International Equities

Vulnerable markets bounce back in January

The ravages of December were partially buried in January as the inevitable market bounce occurred. Even the U.S. Federal Reserve joined the boost party.
February 2019
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The ravages of December were partially buried in January as the inevitable market bounce occurred whilst even the U.S. Federal Reserve joined the boost party by publicly debating the amount of balance sheet shrinkage it should permit together with the timing of future interest rate increases (if any). Has Wall Street had its wicked way with the Fed once again?

The IMF weighed in with its six-monthly update forecasting lower global growth than foreshadowed in its World Economic Outlook projections from last October. The global economy is forecast to grow at 3.5% in 2019 and 3.6% in 2020, 0.2 and 0.1 percentage points below the October projections.

The IMF comments: “Risks to global growth tilt to the downside. An escalation of trade tensions beyond those already incorporated in the forecast remains a key source of risk to the outlook. Financial conditions have already tightened since the fall. A range of triggers beyond escalating trade tensions could spark a further deterioration in risk sentiment with adverse growth implications, especially given the high levels of public and private debt. The potential triggers include a “no-deal” withdrawal of the United Kingdom from the European Union and a greater-than-envisaged slowdown in China.”

In the world of “advanced economies” the IMF forecasts a “…persistent decline in the growth rate from above-trend levels – occurring more rapidly than previously anticipated – together with a temporary decline in the growth rate for emerging market and developing economies in 2019, reflecting contractions in Argentina and Turkey, as well as the impact of trade actions on China and other Asian economies.”

One of the major variables is potential growth in the UK. The IMF has forecast growth of 1.5% in 2019-20 but obviously has no better idea than anyone else about the likely Brexit outcome. The baseline projection assumes that a Brexit deal is reached in 2019 and that the UK transitions gradually to the new regime. Deal or no-deal Britain will have no option but to transition to a new regime. We and no doubt everyone else will be pleased when the ugly term ‘Brexit’ starts to disappear from the headlines.

Analysis of IMF forecasts over the long-term indicates that they are usually optimistic. Downward revisions are routine whilst the accuracy at predicting recessions has been abysmal (self-admitted by the IMF). This is not a criticism as the task of producing twice-yearly decimal-point growth projections for a vast range of countries is, frankly, a burden too far. We, therefore, have no quibble with any of the latest projections other than to remark that we agree with the “tilt to the downside” comment and the cautionary statement about high levels of public and private debt.

 

Housing affordability – not the case in Australia, at least

The annual (now the 15th) release of Demographia’s “International Housing Affordability Survey” has hit the desk. This usually garners a fair degree of criticism as most readers don’t want to believe the data or the conclusions as they point to a significant decline in house prices (at some point) in many major cities. Demographia utilizes median gross income and median house price data (including apartments) in 309 urban markets in Australia, Canada, Hong Kong, Ireland, New Zealand, Singapore, UK and USA to assess “affordability”. The latest release relates to the 3rd quarter of 2018. If the median multiple (median house price divided by median income) exceeds 5.1 the market is deemed by Demographia as “severely unaffordable.”

In Australia all the 5 major housing markets are deemed “severely unaffordable.” In the U.S. 13 out of 55 meet that criterion, in Canada 2 of the 6 and, in the UK, 7 of the 21. The most outrageously priced market is, once again, Hong Kong, with a median multiple of 20.9 (19.4 last year). Vancouver lands in 2nd place with a multiple of 12.6 (12.6 last year also) and Sydney comes in 3rd at 11.7 (12.9 last year). For those interested the next 3 places are filled by Melbourne, San Jose (Cal) and Los Angeles with multiples of 9.7, 9.4 and 9.2 respectively.

You don’t need a plethora of statistics to know when something is out of whack. Anyone participating in any of the above markets or any others in the “severely unaffordable” bracket knows from experience that there is no way into the market for a young worker on a ‘normal-ish’ salary unless the Bank of Mum and Dad comes to the party or the lottery comes good. By contrast, the generation of your scribe (post-war baby boomers) enjoyed median multiples of, typically, around 3 whilst deposits of 25% or more of the purchase price could easily be managed after a few short years of work. The Bank of Mom and Dad was non-existent “back in the day.”

We can’t forecast whether multiples will return to 3 in the major cities but we are prepared to wager that the 9’s and above will end and cause negative equity stress in a large number of cases. In Sydney the multiple is already falling as house prices are down comfortably over 10% since the peak in the September quarter of 2017. They have a way to go.

Where does one travel to find a multiple of 3 or less? The US has several examples – Pittsburgh and Rochester (2.6); Oklahoma City (2.7); Buffalo, Cincinnati, Cleveland, and St. Louis (all at 2.8); Indianapolis (2.9) and Detroit (3.0).

Financial stress relating to housing was the catalyst for the global financial crisis commencing in 2007-8. It would not be smart if we allowed a repeat performance.

 

Politicians playing politics

The partial shutdown of the US Federal government has been much in the news over the past month but it easy to forget that this is relatively commonplace in US political history. It now appears to have ended but it holds the dubious distinction of being the longest shutdown in history and will undoubtedly shave a point or two off US growth in December and January. The cost to the economy is probably more than the cost of the controversial wall. It seems extraordinary that the world’s largest and richest economy can spend a month or more where hundreds of thousands of government employees (and contractors) are furloughed and a variety of Federal services are either suspended or restricted.

In other news we have witnessed the political and economic situation in Venezuela lurch from bad to disastrous. The economy is in free-fall, the rate of inflation is uncountable, crime and corruption is rampant, unemployment has rocketed and the government’s leadership is wobbling (to say the least). And this, a country with masses, and we do mean masses, of proved oil reserves – probably the largest in the world. It is hard to conceive how such a significant natural advantage can be so abused and misused. The US has now imposed billions of dollars of sanctions on the State-owned oil company in an attempt to force the current President, Nicolás Maduro, out of office. Things could get even worse.

China sprinted from the blocks with its 4th quarter GDP announcement long before any other country’s statistical agency was even remotely close to dipping their ‘guesstimating’ pen in the inkwell. Full year growth came in at 6.6% – marginally down on 6.7% in 2016 and 6.8% in 2017. What remarkable consistency! The contributions to GDP growth make interesting reading because consumption expenditure is continuing to edge its annual contribution ahead of that of gross capital formation. This is the intent of government policy so it appears to be working. In 2018 final consumption expenditure contributed 5.03%, gross capital formation 2.14% and net exports a negative 0.57% (source: CEIC).

China’s import growth was much stronger than exports in 2018 but ironically the trade surplus with the US widened as imports from the US stagnated whilst exports to the US were robust. In fact, the negative US trade gap with China is now the largest yet recorded. We doubt that Mr Trump had this in his plan.

Market updates

Stock markets performed well in January. At the time of writing (month to January 30) we have seen the following gains (MSCI local currency price data): Canada: + 8.2%; USA: +7.1%; Switzerland: + 6.8%; Hong Kong: + 6.8%; Germany: +6.5%; France: +5.2%; Japan: + 4.2%; Singapore: + 3.8%; Australia: + 3.8% and the UK: + 3.1%. However, over 12 months almost all equity markets remain in solid negative territory. In the emerging market sector the wooden spoon goes to Greece with a 12 month local currency return of a negative 34.6%. This is ironic as Greece is about to sell 2 billion euros of 5 year bonds to any investors with the appropriate risk appetite. Line up.

Benchmark 10-year government bond yields, virtually everywhere, have tended to fall slightly over the last few months. Perhaps the most striking is the US which closed out October 2018 with a yield of 3.2% but at the time of writing the yield has subsided to 2.7%. Precise reasons for such movements are never easy to determine but a flight to safety following the equity market scare is undoubtedly part of the answer together with dimming global growth prospects. On the other hand, the US has to sell an awful lot of bonds to fund its burgeoning budget deficit so that will maintain pressure in the opposite direction.

In a timely move the Greek 10-year benchmark bond yield has fallen from 4.4% at the end of December to just 3.8% at present (Source: Bloomberg). Timely because of the impending bond issuance referred to above. Curious isn’t it?

Despite the bounce in January we continue to regard equity markets as vulnerable. The global slow-down is real, not imagined, and market ratings in many countries remain steep based upon potential corporate earnings growth.

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