Asset Class: International Equities

Australian economy humming despite political volatility

Australia Canberra Parliament House

Since fox hunting was banned in Britain the world’s best known blood sport has been Australian politics. Malcolm Turnbull, Prime Minister since September 2015, has been ousted by his cabinet colleagues – the 4th Aussie PM to be so-ousted in the last decade. It seems the voting public, even allowing for Australia’s crazily short 3-year electoral cycle, never has a chance to see the leader make it through to the next election. Turnbull squeaked through a federal election in 2016 with a one seat majority and was due to face the voters again in 2019. He has not been given the opportunity. Turnbull followed Tony Abbott (2013-15) into Australia’s top job after he engineered Abbott’s downfall.

It is amusing that Madame Tussaud’s wax works in Australia has announced that it is no longer making models of Australia’s Prime Ministers – they change too often.

The new Prime Minister in Australia is Scott Morrison, a ‘blokish’ 50-year old compromise candidate. Morrison was Treasurer in the Turnbull administration. Immediately following these latest maneuvers Australia’s well regarded Foreign Minister and Deputy Leader, Julie Bishop, resigned her post. Pity.

The great irony is that Australia has been one of the world’s best performing economies over the last 20 years. In fact, no mature, advanced economy has performed as well over that time-frame (using real GDP expansion as the yardstick). The same applies to growth measured since the start of the global financial crisis (measuring from January 2008). Australia escaped without a recession, largely thanks to the mining industry and China. The “lucky country” once again lived up to its nickname. If this is how politicians are treated in a successful economy we dare not think how they will be treated when times are tough.

Turkey: A classic emerging market crisis?

The other country reaching international headlines in August for all the wrong reasons was Turkey. Since January the Turkish lira has lost around 40% of its value relative to the U.S. dollar. This follows President Trump’s imposition of swingeing tariffs on steel imports – an important export for Turkey – and the U.S. is their number one destination. Mr. Trump recently tweeted: “I have just authorized a doubling of tariffs on steel and aluminium with respect to Turkey as their currency, the Turkish lira, slides rapidly downward against our very strong dollar!” Helpful stuff.

Turkey was already experiencing high inflation (averaging around 11% in the last two years) but this latest plunge in the lira has pushed it to 16%. Analysts expect it to move over 20% in the next few months. Interest rates are rocketing as the government tries to stabilize the currency and unemployment, already uncomfortable at 11% in 2017, is moving higher. Perhaps the major problem is that the exposure of foreign banks (largely European) to Turkey has climbed from around U.S. $50 billion in the early 2000s to over U.S. $250 billion today (source: Bank for International Settlements). These borrowed funds have been utilized for extensive and ambitious infrastructure projects.

This then has all the hallmarks of a classic emerging market crisis – high debts (denominated in foreign currencies), high inflation, current account problems, rapidly rising interest rates and a tumbling currency. Virtually all emerging markets have wobbled in sympathy – contagion is always swift and merciless.

The proximate and most recent cause for the increased friction between Turkey and the U.S. is Ankara’s imprisonment of a U.S. pastor, Andrew Brunson, who is accused of having terrorist connections. He faces up to 35 years in jail. Turkey’s President Erdogan is remaining steadfast in his refusal to release him.

We are unable to comment on Pastor Brunson’s guilt, or otherwise, but we do recognize that Turkey’s President, with the unprecedented personal powers granted following a referendum in 2017 (together with an election victory) has assumed an increasingly autocratic posture in all matters relating to Turkey’s development and international relations. His clash with Trump is a typical battle of wills and egos.

Turkey does matter. It is a country of around 80 million people, an important member of NATO, geographically strategic, home to the U.S. Incirlik and Izmir air force bases and increasingly a key destination for the flood of migrants from Syria and elsewhere (following a financially favorable deal negotiated with Germany’s Angela Merkel in 2016).

Our guess is that capital controls will be on President Erdogan’s near-term agenda together with even more foreign borrowing. He will be reluctant to go cap in hand to the IMF. None of this is cheery news.

Is Greece out of the woods yet?

Greece formally exited its eurozone bailout program during August meaning that it is now free to borrow on international markets. What good news – it can now add to its debts! A reminder – this was the biggest bailout in history. The IMF and European Union put together a rescue package totaling €289 billion. Massive budget cuts were imposed and the economy experienced a depression, contracting by over 25%.

So is Greece out of the woods? That would be an extremely optimistic assessment. The IMF estimates that by 2023 Greece’s public debt will amount to 151.3% of GDP (estimated at 188.1% this year), unemployment will be 14.1% (19.9% this year) and GDP growth will be 1.2% (2.0% this year). So if all goes well Greece will be growing but still with an oppressive level of public debt.

The latest IMF assessment concludes: “…high public debt, weak bank balance sheets, reliance on capital controls and emergency liquidity assistance, and worrisome social indicators, including still-high unemployment, all weigh on growth and social cohesion. Fiscal adjustment has been sizable, but has relied on distortionary high tax rates on still-narrow bases and growth-detrimental discretionary spending cuts, and efforts to bring down tax and spending arrears have been met with limited success. Social spending is better targeted, but many social needs remain unmet and the risk of poverty remains high. Bank credit continues to shrink. Structural reform efforts to address obstacles to growth and competitiveness— while significant — have fallen well short of what is needed and competitiveness indicators remain below the Euro Area average.”

Our comment: Greece still needs massive debt forgiveness and a more competitive exchange rate. The latter is impossible whilst it remains a member of the eurozone and the former is unlikely.

What, me worry?

On August 2, the Bank of England increased its base rate by 0.25% to 0.75% – the highest level since 2009. Now this is hardly a startlingly high rate, particularly with annual inflation over 2%, but it does confirm the global trend for gradually higher rates. In the U.S. at least one more rate hike by the Federal Reserve can be expected this year (despite protests from Mr. Trump) and the European Central Bank has announced that its version of Quantitative Easing (QE) will end this year. The average rate of inflation in the Eurozone has now moved over 2%.

Bit by gradual bit the world monetary system is “normalizing”. There is a long way to go but we can take some satisfaction that progress is being made. Corporates and householders living with debts to the eyeballs are on borrowed time.

Quantitative Tightening, for want of a better term, is obviously the opposite of QE and should have the opposite effect on markets. The U.S. is actively draining liquidity from the economy as it shrinks its balance sheet. This shrinkage already amounts to several hundred billion dollars and is on track to achieve an annual rate of around half a trillion dollars during the current year.

The surprise to us, as we have expressed in previous commentaries, is that the U.S. stock market continues to power ahead without a worry in the world. Our view is that valuations were stretched some time ago so by implication they are now in heady territory. It is claimed that this is the longest bull market since WW2. We won’t argue.

We closely watch U.S. corporate profits and note that since 1960 nominal pre-tax whole-economy profits have achieved an average increase of around 6.5% per year. But, as you would expect, the graph of the profit movements is classically cyclical. On a 3-year moving-average basis the current profit growth figure is precisely zero (source: Bureau of Economic Analysis).

As Alfred E. Neuman of Mad magazine used to say: “What, me worry?”

Tesla’s takeover that wasn’t

Self-publicist extraordinaire, Elon Musk, announced via Twitter on August 7 that he had secured funding for a U.S. $72 billion takeover of Tesla. On August 24 he announced that he had abandoned the bid. This demonstrates an alarming disregard for correct procedures. The SEC will be investigating and lawsuits are likely to follow.

Trump’s trade wars

President Trump’s trade war continues apace. He shows no sign of relenting despite the looming mid-term elections. It won’t be long before the impact is seen on U.S. inflation and consumer choice. U.S. growth and growth elsewhere will be adversely impacted. There is simply no part of this plan that can be described as sensible economics.

Monthly update on equities and yields

At the time of writing (August 30) most equity markets are modestly down for the month. A prominent exception is the U.S. which is up by 3.5%. (MSCI price index in U.S. dollars to August 29). Mr. Trump is a darling of the stock market.

In the emerging and frontier market categories there have been some sizable falls in August (MSCI price indices expressed in U.S. dollars to August 29): Turkey: -26.3%; Argentina: -26.0%; Panama: – 14.8%; Brazil: -10.3%; Russia: -8.0%; Chile: -6.8%; Greece: -6.3%. The market in Pakistan fell by 4.3% despite (or because of) the election of former international cricketer, Imran Khan, to the country’s top political post.

Government bond yields, at the 10-year end, changed very little over the month (to August 29). The U.S. yield eased slightly from 2.96% to 2.89% whilst yields in the U.K., Canada and Germany barely flickered. One of the big movers in recent times has been Italy. Since the beginning of May its 10-year bonds have seen yields increase from 1.7% to 3.1%. The new Italian government has more than its share of challenges.

 

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