International Equities

Crazy global environment merits cautious approach

The IMF believes the world has too much debt, trade wars are destabilizing and anti-growth, monetary policy has run its course and productivity remains below historic norms.
August 2019
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So the UK has a new Prime Minister – after all the bloodletting Boris Johnson galloped home by a comfortable margin against his opponent, Jeremy Hunt. He then set about a radical reshaping of Theresa May’s cabinet – 15 senior ministers left the cabinet – either through resignation or being sacked. Those who chose resignation did so to escape the ignominious alternative.

Mr. Johnson has pledged to get the UK out of the European Union by October 31 – deal or no deal. Many in his party and the parliament will fight tooth and nail to prevent a no-deal exit but the rhetoric is often at the expense of plain economic common-sense. This, of course, applies to both sides of the debate. We have never been pessimistic about the UK’s prospects out of the restrictive embrace of the EU machine but recognize that the path to long-term trade nirvana and political independence is beset with many human-imposed trip-wires. For the sake of the sanity of the populace of the UK and all others overtired of hearing about Brexit we hope the colorful ‘Boris’ meets the October 31 deadline.


IMF lowers global growth forecast

In its latest World Economic Outlook update the IMF has marginally lowered its global growth forecast for the current year and in the now-familiar language stated that “Risks to the forecast are mainly to the downside. They include further trade and technology tensions that dent sentiment and slow investment; a protracted increase in risk aversion that exposes the financial vulnerabilities continuing to accumulate after years of low interest rates; and mounting disinflationary pressures that increase debt service difficulties, constrain monetary policy space to counter downturns, and make adverse shocks more persistent than normal.”

In plain language: the world has too much debt, trade wars are destabilizing and anti-growth, monetary policy has run its course and productivity growth remains comfortably below historic norms. To which we would add: the demographic outlook is bleak indeed relative to the post-WW2 “boom years”. This is backed-up by the latest United Nations release of its forward-looking global demographic database.

Around U.S. $13 trillion of government bonds now trade at negative yields. Many of these are in Europe which tells a compelling story about growth prospects in that ageing part of the world. Mario Draghi, President of the European Central Bank, in his final months in office, seems determined to unleash additional stimulus in the Eurozone – perhaps further Quantitative Easing or even a more negative ECB deposit rate. What a sad story when an economy the size of the Eurozone requires its central bank to purchase over two trillion euros of government debt and corporate bonds (so far) and set its key interest rate below zero. And does it provide a tangible and enduring benefit? History will be the judge but we remain healthily skeptical.

Among the plethora of statistics churned out by the UN publication referred to above one of the most interesting is its forecast of countries that will experience declining populations over the next several decades. This amplifies the growth challenge facing Europe as many are in that part of the world. Here is a selection of those facing declines of more than 10% over the next 30 years: Lithuania, Bulgaria, Latvia, Ukraine, Serbia, Croatia, Romania, Albania, Greece, Hungary, Poland, Portugal and Italy. Many, as can be seen, were part of the old Soviet bloc. Outside of Europe the most significant “biggie” facing a decline of more than 10% is Japan.

Declines in population of between 2% and 10% over the same period include: Slovakia, South Korea, Russia, Slovenia, Spain, Taiwan, Thailand, Germany and China. Added up that’s a chunky percentage of the world’s population that will have to run very hard to stand still.


Protests in Hong Kong

Hong Kong remains in a disturbed state as activists continue to protest about the proposed extradition laws – they have been shelved for the time being but not necessarily buried. In a potential escalation of the affair China’s defense ministry announced on July 25 that it reserved the right to deploy the People’s Liberation Army at the request of the Hong Kong government. If this were to occur the situation would become extremely ugly. A spokesman for the defense ministry said: “Some behavior of the radical protesters is challenging the authority of the central government and the bottom line of one country, two systems. This is intolerable.”

In the meantime, and perhaps inevitably, incoming tourist numbers from the mainland are suffering and retail sales are lower relative to the June and July period in 2018. The Hong Kong Retail Management Association released the following statement: “Industry is worried that these events will damage Hong Kong’s international image as a safe city, a culinary capital, and a shopping heaven.” Hard to argue with that.


News around the globe

In Australia the central bank has now cranked its key interest rate down by two successive quarter-point drops to a record low of 1% and there is prospect of even more cuts. The stock market likes it as it has now, finally, passed its pre-crisis peak. Savers hate it, and justifiably so. All those careful calculations by the growing army of retirees have been tossed out the window. This, of course, applies in almost every country in the world. In Australia, however, the game of householders leveraging themselves has been turned into an art form as Australia sits on top of the heap when household debt is compared to personal disposable income or GDP. The government and central bank seem unconcerned. We will do their worrying for them.

In the US the President recently reinvigorated his pro-tariff stance by proudly stating that “We’ve taken in tens of billions of dollars in tariffs from China” – much more, he suggested, than the loss in US agricultural exports (to China). We think, however, that his take on statistics doesn’t bear detailed scrutiny. Government figures indicate that through to the middle of July the US had taken in US$20.8 billion from tariffs on Chinese goods but the subsidy (for loss of exports to China) he has promised to US farmers amounts to US$28 billion. In addition, many US companies have lost contracts and revenue as a consequence of Chinese retaliation against American goods. A tariff war is a lose-lose contest. Let’s hope some common sense soon prevails.

Greece has a new leader. On July 08 New Democracy party leader Kyriakos Mitsotakis was sworn in as Prime Minister after a resounding election victory. He comes from a blue-blood political stable as his late father, Konstantinos, was Prime Minister from 1990 to 1993. He completed his tertiary education in the US and worked at both Chase Investment Bank and consulting firm McKinsey (both in London).

The challenges facing Mr. Mitsotakis and his center-right party are daunting. He has promised to cut taxes and negotiate new terms with international lenders but that may not be possible. Bailout creditors are insisting that Greece stick to its commitment of a primary budget surplus of 3.5% of GDP (surplus prior to interest costs). This, they insist, is the only way its massive public debt load is sustainable. Maybe so, but the economy will continue to stagger under the burden. In our view the only sustainable way forward is for radical debt forgiveness, but this appears a remote possibility. A lower currency value relative to its European neighbors would also help but that, of course, remains impossible whilst part of the Eurozone.

In our research travels we have met with Mr. Mitsotakis and he is an impressive individual with economic views that we empathize with but we’re certain that we wouldn’t want his job. He has our best wishes.

Did you see the report from France indicating that hundreds of public sector workers are being paid to do nothing? Now how do I get that sort of job we can hear many of you asking. Under French law if local government workers lose their job because of a workplace shake-up or because they are considered to be incompetent, they continue to receive full pay for ten years and 50% of their salary afterwards! A proposed “radical” crackdown will change the law so that the idle will have their wages cut by 10% a year. Words fail us.

Despite the growing evidence of a global slowdown and the worrying ruckus with Iran, stock markets were unperturbed during July. Once again investors believe that central banks will come riding to their (dubious) rescue when economic conditions turn awry. Perhaps they haven’t considered that central banks may be part of the problem. At the time of writing ( July 26) most markets are up by between 1 and 3% expressed in local currencies.

The MSCI World price index in U.S. dollars is up 1.3%. Government bond markets continue to offer absurdly low yields. In the US the 10-year bond continues to hover around a yield of 2% and the yield curve remains inverted (relative to 3-month treasuries). Negative 10-year yields are on offer in Germany, Switzerland, Sweden, Japan, France and the Netherlands. In Greece, that pinnacle of fiscal rectitude and solvency, we have seen the 10-year yield fall to 2%. Earlier in 2019 it was precisely double that level.

Low bond yields shatter investment plans and returns whilst eviscerating pension funds and savers. The reach for yield and return drives investors up the risk spectrum. In the short-term equities benefit but the gap steadily widens between earnings (profits) and share prices. It’s a worrying and crazy environment that merits an evermore cautious approach to investing – not the opposite.

The information, opinions, estimates or forecasts contained in this document have been arrived at by Pyrford International Ltd. and were obtained from sources reasonably believed to be reliable but are subject to change at any time. Investments cannot be made in an index.

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