Asset Management: Asset Manager Insights

Protectionism: Is anyone playing a fair international game?

q42016-market-perspectives-header

The revolving door at the White House continued its rapid rotation during August. The Trump inner circle is now almost unrecognizable from the team surrounding him in January. If the White House was in the private sector the shareholders would be calling for the scalp of the CEO – and probably well before now. Soon everyone will be required to wear name tags. It is beyond fiction.

The UK has its own version of political turmoil thanks to the divisions over Brexit. There are some senior figures even plotting another referendum. Get over it! The UK will leave the EU in March 2019. Surely it is not beyond the wit of mankind to get the details sewn up by then. It does, however, require cooperation by the remaining members of the EU as well as the warring factions within the UK. Perhaps expecting the application of commonsense is being a little optimistic.

We hope the final outcome leaves the UK somewhere close to a welcoming free trade zone. Too much of the world remains bogged down with all sorts of protectionism – from outright barriers, to plain-vanilla tariffs, internal subsidies, preferential taxes, special depreciation allowances and so on. The so-called level playing field resembles the Himalayas. Even within the EU there are already many different tax rates and few signs of “harmonization” on the horizon. It is tough to find any country in the world playing a “fair” international game but we would point to New Zealand as having done a very creditable job for more than twenty years – and the economy is performing well.

Despite the gloom being preached by many in the anti-Brexit army we feel it important to point out that the level of unemployment in the UK recently fell to 4.4% – the lowest recorded since 1975. This is not a sign of a rapidly disintegrating economy. In the interests of objectivity we should mention that the household savings ratio is collapsing (savings relative to personal disposable income) and consumer credit relative to disposable income keeps making all-time highs. These are two trends that do not fill us with glee.

In France we note that Mr. Macron’s popularity has plummeted after 100 days in office. In fact, he is now more unpopular than Mr. Hollande after his first 100 days. We know that the voting public can be very fickle but the simple truth is that expectations were always too high. Mr. Macron represented the status quo with the potential for only minor “tweaks”. The few tweaks that have been announced have not been popular – some tax increases and benefit cuts. To make matters worse the inexperience of the large number of debutant MPs in his party has led to many scenes that are borderline shambolic. If the French wanted a genuine renaissance it appears that they have put the wrong person (and party) in the job.

 
Emerging markets – population fluctuations

The United Nations recently published an update of its “World Population Prospects” database and amongst the many fascinating details it served to once again highlight the demographic challenge confronting China. The total population is expected to peak around 1.44 billion around 2030 but the working–age population (defined as those aged between 15 and 64) has already peaked. Over the next 25 years it is forecast to drop by around 130 million and by the end of the century will be roughly half today’s level. Contrast this to India which will become the world’s most populous country in around seven years’ time whilst its working-age population will exceed that of China at much the same time. Only poor management will prevent India from gaining a permanent lead on China in the growth-stakes.

China was the subject of a recent IMF analysis which raised the growth forecast for 2017 to 6.7% (identical to the 2016 outcome) whilst forecasting 6.4% in 2018 and then a gradual decline to 5.8% by 2022. Of concern is the forecast for total non-financial debt to GDP which amounted to 178% in 2012, will reach 251% this year and is projected to climb to a sizeable 297% by 2022. The IMF comments:

“International experience suggests that China’s credit growth is on a dangerous trajectory, with increasing risks of a disruptive adjustment and/or a marked growth slowdown.” Further: “Decisive policy action is needed to deflate the credit boom smoothly: (i) de-emphasize the high and hard GDP targets to contain excessive credit expansion, and reduce credit demand by the least efficient users to increase credit efficiency; (ii) institute reforms to boost consumption to support growth while credit expansion slows.”

The IMF recommendations are sensible but given the scale and rate of Chinese credit growth will not be easy to achieve. The history of all credit booms suggests they continue until they bust (badly) – let’s hope China proves to be an exception.

Returning to the United Nations demographic data we note that Japan and Italy boast the world’s oldest median age (not a proud boast) whilst Bulgaria tops the list of countries expecting the most significant percentage decline in population between 2015 and 2050 (24.4% or 1.75 million people). At the other end of the scale the country with the fastest rate of forecast population growth rate is Nigeria. The UN expects its population to exceed that of the US by 2050 at which point it will become the third most populous country in the world. Indeed, Africa’s share of the world population is forecast to grow from 17% now to 26% in 2050 and 40% in 2100. For everyone’s sake let’s hope this creates opportunity, not burden.

 
Markets react (or not) to NK threats

Continued sabre rattling by North Korea’s baby-faced leader sucked the US President into a retaliatory exchange which no doubt bolstered the ego of this extraordinary individual (Jong-un, not Trump). Global stock markets ignored the proceedings until military analysts declared that it may indeed be possible for North Korea to back its threats with actions – it seems the world may have underestimated the rate of advance of the country’s nuclear and rocket technology. Nuclear brinkmanship is never a desirable course of action, particularly when potential responses from both sides are more unpredictable than usual.

The latest wave of terrorist attacks in Europe then further unsettled the markets so that at the time of writing (August 24) most stock markets are down marginally over the month. Prior to these events the US stock market had put together a string of record closes – and this despite disillusionment over the prospect of Trump achieving any of his capital spending “promises”. Additionally, the country will bump against its Congress controlled debt ceiling by the end of September providing yet another hurdle for the President to overcome.

 
Are recessions a thing of the past?

There seems little point in commenting that equity markets are expensive because with infrequent monthly exceptions they keep on going up. Since February 2009 it has been mainly one-way traffic. The “biggie”, the US market, is up around 9% this year. The S&P 500 index sells on a dividend yield of only 2% whilst the “cyclically adjusted P/E” (source: R J Shiller) is a lofty 30.5.

These statistics demand excellent top-line revenue growth (forever), retention of margins and, obviously, no global or domestic economic weakening. The markets assume that recessions no longer occur (funny, your correspondent recalls an economics Professor telling him way back in the second half of the 1960s that economic management had been perfected to the point that recessions were a thing of the past. And then came the 1970s!).

Of course we will have another economic setback and there will be a decisive break in these trends. When? To that we will give our usual answer: “On Thursday week”. Just don’t ask us to pin down which Thursday.

Pyrford is registered as an investment adviser with the Securities and Exchange Commission and is a wholly-owned subsidiary of BMO Financial Group.

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