We all know how to read the road map, says Michael Wilson. Of course we do. But is that shimmering vision on the blue horizon an oncoming juggernaut?
It ought to be so easy, oughtn’t it? Here we are, sitting on virtually all-time equity valuations, with trade wars rumbling and the IMF forecasting the slowest global growth rate since 2008. With the world’s most important election looming next November, and Britain’s own future dangling on another poll on 12th December. Clowns to the left of us, jokers to the right. Here we are stuck in the middle with nowhere else to go.
And that’s just the macro environment! The investment scene, as any long-term China bug can tell you, is a whole ‘nother dimension which might take its lead from the economic situation, but then again it might not. Dammit, even if we could read the eco-political runes correctly, we’d only be halfway to working out the market prospects. Welcome to 2020, the land of who knows where?
This month I want to give due deference to the skilled and highly-revered analysts who watch over us on the world’s economic behalf. But also to ask whether their models are really up to scratch? There are those among us who suspect that we’re watching the wrong indicators, and that there might be more life in the post-2008 bull market than the traditional measures would have us believe.
Some people never learn…
“There are two kinds of forecasters,” said JK Galbraith: “Those who don’t know, and those who don’t know they don’t know.” Gosh, I wish I’d said that, Oscar. But after nearly forty Christmases of phoning up fund managers and analysts, and of hearing them all insist that they only ever make December forecasts for fun, I jolly well ought to have got the message by now.
Which is that economics has no absolute laws and no red lines that can’t be fudged or stretched – at least, in the short term. And that even if we had economic certainty, there’s no certainty that stock or bond valuations would take any notice. And that even if we knew how markets would be, we’d still be powerless in the face of inverted yield curves, negative interest rates, and a billion investors with cash waiting to buy on the dips. And that Keynes’s line about irrational markets is as valid today as it ever was.
But what the heck, I’m, going to have a crack at this prediction game anyway. Although not before I’ve chucked another rock into the pool of our so-called assumptions. Have we understood this Gross Domestic Product thing properly in the first case?
The MAGA conundrum
The reason I ask, of course, is that Donald Trump’s America has got most of the right-thinking world scratching its head to figure out how he ever managed to pull such a very substantial rabbit out of the presidential hat? Even the estimable Gavyn Davies, a former international managing director at Goldman Sachs, and “wise man” to John Major’s Treasury, conceded in a recent Financial Times commentary that Trump’s $1.6 trillion tax handouts did indeed seem to have added 1.6% to GDP during 2017-2018. And that America was currently running at very close to full capacity. Extraordinary.
So they weren’t just empty calories after all? But were in fact a credible reason for the continued surge in US equity prices, which last year took the Shiller CAPE value of the S&P 500 to 33 – since when they have subsided to a (ha ha, relatively) affordable 30. Okay, that’s still getting on for double the historical mean of 17, but these are strange times, for all the aforementioned reasons, and then some.)
Like any good economist, Mr Davies is careful not to sound too convinced about 2020. Further growth in a full-capacity US, he says, is going to be hard to find, and worries about the prospect of a hard-left Democratic candidate for the November election are already subduing Wall Street sentiment. Worse, perhaps, is that solid global growth in manufacturing production is obscuring a much weaker performance from services, where PMI Market indicators fell by a full 1.5 points between July and October.
At the same time, Davies suggests, China appears to have taken its own path. Trump’s trade war threats against the People’s Republic are being effectively absorbed by Beijing, which has been loosening fiscal and credit policy so as to increase domestic demand as its export prospects diminish.
But despite that, frankly, President Xi seems not to be pushing for China’s GDP to exceed next year’s target rate of 6% to 6.5%. He’d rather reduce the heat in the shadow banking sector, which has become over-leveraged in recent years. And, I’d add, although that might be a sound move for the stability of the country’s financial system, it doesn’t put very much fire in the belly of a foreign investor looking for a catch-up to the Shanghai p/e ratio (currently 14).
The European Exception?
Alas, as for Europe, Davies can’t seem to see very much room for optimism in 2020. The short-lived upturn in 2016-2018 resulted, he suggests, from “a broadening of the European Central Bank’s unconventional monetary stimulus, normalisation of bank credit growth in the eurozone’s indebted economies and an easing of deflationary fears.” But all that seems to have run into the sand in the last 18 months or so: many other commentators have noted that the ECB has all but run out of fiscal bullets, now that eurozone interest rates are nudging zero and the bond yield on government paper is turning steadily negative.
Whatever it takes to jump-start a eurozone GDP growth rate that’s fallen to just 1.1% in 2019 (European Commission forecasts in October), a drop in interest rates probably isn’t it. The Commission has already dropped its forecast for 2020 and 2012 from 1.4% to just 1.2%, but that isn’t so much because of US trade threats. Rather, it seems to reflect a general dullness in all the major economies: of the larger EU members in mid-2019, only Spain, Denmark and the Czech Republic were beating 2% growth, with Germany making just 0.4% and Italy just 0.3%.
On the bright side, there was 5% to 6% to be had in Ireland, Poland, Hungary and Ukraine, but all of those countries were presenting other worries of their own as 2020 approached. Ireland’s chances of a rebound during the new year are likely to depend on the outcome of the Brexit negotiations, but the European Commission has noted solid Irish construction activity and healthy rates of consumer activity. (To which we’d add that the migration of some London-based money during the Brexit scrummage has probably done no harm.)
That said, the sword of Damocles seems to be hanging over so many economies at the moment, and not just within the EU. Russia’s projected economic growth in 2019 is down to 1%, and Turkey’s will be lucky to scrape above zero, says the Commission.
The view from PIMCO
But come on, chaps, it’s Christmas soon, and we could all do with something more positive to warm up the Bleak Midwinter. Surely the level-headed people at fixed interest specialists PIMCO can inject a little bit of cool intelligence into all this?
Indeed they can, but sadly they don’t have anything very different to say. September’s quarterly report, tabbed “Cyclical Outlook”, bore the unpromising title “Window of Weakness”, and it didn’t hold back on its recommendation that investors should aim “to focus on capital preservation, to be relatively light in taking top-down macro risk in portfolios, to be cautious on corporate credit and equities, [and] to wait for more clarity.” Gee, thanks guys. Can’t you do better than that?
Yes, they can. PIMCO says that it expects global GDP growth to “slow to stall speed” during the first half of 2020, with US growth dropping to just 1%. A rate which, it says, heightens America’s vulnerability to external shocks.
Now, I’d have to protest that I personally don’t buy that argument in all its damning force, because I’m pretty sure that Donald Trump will unleash another shower of tax-break goodies as the US economy slows and the November election nears. But I digress…
In the meantime, PIMCO adds, there are signs of some things going right. The group forecasts (accurately, at the time of writing) that US-China trade tensions will remain in low-boil mode while Trump and Xi sort things out. It likes the strategies developing in some emerging markets, and it says it’ll be favouring modest overweights in EM currencies.
PIMCO notes, like Gavyn Davies, that China’s leadership is taking fiscal loosening steps that will de-claw America’s trade threats, and it reckons on seeing 5% to 6% GDP growth in 2020 from China and 6.5% to 7.5% from India. On the other hand, it’s not expecting more that 1.25% from the eurozone or 0.75% from Japan. Latin American investors will need to be choosy – but Mexico and Brazil are both forecast to beat 3.5%, as is also Russia.
“An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.” Laurence J. Peter, the originator of the Peter principle
“GDP is Fake News”
Are you feeling depressed yet? Let’s see whether we can lighten your seasonal mood with a question that comes up every few years, but which has rarely seemed so relevant as it does right now. Can we honestly feel confident that Gross Domestic Product figures are worth the spreadsheets they’re written on? And if not, do we need to revisit our investment assumptions?
The reason I ask (surprise, surprise) is that we really don’t understand why Trump’s sugar pills have generated so much apparently genuine growth. Could it really be that the markets have intuited an upward trend that the economists have not built into their forecasts?
I refer you, dear readers, to a recent report (https://think.ing.com/reports/gdp-a-digital-remix/ ) by ING’s chief economist Mark Cliffe, in which he and John Calverley, of Calverley Economic Advisors, query the validity of the entire economic construct, and then wind the calculations back by thirty years or so to show how we’ve all been ignoring productivity factors that we haven’t even been aware of.
To put it briefly, Messrs Cliffe and Calverley say that the conventional ways of measuring GDP don’t take account of the long-term contribution from advanced technology, which they say has been quietly slipping 0.4% a year into our quality of life since the 1990s without our noticing. Then there are the missed enhancements from the service sector, which isn’t properly valued either – and finally there’s what they mysteriously call “intangible activity”.
The result, they say, is that at least 0.75% of real annual GDP growth hasn’t been going into the statistics for so long now that all our calcs are out of kilter with the daily experience – which is that things are getting better all the time. Rather startlingly, Cliffe and Calverly claim that the actual invisible enhancement might be as high as 2% a year – and that “If GDP has been underestimated by 1 per cent per annum since 1990, then median income has risen [by] 50 per cent instead of the 15 per cent recorded.”
That, together with the falling real prices of technology, energy and food, might explain why America’s squeezed middle classes haven’t been rioting in the streets while the country’s profits growth has slipped inexorably into the pockets of the top 1% – and while their own salaries have (apparently) stagnated.
And then think of the previously unthinkable option of using alternative currencies when settling a bill. I’m not writing off the chances that bitcoin and the rest will storm the global financial community – only last October, Philadelphia Federal Reserve bank president Patrick Harker told a community banking conference that it was “inevitable” that central banks, including the U.S. Federal Reserve, would start issuing digital currencies. Why, China is planning a national “stablecoin” called the Digital Currency Electronic Payment (DCEP), apparently in an attempt to swamp Facebook’s cryptocurrency Libra, which no government likes.
Nor is Mr Harker alone in this conviction. Agustin Carstens, the general manager of the Bank for International Settlements (BIS), was recently quoted as saying that central banks will soon be forced to issue their own digital currencies. (Yes, really.) And in a way, that might counter the worry that unregulated third-party currencies such as Libra might undermine the fiscal stability of existing money forms.
At the end of the day, a conventional currency depends on some economic fundamentals – GDP, trade, bond yields and the like – and that’s where its ultimate credibility comes from. We can’t know yet whether a digital currency from a central bank would carry the same kudos, but I suspect we’re about to find out.
“The only function of economic forecasting is to make astrology look respectable.” Galbraith
Old Bore’s Almanac, 2020
Much though I’d like to dodge the seasonal flak, not to mention the ignominy of getting it all wrong six months down the line, here’s my personal twenty-twenty, finger-in-the-wind, guaranteed dead cert betting card for the New Year. No, don’t thank me, it’s been a pleasure. Give my regards to your seasonal bookmaker.
January: Boris Johnson’s triumphantly re-elected government sets about the important task of forgetting the majority of the lavish pre-election promises that it has made to the voters. Although the Chancellor who used to be Sajid Javid will have no option but to abandon the planned return to a balanced budget,
January: The Year of the Rat begins in China on 25th January. The first animal in the Chinese zodiac cycle, the rat represents wealth, surplus and success. Unfortunately, the last Year of the Rat was in 2008.
February: The UK’s Brexit extension is due to have expired on 31st January. Will the EU allow more time? It seems improbable unless we have either a full deal or a Labour government promising a referendum. But the transitional arrangements should provide at least some stability.
June: The usual mid-year spike in oil prices fails to materialise, mainly because of uncertainty in the emerging markets. Although Middle East military threats tend to diminish in the summer months because of the searing heat, disruptions of other kinds seem likely to continue.
September: Hong Kong’s Legislative Council elections are due to be held. Likely to impact on financial markets unless protests can be tightly controlled.
October: Asteroid 2018 VP1 will steal valuable newspaper column space from the upcoming US elections, causing alarm and panic throughout the world’s apocalypse believers. Although small enough to be susceptible to unpredictable gravitational pulls, NASA says it is currently due to pass the earth safely, on 2nd November, missing Washington DC by 260,276 miles.
November: Donald J Trump secures a second term of office, having seen off a left-of-liberal Democrat challenger with a yuuuge tax break that will ensure that the Senate doesn’t endorse the impeachment proceedings. But that his wings will have been permanently clipped.
December: Currently the end date for the Brexit transition period. A free trade agreement is, in theory, due to have been signed by the 31st. Good luck with that one, chaps.
I’ll tell you one thing, though. 2020 will probably be the year I stop saying two thousand and twenty, and start saying twenty-twenty. It’s never too late to lose an ingrained habit.