Asset Class: International Equities

Global output gets a nudge; crypto stumbles

Crypto news and costly hacks

Much of the air came out of the Bitcoin bubble in January. It finished 2017 around U.S. $14,300 (having very briefly touched U.S. $20,000 during December); it bounced back to U.S. $17,000 early in the New Year but by the end of January it had subsided to sit around U.S. $10,000. Where it goes next is not something we can offer an opinion on as its price movement has nothing to do with fundamentals – because there are none. Perhaps it will end up a bit like Australia’s Poseidon bubble in 1969/70 – there will be plenty of stories along the lines of “were you there when…?”

In more crypto news it seems that hackers stole approximately U.S. $500m in digital tokens from Coincheck Inc. in the early hours of Friday, January 26th. This is not the first such “hack” – in 2014 Tokyo-based Mt. Gox was penetrated and there have been others since. Coincheck has promised to “make-good” on all losses. At the time of writing Coincheck is yet to resume trading. Costly hack!

IMF tweaks Outlook after U.S. cuts taxes

The IMF in its latest World Economic Outlook has reaffirmed the general impression that the global economy is experiencing a sustained cyclical upswing and growth is nudging ahead of earlier expectations. The IMF expects global output to expand by 3.9% in 2018 – up from an anticipated 3.7% in 2017. The U.S. growth forecast has been revised up as the corporate tax cuts are expected to have a positive impact through 2020 although growth after 2022 is projected to be lower than previously anticipated. This is a consequence of “…the increased fiscal deficit, which will require fiscal adjustment down the road, and the temporary nature of some of the provisions.”

Having being caught out many times in the past projecting growth rates superior to those actually achieved the IMF inserts its usual caveat in its forecast: “Risks to the global growth forecast appear broadly balanced in the near term, but remain skewed to the downside over the medium term…rich asset valuations and very compressed term premiums raise the possibility of a financial market correction, which could dampen growth and confidence. A possible trigger is a faster-than-expected increase in advanced economy core inflation and interest rates as demand accelerates.”

The possibility of increasing inflation is something that has kept our brows furrowed for some time. We note that in the Eurozone all countries bar Cyprus experienced positive inflation in the year to December whilst five of the nineteen experienced inflation ahead of the ECB’s target of 2%. Even Greece managed an inflation rate of 1% in 2017.

Increasing fuel prices have impacted headline inflation rates around the world. One chart we always keep an eye on is the correlation between the rise and fall in the oil price and the rate of consumer price inflation in the United States – there is a remarkably strong connection and the recent strengthening in the oil price suggests that inflation is more likely to surprise on the upside than the downside. Add in fast growing consumer credit, a rapidly falling personal savings rate, a booming stock market, strong employment and a narrowing output gap and you have a recipe that in “normal” times would promote inflation. We shall see.

Trump tax initiatives and protectionism

U.S. corporate profits are rarely far from the financial headlines and never more so that at present as a consequence of the Trump tax initiatives. Regular readers will be aware that we like to look at facts and figures over the long-term and we calculate that since 1950 pretax whole-economy profits in the U.S. have increased at an annualized compound rate of 6.57%. Over the same period GDP in the U.S. has increased at an annualized compound rate of 6.50% (both in nominal terms – source: Bureau of Economic Analysis). It is no coincidence that the numbers are almost identical as profits tend to occupy a fairly consistent share of the economic pie over time. Over the same 67-year period consumer price inflation has averaged 3.5% in the U.S.

We have reported previously that our long-term estimate for trend real GDP growth in the U.S. is 2%. The Federal Reserve expects just 1.8% while the OECD plumps for 2.4%. As in the past, we expect pre-tax corporate profits to grow at much the same rate as GDP. Does this long term outlook mesh with the current lofty U.S. stock market valuation? In a word – no.

President Trump now appears set on ramping up protectionism – after twelve months of comparative silence on the topic. If he proceeds with plans to erect various tariff barriers our view of potential U.S. and world growth will become somewhat less sanguine.

China GDP exceeds expectations

China announced in January that 2017 GDP growth came in at 6.9%, exceeding the target of 6.5%. As usual, China published its GDP number well before any other country’s statistical service could do the same. This comes after disclosures about a number of fabricated provincial growth numbers. This unsurprising revelation at least indicates that President Xi Jinping means business when he speaks about exposing corruption.

China’s massive state-funded construction program virtually locks-in fast GDP growth but does leave lingering questions about quality versus quantity alongside concerns about the mounting debt pile. Nevertheless we have always felt it dangerous to underestimate China’s potential (and will) and now that Xi has the helm, as never before, it is probably not timely to harbor excessive reservations.

QE, QT and world markets

The Bank of Canada cranked its key overnight interest lending rate by quarter of one percent to 1.25% in mid-January. This was the first move above 1% in nine years but it was not unexpected and confirms the tightening trend amongst the world’s major central banks. Quantitative easing is gradually morphing into quantitative tightening. Even in Japan the central bank has reduced its intake of long-dated Japanese government bonds – of course, the BOJ already owns almost half the outstanding issuance! The BOJ also owns a pile of equities but denies that it has caused market distortions. Extraordinary.

Bond yields around the world still remain absurdly low – in fact, more than U.S.$10 trillion of bonds across developed markets trade at negative yields – but the punch bowl is gradually being removed and with inflation stirring it is clear that this particular party is far closer to its end than its beginning.

For those who have taken their eye off Germany it is worth reminding that the Federal elections, which took place last September, have yet to produce a settled outcome. Talks have been underway for months and it now appears likely that the Christian Democrats of Angela Merkel (CDU), the Christian Social Union in Bavaria (CSU) and the Social Democrats (SPD) will form another grand coalition – despite the SPD initially stating it would now prefer a period in opposition.

Ms. Merkel’s position has been weakened as a consequence of the unsettling election result and if a final agreement between the parties cannot be reached soon she may have no option but to try and form a minority government or perhaps even call another election. None of this fills us with glee but what is surprising is that the political travails of Europe’s largest economy are largely absent from the daily international news. It seems that attention-spans continue to shorten.

Equity markets generally performed strongly during January although they tumbled from their month highs in the last few trading days. Utilizing MSCI price indices and expressed in U.S. dollars, the ‘world’ index rose by 5.2% in January and EAFE by 5.0%. In local currencies the EU was up 1.3%; Eurozone 3.3%; Europe 1.0%; Far East 1.9%; Nordic countries 1.0%; North America 5.2% and the Pacific 1.4%.

At the country level, again utilizing MSCI local currency price indices, we saw the following gains in January: Italy: 7.4%; Austria: 6.9%; USA: 5.6%; Spain: 4.7%; Hong Kong: 4.7%; Singapore: 4.2%; France: 3.1%; Germany: 2.1% and Japan 1.3%. There were, however, a number of negative country performances: UK: -2.0%; Canada: -1.3%; Ireland: -1.1%; Australia: -0.6%; Switzerland: -0.5% and New Zealand -0.3%.

Long-dated government bond markets were nothing but a sea of red during January. At the benchmark 10-year level U.S. bonds moved from a yield of 2.41% to 2.72% (the highest since April 2014); UK from 1.23% to 1.5%; Germany 0.42% to 0.63%; Japan 0.05% to 0.08%; Australia 2.63% to 2.81% ; Canada 2.04% to 2.30% and Switzerland -0.13% to 0.05% (source: Thomson Reuters Datastream).

Long-bond holders will be suffering. In the U.S. the bond yield trough was back in July 2016 so holders in that country have, in fact, already been suffering for 18 months. We suspect the pain is a long way from being over.

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

Related Articles

International Equities Aug 6 Brexit, Brexit, Brexit!
International Equities Jul 9 A trade and a currency war? Not what the doctor ordered.
International Equities Jun 5 A recipe for a particularly muddy global situation

You are now leaving the BMO Global Asset Management web site:

The link you have selected is located on another web site. Please click OK below to leave the BMO Global Asset Management site and proceed to the selected site. BMO Global Asset Management takes no responsibility for the accuracy or factual correctness of any information posted to third party web sites.

Thank you for your interest in BMO Global Asset Management.

You are now leaving the BMO Global Asset Management web site:

The link you have selected is located on another web site. Please click OK below to leave the BMO Global Asset Management site and proceed to the selected site. BMO Global Asset Management takes no responsibility for the accuracy or factual correctness of any information posted to third party web sites.

Thank you for your interest in BMO Global Asset Management.

You are now leaving the BMO Global Asset Management web site:

The link you have selected is located on another web site. Please click OK below to leave the BMO Global Asset Management site and proceed to the selected site. BMO Global Asset Management takes no responsibility for the accuracy or factual correctness of any information posted to third party web sites.

Thank you for your interest in BMO Global Asset Management.

You are now leaving the BMO Global Asset Management web site:

The link you have selected is located on another web site. Please click OK below to leave the BMO Global Asset Management site and proceed to the selected site. BMO Global Asset Management takes no responsibility for the accuracy or factual correctness of any information posted to third party web sites.

Thank you for your interest in BMO Global Asset Management.