• The global economy continues to fall short of expectations. GDP growth in high-income economies remains sluggish, including in the US and the UK – the two countries where the upturn is the strongest. In most emerging markets, output is stumbling, most notably in Brazil and Russia.
  • Yet, the financial markets continue to defy gravity against a backdrop of ever-lower volatility. Despite her concerns about the overvaluation of small companies, biotech and social media, the Fed chair, Janet Yellen, however, tells us not to worry about the broader market, where valuation of shares “remains within historical norms”. This may be complacent. Let’s not forget Alan Greenspan’s assertion in May 2005 that home prices were not inflated; or Ben Bernanke’s assurance in March 2007 that problems in the subprime mortgage market were contained. Beware the “illusion of control” and an unquestioning belief in the infallibility of central bankers.
  • At last, the British economy has just become larger than it was 6 years ago, when the financial crisis started. The recovery has been the weakest on record, with an unusual combination of strong job growth and slow GDP growth. The BoE characterizes this low productivity as a “puzzle” since there is no definite explanation for it. Household consumption remains caught in the vortex of falling real wages; but unless productivity improves, the BoE will have to raise interest rates sooner than expected to prevent a rise in inflation.
  • A similar conundrum, in which the job market fares better than the economy, prevails in the US, where the rise in employment has exceeded the forecasts of most policy-makers and economists, while GDP has done the opposite. This widening divergence between jobs and growth is a particular feature of the current “half-baked” recovery. Like in the UK, explanations oscillate between cyclical (therefore benign) and structural reasons (more worrying). If it proves to be the latter (still an “if”), these structural headwinds would damage the nascent recovery by hitting business and consumer confidence alike.
  • Fall-out from Espirito Santo – a Portuguese bank with a “Spaghetti bowl” of issues difficult to disentangle – is for the moment contained. But there are surely similar cases to come, as persistently low economic growth and inflation in the Eurozone expose underlying financial vulnerabilities in the banking system.
  • Chinese official GDP numbers continue to confound expectations, with growth in Q2 meeting the 7.5% target. Data from the China Beige Book (a private and independent survey of 2,200 Chinese firms) tell a different story – that of a deepening and broad-based slowdown. Weakness in both capital expenditure and loan demand is hard to reconcile with the official GDP growth numbers, and suggests that the deceleration may be bumpier than many expect.
  • The point above raises the issue of how pertinent macro-economic indicators really are. We take most of them at face value and base our investment decisions and asset allocation on what GDP, inflation, unemployment, trade numbers and many others tell us, but the truth is: they can be very misleading. Leading indicators can be “massaged” (like GDP in China) or simply mislead (like trade numbers, still calculated on the absurd assumption that each product has a single country of origin). Big data is about to change all that, replacing “one-size-fits-all” numbers with bespoke leading indicators, capable of providing an accurate picture of the dynamic of local conditions.
  • In June, Japanese industrial production contracted 3.3% from the previous month, reflecting (1) a slump in consumer spending after the sales tax-hike of April and (2) a failure of exports to pick up despite the 18% depreciation of the yen in 2013. With the twin-engines of consumption and exports sputtering, downside risks to Abenomics are on the increase.
  • Brazil’s performance in the World Cup mirror imaged its economy, whose growth forecast has just been sharply downgraded, from around 2% to just above 1%, while inflation is rising towards 7%. With hindsight, the USD14bn spent to host the event would have been better invested elsewhere. This might explain why there are only three bidders for the 2022 Olympic Winter Games: in the absence of a feel-good factor difficult to measure, returns on countries’ investment in sporting mega events tend to be dismal.
  • Until now, the rise in security crises around the world hasn’t affected the financial markets. Turmoil in Thailand, Ukraine and the Middle East, rising tensions in Asia and sub-Sahara Africa, and significant social unrest in several emerging markets were discounted. The truth, however, is that the world currently suffers from a “global order deficit”, which is beginning to affect growth in the real economy. This happens not through traditional supply side shocks (such as energy supply crises), but rather through “demand withdrawal”. Loss of confidence is indeed starting to have an effect on flaws of trade and investment.
  • Barely a day passes without a bank being fined by the regulators or the courts, so much so that fines have now become an operating cost of the banking business. This year, US regulators have already imposed fines totaling USD35bn. BNP Paribas will soon pay USD8.9bn and be excluded from $ clearing for a year on its oil and gas business – a sizeable “capital” punishment! The conjunction of unpredictable regulatory and geopolitical risks adds an extra layer of opacity to the way in which banks operate. It also makes valuing banks a quasi-impossible task.
  • All around the world, the marginal cost of water is increasing. Water quality and water scarcity now pose a threat to companies across all industries, ranging from agri-business to power generation, from petrochemicals to tech (for which water is the big elephant in the room, in the words of a Google executive). Since 2011, companies worldwide have spent USD84bn “to conserve, manage or obtain” water. The conflation of a surging global population, rising middle class and climate change suggests that this figure will increase substantially over the next few years. Soon, all companies will be required to report on how they tackle the issue of water scarcity and how it will affect their long-term returns.
  • The major “must-watch” issues that will affect investors’ and decision-makers’ sentiments over the next month(s) are – in no particular order: (1) the slowdown – or burst – in Chinese property prices; (2) signals about an earlier rise than expected of interest rates in the US and the UK; (3) deflationary pressure in the Eurozone; (4) possible widening of Eurozone bond spreads; (5) US currency risk in EM corporate debt; (6) global geo-political tensions. For insights and real-time analysis on any of these, please contact us.
print