Blog: You, us, everyone

Economic trends: Can you read them when you’re upside down? It’s hard, but here are few pieces that might help solve the puzzle.

The economic status of Europe

The current business climate in the eurozone is highly perplexing. European domestic consumption is showing signs of a sustainable recovery, but it isn’t translating into an increase in the overall European growth rate. Obviously this can partly be explained by lower energy prices which have increased the average purchasing power of every European household by around € 1,200. In spite of this stimulation and the generally positive environment, the capex cycle of European companies has stagnated. One contributing factor could be the ongoing absence of long-term economic visibility. Normally company management would take some action, but at the moment they’re not. The absence of any clear guidelines and a lack of understanding regarding Europe’s economic policy, as well as the now year-long refugee influx, which has recently reached new all-time heights in many eurozone countries, makes deciding on long-term issues just educated guesswork. We envisage the recent migrant developments will fundamentally change the way the euro-zone functions as the immigration crisis and its far reaching ramifications will be harder to solve than the past Greek financial crisis.

Nevertheless, the overall situation in Europe is not totally lackluster; any changes will be slow and manageable. Therefore the present economic dynamics should remain in place for quite some time and we expect outperformance in sectors such as the healthcare, financials (retail banking should perform well), as well as subsectors which are strongly linked to domestic consumption. 

Inflation: The present inflation rate is well below central bankers’ desired level. There are a number of reasons for this: a) private consumption is hard to turn on as the average employee has not enjoyed a pay rise, and b) QE has a negative mental impact on consumers (what is the purpose of stimulating the economy when there is no visible and measureable result for them). The moral of the story is that private consumers have changed their attitude, especially European consumers, who are swinging less with the market.

The broader top-level picture is obviously different. European QE had a highly beneficial impact during the most recent episode of the Greek financial crisis. The program can be seen as a market stabilizer. Given its success, although limited, one can expect that the European Central Bank (ECB) will amend the program in two directions: volume and length. Consequently interest rates will remain low for years to come; we expect the present low interest rate scenario in Europe to persist well into 2019/2020.

Consumers should heartily welcome this situation, but what’s the hidden message?  At the level of the stock market, this clear status quo will benefit investments in financials, building material, and industrial services and support companies.

USA

Outside Europe, the situation is more complex. The unemployment market in the US is key to any interest decision to be taken by the Fed. . The first rate hike is subject to today’s publication of the unemployment rate in the USA.

The current unemployment rate stands at 5.1 percent. Yet, when underemployed people [considered as underemployed are: a) people who are working part time for economic reasons, and b) these who haven’t searched actively for a new job] are accounted for, this statistical measure increases to 10.5 %. This together with the fact that the average pay is declining for about 20 % of the workforce [statistics show that the wage decline between 2009 and now is about 5.7 %], while the cost of living is increasing, should be a concern for the FED, local policymakers, regulators and private-sector leaders.

 Until now, the market has predicted that the first intervention would take place in September, but the market’s recent distress and subsequent financial fluxes show evidence that even in the United States investors don’t have visibility and are preferring to stay in cash instead of equities or bonds. Although a Fed intervention in September is possible, the unanswered question is: How much and when will the next one (interest rate hike) occurs? It seems to us that there’s little room for the Fed to maneuver at the moment and this is extremely worrying.             

An increase in the USD cost of capital will bring its own problems, including a) the future EPS of American companies, which are historically highly leveraged, will diminish, ultimately resulting in a lower capital expenditure by companies and a knock-on effect on job creation, b) USD investments, particularly investments in the New York stock exchange, will become less attractive, c) the volume of USD carry trades will decrease, and d) since there will be lower industrial activity, existing raw material resources will be developed in a more efficient manner, and the demand for oil and its subsequent products, will decrease. Consequently, oil producing countries such as Saudi Arabia, Venezuela, Iran, Mexico, and Brazil amongst others will be obliged to reduce their share of USD denominated assets. For these reasons, and although the attractiveness and predominance of the USD is not in question here, we expect the currency EUR/USD pair will move into the region of 1.18 to 1.20.

Emerging Market countries: 

The majority of governments across the world aspire to fulfill the same purpose, i.e. a better life for their citizens. Through the past centuries, Western civilizations have defined this, more or less precisely, as achieving a “ good living standard”. However, our definition is not the standard of all governments across the globe and more importantly, the approach to achieving this standard can differ substantially from one region to another. Yet each government believes that its solution is the best one and appropriate for its purpose. In developed regions, decisions need to immediately effect measureable change. The implementer seeks confirmation that the proposition and the decision making processes were correct. In emerging market countries, politicians, ministers, and central bankers tend more often than in developed markets to aim at solutions which address the big picture rather than a mediocre interim result. The fact that the “time” factor is often neutralized is understandable because they don’t have the pressure of Western philosophical and economic theorists such as Voltaire, Tocqueville, Montesquieu, Hayek, Friedman, Kaynes, etc. who emphasized the role of time in an economic system and heavily influenced their current generation of economists. So why should we expect them to act different than they do?

China:

The most recent market correction will not greatly affect consumption as only about 12% of the Chinese population has equity related (in quotes) investments. While the Chinese Communist Party (Politbüro), should approve some measures of support (especially verbal measures) to the broader economies, it should not be taken for granted that beyond that, it will fundamentally change its political and economic decision making process and cater particularly for one or another group of citizens, for instance UHNW and HNW individuals who have lost some of their wealth recently versus the very poor who have never enjoyed the benefits of money. The Politbüro will inevitably take a utilitarian approach and engineer its decisions to meet the requirements of the maximum number of its own citizens (decisions cater for 1.3 to 1.4 billion people). The timescale is not necessarily important, because they know that if they rush into matters, they will lose out on the support of millions of people which ultimately will jeopardize their own comfortable situation. So one can expect that the Chinese leaders will implement the right measures, (which will not be understood by developed market governments), to stabilize growth, but probably at a lower level than in the past. This will be fruitful to a vast majority of its own population and the neighboring regions.