminished fears of a no-deal Brexit, leading to some retreat from the risk-off environment that had set in at the time of the October World Economic Outlook. However, few signs of turning points are yet visible in global macroeconomic data.”

Labor productivity growth slowing

In its January update the World Bank, which focuses mainly on emerging market and developing economies (EMDEs), commented: “A broad-based slowdown in labor productivity growth has been underway since the global financial crisis. In EMDEs, the slowdown has reflected weakness in investment and moderating efficiency gains as well as dwindling resource reallocation between sectors. The pace of improvements in key drivers of labor productivity—including education, urbanization, and institutions — has slowed or stagnated since the global financial crisis and is expected to remain subdued…productivity growth is the primary source of lasting income growth, which in turn is the main driver of poverty reduction. Most cross-country differences in income per capita have been attributed to differences in productivity.”

Weak productivity growth has been one of our oft-repeated concerns in recent years and there seems to be little prospect of any near-term improvement. Our other main concern has been the significant build-up of debt and in this respect the World Bank comments: “The global economy has experienced four waves of debt accumulation over the past fifty years. The first three ended with financial crises in many EMDEs. During the current wave, which started in 2010, the increase in debt in these economies has already been larger, faster, and more broad-based than in any of the previous three waves.” This provides little cause for comfort (our comment). The World Bank further remarks: “…high debt carries significant risks for EMDEs, as it makes them more vulnerable to external shocks. The rollover of existing debt can become increasingly difficult during periods of financial stress, potentially leading to a crisis.” Quite.

Negative interest rates - here to stay?

Turning elsewhere we note that the European Central Bank has indicated it plans to leave negative interest rates in place for some time, despite growing misgivings about the effectiveness of this unconventional policy tool. Rates have now been negative for 5 years yet eurozone growth has continued in the doldrums. As indicated above, the IMF expects relatively anemic output growth for the eurozone of 1.3% this year and 1.4% next year. The three biggest economies – Germany, France and Italy are barely growing – the IMF estimates that output in the three countries in 2019 grew by 0.5%, 1.3% and 0.2% respectively. Italy is now, once again, in political turmoil following the resignation of the leader of the Five Star Movement (M5S) – Luigi Di Maio. Five Star is the largest party in a fragile coalition government headed by Prime Minister Giuseppe Conte. It is being hunted down by Matteo Salvini’s right-wing League which is ahead of all other parties in the opinion polls.

Economists (and Pyrford) debate the effectiveness of negative interest rates. They are supposed to stimulate borrowing, spending and investment but appear to be having the opposite effect as corporates and householders hunker down in what they perceive as bleak economic conditions. “If rates are below zero things must be really bad” – is how the train of thought appears to go. And it is hard to criticize such thinking. To top it off the ECB launched another bout of quantitative easing (QE) last September further confirming the view that “things must be really bad.”

One of the obvious impacts of negative rates is the damage done to household finances. In a country such as Italy, with one of the most serious ageing problems in the world, all household savings plans are thrown into disarray when banks gradually confiscate your nest egg instead of providing an interest rate that helps provide a reasonable standard of living. It’s turned into a crazy old world.

Protests in Paris

In France, President Macron has been forced to scrap (at least for now) a plan to increase the full-benefits retirement age from 62 to 64. A wave of massive street protests in Paris spurred his backdown. France has an expensive and complicated pension system and any initiatives leading towards simplification and an increase in the average retirement age receive our support (see the December issue of Pyrspectives for a general discussion on global pensions) but it seems the French militant unions do not agree. This issue will not go away. It will be a stern test of Mr Macron’s leadership. Similar tests will arise in many other countries.

Tesla back in the news

Never far from the front pages, Tesla, made news again in January when it became the second biggest auto manufacturer in the world – based on market capitalization. It surged past Volkswagen and is now second to Toyota. Its market cap is greater than Ford and General Motors combined. This is quite a feat as it still makes many fewer cars than its major rivals and only 12 months ago its very existence seemed under threat. Loyal shareholders will be mightily pleased. Much of the recent stock enthusiasm appears related to the commencement of trial production in the company’s Shanghai Gigafactory.

Tesla has now announced 4th quarter 2019 results reporting net income of US$105 million. In the same quarter of 2018, the company reported net income of US$140 million. Revenue in the quarter amounted to US$7.4 billion, up by 2% over the same period last year. The company delivered 367,500 vehicles in 2019 and anticipates output of more than 500,000 vehicles in 2020. After the announcement the stock price jumped by 12%!

We have always expressed admiration for the Tesla as a vehicle but have wondered aloud how it will fare when all the major and long-established auto manufacturers really sink their teeth into electric vehicle design and manufacture. And that is certainly what they are doing. Barely a week passes without one or more announcements about another initiative in this field. Electric vehicles still only make up a tiny proportion of the world vehicle fleet, but the momentum appears unstoppable. Whether Tesla can maintain its position near the head of the chasing pack and justify its sky-high stock valuation is something that is beyond our forecasting powers.

A look back at market movements

As indicated above, the Australian share market delivered excellent performance relative to other developed markets in January (bested only by Portugal which gained 6.1%). This is remarkable when you consider that Australia is reeling from the bushfires and is massively exposed to China – the epicenter of the coronavirus outbreak. Perhaps Aussies are looking towards the trading opportunities offered by a Post-EU Britain. Back in the early 1970s Australia exported thousands of tons of butter and sugar to the UK – today the figure is zero. Exports of wheat and beef to the UK have also almost disappeared.

Other markets with positive moves in January were: New Zealand (+ 3.5%;) Denmark (+3.1%); Finland (+2.5%); Canada (+1.4%); Switzerland (+0.4%); Sweden (+0.2%) and the US (+0.1%). Some of the negative movers were: Hong Kong (-4.8%); UK (-3.4%); France (-2.3%); Singapore (-2.1%); Norway (-1.9%); Netherlands (-1.8%); Germany (-1.8%); Spain (-1.6%); Japan (-1.6%) and Italy (-1.3%). (Source: MSCI local currency price indices).

Bond markets, at the benchmark 10-year maturity, saw significant yield falls over the month – no doubt reflecting a flight to quality as the potential global reach and impact of the coronavirus became apparent. In the US the yield fell from 1.9% to 1.5%; UK from 0.82% to 0.54%; Canada from 1.7% to 1.32% and Australia from 1.37% to 0.96%. In Germany and Japan, the yields fell deeper into negative territory: to -0.44% and -0.05% respectively (Source: Datastream).

All forecasts, such as those we quote from the IMF and World Bank, are potentially already out-of-date because of the coronavirus. Its economic impact could be sizeable. We should know more when we put pen to paper at the end of February.

Disclosures

Pyrford International Ltd is authorized and regulated by the Financial Conduct Authority, entered on the Financial Services Register under number 122137. In the USA Pyrford is registered as an investment adviser with the Securities and Exchange Commission. In Australia Pyrford is exempt from the requirement to hold a financial services license under the Corporations Act in respect of financial services it provides to wholesale investors in Australia. In Canada Pyrford is registered as a Portfolio Manager in Alberta, British Columbia, Manitoba, Ontario and Quebec. Pyrford is a wholly-owned subsidiary of BMO Financial Group, a company listed on the Toronto Stock Exchange (ticker BMO).

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