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2019: A tough call

  • By Michael Wilson

Spare a thought for Michael Wilson, as he reads the runes for what looks like a challenging year


The easiest way to make a fund manager wince, I find, is to ask him what his economic predictions are for the coming new year. I’ve been trying to get the perishers to nail their colours to the mast for the last thirty Christmases or so, and I can’t remember very many managers who didn’t stop, cough nervously, and ask me to please make it perfectly clear to the readers that they were only making their guesses in a light-hearted, sporting seasonal spirit, and that their fingers were firmly crossed behind their backs?

You can hardly blame the poor devils for trying to stay on the fence this time. A manager who expects a bearish new-year retrenchment is damned if he says so, and damned if he doesn’t. I mean, who’d want to be the exception who missed out on the Christmas surge because he was busy being the harbinger of doom while everybody else was raking in the unexpected seasonal wave or profits? Who’d want to have to tell his boss that the hefty December outflows from his fund were down to his gloomy prognostications?

Surely, you might ask, he’d be able to glory in his prescient judgement if January did indeed turn cold on him? Well, thank you very much, but he’d probably rather not take the career risk. You know what they say about tall poppies.

Take it from the top

Which is why I’ve decided to give the managers a break this year, and to turn my attentions instead to the pure(r) economists and to all the fixed interest experts who tend to keep their noses pressed a little bit closer to the fiscal grindstone than the rest of us. When a 0.5% shift in the yield can turn your bond portfolio upside down, you keep your eyes on the maths and the algorithms, and to hell with fashion or politics or the vagaries of Mr Market.

Heck, if I wanted to go just a little further off the wall I’d probably have asked the betting houses, who live or die by their calculations. But maybe that would have been just a small step too far?

2018 so far…

Last February, IFA Magazine said that the incoming year was a wall of worry. It wasn’t just Trump who was creating pan-global uncertainty, we said – it was also China, the oil price, the Brexit negotiations and a deteriorating situation in the Middle East. We also said that, although corporate profits in America seemed to be on the up, the ten-year Shiller p/e ratio (at around 33.3) didn’t leave very much more room for upside. And that other markets might prove more attractive. Why, we might even have nominated London as a possible beneficiary.

We were, of course, wrong. Donald Trump’s $1.6 trillion tax handout was a basically fistful of empty calories, just as we’d predicted, but its effect on America’s economic morale turned out to be outstanding in terms of the confidence it induced. By the mid-autumn the beneficial effect on Wall Street was so great that the dollar economy swiftly sucked all the liquidity out of Asia, Europe – and, yes, Britain.

By the fourth week of November, US GDP growth for 2018 was being guesstimated at 2.9%, compared with 2.1% for the Euro area and just 1.3% for the UK. And the S&P had put on 1% against the FTSE’s 9% loss. To which you’d have to add another 6% for the pound’s slide against the mighty dollar. Ouch, that might be mainly because of Brexit, but it still hurts.

Things weren’t a whole lot better for the Eurozone, with the FTSE Eurofirst 300 losing 9%, plus another 6% for the euro/dollar slide, and a ghastly 13% fall in the German Dax (plus the euro slide). So much for sneaky Berlin playing unfair against the long-suffering US.

And for 2019?

Aaah, say the wise heads, that’s where the passive approach comes in. Forget all the active management hype, and sail your boat instead on the rising and falling tides of the market, and keep your eyes firmly on the far distant horizon. It’s also what an IFA would recommend to many of his clients. Pound cost averaging and all that. Sleep easy.

They’re not alone. Right now, you’re probably aware that active funds are having a torrid time, with worldwide investors pulling more than $86 billion from active funds during the third quarter – the heaviest outflows since third-quarter 2011, according to the Financial Times. But for those of us who still prefer active management – or just the active/passive strategy of choosing the right passive funds at the right moments – the need for vigilance, perspiration and a critical sixth sense is as important as it ever was. Nothing’s changed.

The OECD’s View

So, what’s in the financial runes for 2019? The Organisation for Economic Co-operation and Development published its autumn Economic Outlook on 21st November, and it didn’t fill anybody with unbounded optimism. This is looking like a challenging period.

But perhaps not quite dispiriting as all that. On the minus side, the report said, the global economic upswing, seems to have peaked. Global growth is projected to shrink next year to 3.5%, compared with 3.7%, and by another 3.5% in 2020. Although many countries have seen unemployment at record lows, combined with emerging labour shortages, there were “rising risks” that “could undermine the projected soft landing from the slowdown”. (http://www.oecd.org/eco/outlook/economic-outlook )

“Trade growth and investment have been slackening on the back of tariff hikes,” the report said. “Higher interest rates and an appreciating US dollar have resulted in an outflow of capital from emerging economies and are weakening their currencies. Monetary and fiscal stimulus is being withdrawn progressively in the OECD area.”

Trade tensions are already harming global GDP and trade, the OECD says; and it added that, if the US were to raise tariffs on all Chinese goods to 25%, with retaliatory action being taken by China, then world economic activity could be much weaker.

“By 2021, world GDP would be hit by 0.5%, by an estimated 0.8% in the US and by 1% in China. Greater uncertainty would add to these negative effects and result in weaker investment around the world.” Indeed, the report “also shows that annual shipping traffic growth at container ports, which represents around 80% of international merchandise trade, has fallen to below 3% from close to 6% in 2017.”

The OECD repeated its earlier warnings about slowing growth in China, although that may not be entirely bad news: the change, it said, resulted partly from new US tariffs on Chinese imports, but also from tighter rules on “shadow banking” outside the formal banking sector, combined with a more rigorous approval process for local government investment. But it confirmed recent market expectations that new stimulus measures from the Beijing central bank “may help to bolster slowing growth and help engineer a soft landing”.

So far so good. But failing that, it adds, “a much sharper slowdown in Chinese growth would damage global growth significantly, particularly if it were to hit financial market confidence”.

Part of the problem, it says, is that policy-makers’ room for manoeuvre in the event of a more marked global downturn is somewhat limited. “With very low interest rates in many countries – particularly in the euro area – and [with] historically high debt-to-GDP levels (both public and private),” The point here is that the OECD says it’s important to be able to use tax and spending policies to stimulate demand if growth should weaken sharply. And, with that sort of freedom in short supply, “co-ordinated action will be far more effective than countries going it alone”. (Are you listening, Mr Trump?). Such stimulatory action, it says, “should be focused on growth-friendly measures, such as investment in physical and digital infrastructure and targeting consumption spending more towards the less well-off.”

Let’s add to that assessment a telling little note from the blog that OECD chief economist Laurence Boone wrote back in September. The downside of US trade policy, she wrote, is that Trump’s own tariff wars are already actively hurting US producers. “The prices of washing machines for US consumers jumped by 20% between March and July this year after the imposition of tariffs,” she wrote. “And US imports of steel from China are sharply down, just like Chinese imports of cars from the US.”

Higher tariffs, she insists, will generally mean higher prices for consumers, less investment, and ultimately losses in productivity and standards of living. “Just consider,” she adds, “that 13 million jobs in the US and 8 million in Japan depend, directly or indirectly, on foreign consumption.”

But the impact of the stronger dollar on emerging markets is a more serious matter. Rising interest rates in the United States, and the associated appreciation of the US dollar, have combined with a shift in risk sentiment to result in sizeable currency depreciations in many emerging-market economies, the interim report says. And “countries with large external deficits or high foreign-currency denominated debt have been particularly exposed, most notably Argentina and Turkey.”

Is there any good news at all? Yes, Boone says, the lessons of 2008 have been learned on the financial front. “Banks are now better capitalised, and financial regulation has been stepped up thanks to a large extent to international coordination.” But financial risks are on the up again. Debt has reached “unprecedented highs”, she says, particularly in the public sector and for corporate debt. China is still having to deal with inflation (and, in the opinion of other observers, with an overload of bad bank det). And generally, the march of less-regulated shadow banking is causing him some worry.

Trade worries? What trade worries?

It’s at this point that my research took me in an unexpected direction. Who better to advise on the state of the fiscal and trade economy than Mohamed El-Erian, the chief economic adviser at Allianz who once co-piloted the astoundingly successful PIMCO bond fund portfolios with Bill Gross? A man who eats, sleeps and dreams about fiscal balances and suchlike?

Was Mr El-Erian concerned about the impact of Trump’s fiscal loosening on the US economy? Not as far as could be seen from a bullish interview he gave to CNBC last month at the Barclays Asia Forum. The IMF was wrong to have downgraded its 2019 forecast from 2.7% to 2.5%, he said – and he wasn’t shy about why.

“We’ve got three drivers of domestic demand all hitting at the same time: government spending — which is going to get stronger not weaker — household spending, and business investment,” he told CNBC. And 3% growth for both 2018 and 2019 was definitely in the frame, he added.

If there was a problem, he explained, it would probably come from outside the US’s booming economy, and not from within it. The concern, he said, was about possible “spillbacks”, either through America’s own actions in triggering a full-scale trade war (as distinct from what he termed “trade skirmishes”), or because of “major disruptions in Europe and in the emerging world.”

One thing we forecast correctly was that oil prices would prove to be a wild card, with no apparent correlation to demand but with plenty to supply disruptions

There was, he conceded, a 25% chance of a fullscale trade war developing. Wasn’t this on the low side, he was asked? Well, China remained a problem during 2019, he said, but he was still bullish about the way it would go.

“My assumption has been that China will understand what Korea, Mexico, Canada and the EU have [already] understood,” he told CNBC. “If the U.S. decides to focus on sticks and not carrots, and if the U.S. is willing to incur the cost of trade skirmishes, it wins. It wins every single bilateral trade conflict.”

Trumpian logic, then. Divide and rule. But is he correct? We must wait and see. I haven’t noticed the EU going soft on trade yet, have you?

Oil, still a random walk

One thing we forecast correctly was that oil prices would prove to be a wild card, with no apparent correlation to demand but with plenty to supply disruptions. Last January’s $64 per barrel for Brent crude soared to $86 in October as Trump’s Iran sanctions were confirmed by the White House, but they were back down to their mid-year $70 level by the time November hove into view.

So what’s new? Firstly, that you’d have to go back to 2014 or 2015 to see any kind of a price decline happening in the final quarter of the year – normally the incoming winter in the northern hemisphere settles those kinds of doubts. This year’s fluctuations have been significantly down to Trump’s actions toward Iran and toward Saudi Arabia, which had signalled a tightening of its oil exports as the year draws to an end.

One oddity of the petroleum industry is that the industry keeps its production in the ground until just before it’s needed. Only about 60 days’ worth of crude oil consumption is usually being stored at any one time, either in land-based tanks or bunkers or in floating tankers. (Why? Could you imagine what a logistical nightmare it would be to do it any other way?) And that means that short-term disruptions can have massive shock effects. The world would be starting to panic if even a quarter of those aboveground reserves were to get used up.

That’s why every little political spat, every trade threat and every minor gunboat incident has huge price implications. As I write, four countries with some of the largest oil reserves in the world – Saudi Arabia, Iran, Russia and most importantly Venezuela – are in the political crosshairs. It’s a good job that, in oil at least, the balance between supply and demand is generally run by the markets and not by the politicians.

QE and the bank rate

Probably the most important factor in the new year is also the most obscure and unfashionable. President Trump’s central bank governor, aka Fed chairman Jay Powell, isn’t the only bank supremo in the world who’s been winding back on the colossal issuance of quantitative easing that’s been transforming the investment economy during the last ten years or so. And his programme of carefully-staged bank rate rises is in step with much of the developed world. Even though it annoys the heck out of his boss, President Trump, who seems to see higher rates as a betrayal. You can’t please everybody.

In Europe, in the UK, and maybe even in Japan, central banks have been taking steps to slow the amount of new ‘unfunded’ liquidity that they’re pouring into the developed economies of the world. While simultaneously raising bank rates, inch by cautious inch, in an attempt to tighten the reins of their respective economies and to reinstate the sense of a need for responsible lending.

There’s no doubting that the world’s recovery from the 2008 crisis would have been much slower without the surge of new investment capital that QE provided. But ts period of usefulness passed a couple of years ago, and the regrowth of inflationary pressures in western nations ought to be sounding a time’s up message.

One word of caution, though. In China, the swamping of consumer and property markets with easy credit has been quite rightly ended, although there are those who think that Beijing may reopen the money taps if GDP growth drops below 6% next year.

So much to play for

You won’t have missed all the doom-saying this year. The great rotation from fixed interest into equities is moving along, and soon there might be attractive opportunities in bonds again. Or, alternatively, the 25 year equity bull run is moving into silly-money territory. The global industrial cycle is moving past its peak, and it’s all going to be downhill from here for a while.

The US President will have to back down in the face of a Democrat-controlled House, unless of course he decides to invoke national security and rule by decree

The European bloc project is either gasping for breath or else steeling itself for its next forward leap. The US President will have to back down in the face of a Democrat-controlled House, unless of course he decides to invoke national security and rule by decree.

It’s becoming clear that business and economics aren’t in the driving seat as much as we usually suppose – instead, the politicians and the tacticians and even (sometimes) the generals are in charge of market trends

Japan continues to struggle for growth, or sometimes even for a role. China and Russia may continue their rapprochement, to the general concern of many. And Britain, of course, may declare a People’s Vote which cancels Article 50…..

Or not. It’s becoming clear that business and economics aren’t in the driving seat as much as we usually suppose – instead, the politicians and the tacticians and even (sometimes) the generals are in charge of market trends. It was ever thus, of course. So welcome to 2019, and good luck to all who sail in her.

Your guide to the 2019 hotspots

21 January: Davos World Economic Forum, Switzerland
February to June: Parliamentary elections in Dominica, Panama, Guatemala, Haiti.
February: Presidential elections in El Salvador
29 March: UK provisionally scheduled to leave EU (subject to extensions)
April/May: India general election
May and November (latest): Australian senate and parliamentary elections
23-26 May: European Parliament election
22 July: NATO annual summit, Brussels
23 September: NATO fall summit, California
October: Presidential elections in Argentina and Uruguay
20 October: Greece general election
21 October: Canada federal elections
November: Polish general election
By 5 November: Israel general election

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