Archive for the ‘Global Economy’ Category

French Elections and Les Autres Stuff

April 24, 2017

Summary:  April has turned out to be an active month on the geopolitical front and in markets.  The last week of the month is not going to be an exception as France, the United States, Italy, North Korea and Venezuela are all likely to remain in the headlines.  The net impact is that while the news out of France was good for markets and the global economy, there are significant risks with other developments which dampen investor expectations. The U.S., in particular, is likely to see considerable negative political press as the Trump administration seeks to advance a continuing budget resolution through the Congress, but positive economic data probably will continue to demonstrate economic expansion, evidenced by strong earnings.  The VIX ended last week at 14.63 and the 10-year Treasury was 2.237%; look to the VIX to go lower initially, but climb again through the week and for the 10-year Treasury yield to remain roughly where it is as risk mounts in the U.S. and North Korea.

France – Round Two!: The first round of the French presidential elections has already produced plenty of corny titles for articles, with one of the worst being, “Le Pen is Not Mightier than the Macron”. No doubt that as France heads toward the May 7th second round vote between far-right candidate Marine Le Pen and centrist Emmanuel Macron, more bad titles will follow. However, the outcome, which is currently projected with Marcon at 23.7% of the vote and Le Pen at 21.7%, is positive for markets.  French opinion polls proved relatively accurate and currently indicate that Macron should handily defeat Le Pen in the next round, roughly 60% to 40%.  We think it could be a little closer, but Marcon should winThe euro has already rallied on the news.

Projected Results April 23, 2017
Macron  (Le Mache!)          23.9%
Le Pen  (National Front)    21.4%
Fillon  (Republicans)          19.9%
Melenchon  (LFI)                19.6%
Hamon (Socialists)               6.3%
Dupont-Aignan (DLF)         4.7%
Others                                     4.2%
Total                                   100.0%

A few points are worth noting for what comes next. Round one was a victory for the “outsiders”. Although the cases can be made that both Le Pen and Macron have been part of the “system” for a long time, what is striking is that Le Pen’s National Front and Macron’s En Marche! (established only late last year) have never been in power.  The two major blocs, represented by the center-right (through various parties, the latest being the Republicans) and Socialists have dominated Fifth Republic politics since 1958.  This is the first presidential contest in which one of the major parties did not place a candidate, reflecting a deep disenchantment with the traditional parties and a willingness to embrace outsiders. Benoit Hamon, the Socialist candidate, is projected to win only 6.5%.

The new political alignment that will be played out in the remaining two weeks of the election will stress Le Pen’s emphasis on the nation-state, strong defense of the borders (from both terrorists and immigrants), protectionism in trade, a return to the franc, a referendum on leaving the European Union, closer relations with Russia, and an extension of the state into the economy and society (more benefits and a roll-back of labor reforms undertaken by the outgoing Hollande government).  Le Pen will also seek to paint Macron as part of the establishment, especially after he has received the endorsements of Fillon and Hamon.

This will be in contrast to Macron’s call to make the European Union work better, overhaul state finances, reduce the social welfare state, maintain the autonomy of the central bank, support NATO and push more labor market deregulation. Indeed, Macron’s plans call for the reduction of 120,000 public sector jobs and 60 billion euros in spending.

One last item on the French front is that the worst-case scenario was averted — a second round between Le Pen and far left Jean-Luc Melenchon, who finished fourth and had enjoyed a late surge in the polls.  French voters now have to endure two more weeks of electioneering as the two candidates left standing battle for their attention.  We remain true to our first call — Macron will be the next president of France. The first round result is good for markets and the euro.

Les autres stuff…
While the French elections dogged markets last week, they are likely to recede as a risk factor. Indeed, we would venture that next week the drama will return to the U.S., where the Trump administration is pushing Congress to avoid a government shutdown on April 28, while pushing the legislative body to move quickly on another attempt to pass a repeal bill of the Affordable Care Act (ACA).  President Trump also indicated that he plans to unveil his plan to overhaul the tax code.

The funding bill is probably the most significant story, as in addition to asking for funding to keep the federal government running, the Trump administration is asking for $3 billion for border security and the construction of a border wall and an additional $30 billion for defense spending. These items incur Democratic opposition and generate mixed feelings within the Republican camp.

There is considerable pressure on President Trump to have something to show on the legislative front for his first 100 days. The last effort to repeal and replace the ACA failed. However, presidencies are not determined by the first 100 days, but through their duration.  The outcome will probably be another extension on funding the government as Congress, especially the Republicans, do not want to be blamed for shutting the government down.  We would also expect that between tax reform and a new effort on healthcare, the Trump administration will pull something through the Congressional mire over the next several months. Funds for the construction of the border wall may have to wait.

Investors should also be aware that North Korea has not left the stage. North Korea usually follows significant dates with an ongoing stream of military power demonstrations. On Tuesday, North Korea celebrates the founding anniversary of its military. South Korean officials are warning that Kim Jung-un could opt to conduct a new nuclear test or launch its maiden test of an ICBM.  Indeed, U.S. commercial satellite images indicate increased military activity around North Korea’s nuclear test site, while Kim has indicated that the country’s preparation for an ICBM launch is in its “final stage”.

North Korea’s actions are closely tied to one thing — regime survival. While the rest of the world regards North Korea’s actions as highly provocative and the Trump administration has noted that strategic patience is over, much of the Kim regime’s actions are to probe how far it can go and hope to extract something from its actions. At the same time, the North is well aware that any efforts, like the U.S. strike in Syria, would lead it to threaten to turn “Seoul into a sea of flames” or strike out at Japan.  This makes striking North Korea a very risky venture.

We suspect that China has leveled considerable pressure on North Korea.  There have been reports that gasoline, which is imported from China, is in short supply in the North. China does not want the U.S. to strike at North Korea — an action that could unleash war on its border and radically change the geopolitical structure of international relations in Northeast Asia. Look for more North Korean drama, but the Kim regime’s actions may a little more limited. Ultimately, we suspect that North Korea will see regime change, much along the lines of what happened in Romania in 1989, but with considerable Chinese help. For those who do not remember, the near-totalitarian regime of Nicolae Ceaușescu ended when the aging despot and his power-hungry wife, Elena, were ousted from power and then lined up in front of a firing squad on Christmas Day.

And what about Italy?: Now that fears over a Le Pen victory are receding, Italy takes its place as our biggest risk factor in Europe. The economy is likely to struggle to get to 1.0% real GDP this year, while unemployment stood at 11.5% in February.  The ruling Democratic Party-led coalition remains in control of the government for now, but it has fractured with a number of more leftist members setting up their own anti-austerity party.  At the same time, the populist and anti-EU Five Star Movement has led in opinion polls, which could pose big problems for the rest of Europe should that party and other anti-EU parties gain an outright majority in parliament.

Italy Economic Data

2014 2015 2016 2017 2018
Real GDP % 0.5 0.8 0.9 0.9 1.0
Inflation % 0.2 0.1 -0.1 0.8 1.0
Unemployment rate % 12.6 11.9 11.5 11.0 10.7
Gen. govt. fin. Bal/GDP % -3.0 -2.6 -2.4 -2.4 -2.4
Gen. Govt. debt/GDP %

(Maastricht definition)

131.8 132.4 132.1 132.2 132.0

Source: http://www.oecd.org/eco/outlook/economic-forecast-summary-italy-oecd-economic-outlook-november-2016.pdf.

The Five Star Movement favors ditching the euro and returning to the lira, as well as cutting taxes and raising social benefits.  Considering the weak condition of Italian banks, the political overhang is not good news for their business or the general economy.

On April 21 Fitch cut Italy’s sovereign ratings from BBB+ to BBB, with a stable outlook. The rating agency said the downgrade was due to huge debts (equal to 132.6% of GDP), a stagnant economy and divided politics.  At the same time, Fitch’s outlook for Italy’s banking sector was negative, reflecting the high level of non-performing loans and weak profitability. Three banks – Monte dei Paschi di Siena (one of the largest in the country), Banca Popolare di Vicenza and Veneto Banca – are seeking public intervention to keep them afloat. The Italian banking sector as a whole is weighed down by some 203 billion euros ($US 217.68 billion) of bad loans. Fitch said that ahead of next year’s election, the “risks of weak or unstable government have increased, as has the possibility of populist and eurosceptic parties influencing policy.”

Fitch is not alone in having concern over Italy’s creditworthiness. Canadian rating agency DBRS cut Italy’s sovereign rating in January 2017 due to the same problems highlighted by Fitch. Moody’s Investors Service also has the country on a negative outlook, meaning a downgrade looms. No election is officially scheduled, but Italy is in its third government since the last election and speculation is growing that the country could go to the polls before 2018.

Last, but hardly least is Venezuela.  The country’s economy is in free-fall as are its politics. While basic staples for daily life are difficult to obtain, law and order appears to be breaking down. It could well be that the Maduro regime’s socialist experiment is reaching into its end-game — if it cannot control the streets with a combination of police, thugs and the military, the country is heading into civil war.  This means that the state-owned oil company, PDVSA, long expected to default on its debt, could finally do so.

Venezuela Economic Data

Economic Snapshot 2016 2017 2018
Real GDP % -18.0 -7.4 -4.1
Consumer Prices 254.9 720.5 2,068.5
Current Account bal./GDP % -2.4 -3.3 -2.1
Unemployment % 21.2 25.3 28.2

Source: International Monetary Fund

We are also concerned about the impact of a failed state in Venezuela on the neighborhood, including Colombia, Guyana, Suriname, the Dutch islands of Aruba, Bonaire and Curacao, and Trinidad and Tobago.  A failed state could see a surge in Venezuelans fleeing conflict, greater illicit flows of money and arms throughout the Caribbean and an upsurge in drug trafficking through Venezuela and into the Caribbean, pushing cocaine to northern markets in North America and Europe. This could complicate economic policymaking and debt management for some of these countries.

Dr. Scott B. MacDonald
The Global Economic Doctor

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Italy – Beyond The ECB’s Fairy Dust

December 5, 2016

On Sunday, December 4th, Italian voters went to the polls and strongly rejected the proposed constitutional reforms advanced by the government of Prime Minister Matteo Renzi by a margin of 59.41% to 40.59%. In the aftermath of the defeat Renzi resigned, potentially setting the stage for a new crisis in Europe.

The problem is that Italy’s banks are weak and need capital infusions (which they are supposed to get from either bail-ins from equity and bondholders or capital markets). Economic growth is weak, expected to be 0.8% this year after a flaccid 0.6% last year (according to the OECD). Italy’s public sector debt is also an issue as it stands at euro 2.33 trillion, equal to 135% of GDP and access to markets to critical for it to be financed. To keep the Italian ship of finance afloat the government and its banks are at the mercy of international markets. The No vote outcome is not a confidence-building action.

Renzi’s proposed reforms sought to streamline Italy’s political system so his Democratic Party-led government could push through a major economic reform package. Along these lines, the referendum would have allowed a restructuring of the government – reducing the number of senators and limiting the senate’s power relative to the lower house of parliament. It would have also curtailed the political power of Italy’s regions and provided the largest party in the lower house after elections with an additional bloc of seats to guarantee a solid majority and stop the country’s rotation of governments. Italy has had over 60 governments since the end of the Second World War. Renzi’s government lasted longer than most – two and a half years.

No one disputes that the Italian economy needs reform. Indeed, The Independent’s Alexandra Sims (December 5, 2016) noted: “Few dispute that economic reforms are necessary: the Italian economy has essentially gone nowhere for 16 years and unemployment is high at 11.5 per cent. With the exception of Greece, Italy has had the worst performance of any eurozone country since the 2008 financial crisis.” Her comments are not reassuring for markets.

Post-referendum Italy sits in uncertain territory. Renzi has resigned and the country’s head of state, President Sergio Mattarella, can accept the Prime Minister’s resignation (which is likely) and ask other parties to form a new coalition government or set a date for new elections. The latter course implies that the President appoints an interim administration. Considering it is December, the likelihood is that any new elections would take place in January, but more likely in February of March. This leaves the all-important post of finance minister open at a time when Italian banks are struggling with large levels of non-performing loans and capitalization issues. Under the circumstances, it will difficult for Italian banks to raise capital and sends the wrong signal to international debt and equity markets.

What further leaves global investors and economic policymakers with a degree of angst is the potential outcome of new elections. A new parliamentary vote could bring the Five Star Movement to power, which was strongly opposed to constitutional reform. The populist party was created by the comedian and internet populist Beppe Grillo, whose slogan is Vaffa! (fuck off) to more or less everything, including the euro.

Grillo wants another referendum to pull Italy out of the eurozone, which he sees as an important step in breaking the so-called German mercantilist hold over Italy’s economy. He also favors an end to EU-mandated government spending limits, income guarantees for all citizens, and possibly defaulting on the country’s debt (which would reduce the burden on the country).

In recent opinion polls, the Five Star Movement, at 28%, is just behind Renzi’s Democratic Party (32%). However, the undisputed winner of December 4th is Grillo and it remains to be seen if he can capitalize on the victory. He still has a lot of work to do if he wants to gain enough votes to be the leading force in forming a new government. Nonetheless, the No victory reinforces the populist tide in the West, which fits in with the Brexit vote and Donald Trump’s victory in the United States. It is no shocker that Grillo announced that he likes Trump.

Italy’s vote adds considerable pressure on Chancellor Angela Merkel and Germany. Berlin is already dealing with Brexit, a looming change of government in France (most likely with a move to the right), and elections in the Netherlands (with its own populist movement under Geert Wilders likely to gain ground or have a say in the government). At the same time, in Germany the anti-immigrant right has gained ground in local elections and the Chancellor faces a new election test later in 2017. Turkey looms as a headache on the foreign policy front, with relations with Germany and the EU taking a downturn over the Erdogan government’s human rights violations in the aftermath of the July coup attempt. The Turkish president has indicated that he might be willing to loosen up control over refugees in his country, which could put pressure on the EU’s southern front again. It would certainly become an election hot button in German elections.

One last item on Berlin’s and Brussels’ foreign policy agenda is that Algeria’s leader for 17 years is quite ill. His departure could open the door to a crisis in that country, including the strong possibility of a renewed civil war between the military and Islamists. This could complicate energy security for France and Italy as well as open a new front on the migration issue if a new civil war broke out in North Africa. For anyone looking France and Italy are due north of Algeria.

The Italian referendum has come and gone. Renzi has done the same, unseated by rising populist forces, much like David Cameron in the UK. The No victory clearly gives a boost to populist forces throughout Europe and trumps the victory of the green candidate over the far right candidate in Austria’s presidential election this weekend. Italy represents the potential for a major crisis as the country is too big to fail: if there are problems in its ability to refinance debt or to keep its banks afloat, it will take more than what journalist Ambrose Evans-Pritchard has called “the European Central Bank’s fairy dust of quantitative easing” to save the day. It is doubtful the same political will could be raised to “save” Italy the way Greece, Portugal and Ireland were saved. Equally important, it is questionable if Italy would want to go through a Greek-style structural adjustment program; rather an exit from the eurozone would probably be preferable. Hopefully Italy’s No vote does not slide into a new European crisis, but it clearly raises the potential for higher volatility in markets and casts a very dark cloud over the country’s finances.

Dr. Scott B. MacDonald
The Global Economic Doctor

The Election of 2016 and Its Implications

November 9, 2016

Asian markets are tumbling.

The U.S. presidential election of 2016 was decidedly one for the history books.  Although 2016 is certainly not 1860, which led to the U.S. Civil War, it was a dirty, brutal and personalized campaign that tapped into the angst of a voting public angry with widening socio-economic disparities, sub-par economic growth and a dysfunctional Washington. 

Why did Donald Trump, the Republican candidate, win?

1. Public frustration with Washington’s corruption and its seeming ineffectiveness in addressing the country’s major problems.  Clinton was clearly seen as more of a Washington insider than Trump, who has never held an elected political office before.

2. The ongoing whiff of corruption that surrounded Democratic contender Hillary Clinton (not that Trump is a saint), related to her emails and the finances of the Clinton Foundation. Past Clinton “scandals” did not help.

3. The intervention of the FBI and WikiLeaks into the electoral process via disclosing embarrassing emails, which only maintained attention on Clinton’s email scandal. Furthermore, having her name associated with former Congressman Anthony Weiner (with his sexting scandal) obviously did not help Clinton in the last days of the campaign.

4. The growing divisions in U.S. society, especially along an urban-rural divide. One thing that gave Trump an appeal to many living in rural areas was that he appeared to listen to them and mocked the political correctness that many found stifling.   

5. The Democrats underestimated Trump.  As General Colin Powell stated: “No battle plan survives contact with the enemy.”  This was certainly the case of Clinton with Trump.

6. The appeal of a strongman leader. The last reflects a major paradigm change in global politics — the rise of strongman leaders, who offer simple solutions to complex problems. Considering the scope of U.S. problems and the challenging nature of international relations, Trump’s “tough guy” persona was a point of attraction to some voters. There are certainly echoes of this in other countries.

What next?  A Trump victory was not expected by global markets or political leaders in many other countries (many of whom have been critical of the Republican leader now president-elect).  The next week is likely to see an unwinding of the “Clinton trade” (risk on) in global debt and equity markets, downward pressure on oil prices, and a further pounding of the Mexican peso. 

Investors find a Trump victory unsettling from the standpoint that during the campaign he was anti-trade, opened up the possibility of negotiating the U.S. debt, and wants to overhaul of the U.S. alliance system around the world (such as with NATO). The last time the U.S. embraced protectionist trade policies in a major fashion was the 1930s, in the form of the Smoot-Hawley Tariffs. U.S. protectionism was a major cause of the deepening of the global Depression. The extent of the market downdraft will depend on Trump’s acceptance speech, his comments on policy matters before he gets into the White House and who he appoints to his cabinet. 

The major challenge in the days ahead will be to find a way to reunite the country after the election.  In many regards, this may be an impossible process, considering the bad blood between Democrats and Republicans since 2008.  A dangerous development in U.S. politics is the destruction of the political center – the area where compromise and dialogue are reached and policies can move forward. 

The U.S. sovereign ratings are Aaa/AA+/AAA, with a stable outlook.  The policy format of the incoming Trump administration will no doubt be carefully examined, in particular on its debt management and trade policies. 

For American politics to become more workable, President Trump will have to demonstrate an ability to lead, but also work within a constitutional system that he might find constraining.  As he moves to “drain the swamp”, Trump will have to make the transition from candidate to elected official and from someone who is critical of Congress to a leader who will have to find the means to work with it.  For their part, both the Republican Party (which held on to both the Congress and Senate) and Democratic Party will have to adjust to a President who has not emerged from their ranks.  A new Washington looms on the horizon – hopefully it works.

Dr. Scott B. MacDonald
The Global Economic Doctor

The Global Economic Doctor

August 2, 2016

Global Economic Doctor_thumb

 

 

The Global Economic Doctor– Click link to read the full edition.

 

 

Welcome to the latest edition of The Global Economic Doctor.  This week, Dr. Scott B. MacDonald writes:

Lead Us Not into Temptation

“Lead us not into temptation. Just tell us where it is; we’ll find it.”
 — Sam Levenson, American humorist

Summary: High risk assets have been in demand.  It has been so tempting. Everything from high yield and emerging market debt to leveraged loans have been sucked up by investors driven to looking for yield.  Even investment grade debt has been in demand.  Lipper US Fund Flows noted that Corporate US Investment Grade bonds pulled in $1.475 billion net inflow for the week ended July 27th and it is estimated the new supply for August could be $70-$80 billion. As advanced economy central banks are still following the mantra of “lower for longer” in terms of rates, liquidity has trumped Brexit, tremors over Italian banks, and even bad economic data. The last  was best exemplified by Q2 2016 real GDP, which was expected to be over 2.0% and came in at disappointing 1.21%; the VIX (Volatility Index) ended last Friday at a low of 11.87 (and has since nudged up to around 13.00).   But for anyone watching, markets are frothy, having hit highs, to a backdrop of flaccid corporate earnings, low levels of corporate capital expenditures, anemic economic growth and an uncertain political situation in the fall.  And that is just in the United States!  (Europe has a cornucopia of political and economic risk and Asia’s two major economies, China and Japan, are struggling with their own set of issues.) Moreover, the US central bank increasingly seems to have lost its way.  This was reflected by Jeffrey Gundlach, CEO of DoubleLine Capital (which manages $100 billion in assets), who stated at the end of July: “The Fed is out to lunch. Does the Fed look at what’s going on in the economy?  It is unbelievable.” Gundlach is not alone in questioning Federal Reserve policy, which is a serious development.  He is recommending gold (which he expects to hit $1,400) and gold mining companies. Considering growing concerns about the potential for a US recession and political uncertainty surrounding the November presidential elections and their aftermath, it is critical that the central bank leadership is able to project a degree of confidence. While Chair Janet Yellen is a competent economist, one has to wonder about her ability to steer through the storms that loom ahead. And the storms are coming.  We expect that August is likely to see the risk-on trade in markets continue a little longer, but the fall could well be setting up to be filled with volatility and downward pressure. Too much temptation can be a bad thing.

 

 

The Global Economic Doctor

July 12, 2016

Global Economic Doctor_thumb

 

 

The Global Economic Doctor– Click link to read the full edition.

 

 

Welcome to the latest edition of The Global Economic Doctor.  This week, Dr. Scott B. MacDonald writes:

Life During Wartime

This ain’t no party, this ain’t no disco,
This ain’t no fooling around
No time for dancing, or lovey dovey,
I ain’t got time for that now
— Talking Heads, Life During Wartime.

Summary:

The narrative for the global economy is going to be dominated by political risk factors through the rest of 2016 and well into 2017. Brexit was certainly a factor in the US Federal Reserve’s decision not to raise rates in June and July; the massive injection of uncertainty into markets in the aftermath of the British vote will pressure the US central bank not to raise rates again in 2016. There will be further pressure not to raise rates from the uncertainty surrounding the US presidential election in November. Other headwinds to global growth include what could be a worsening bank crisis in Italy, a recession in the UK and possibly other countries in Europe. Asia, the Middle East and Latin America have their own set of political risk factors, which add stress to markets. Moreover, Q2 2016 US corporate earnings, which start this week with Alcoa, are not likely to lift markets on a sustained or meaningful basis. The consensus view is that the S&P 500 Index companies are expected to see another drop; this time a 5.1% decline year-on-year.  This is better than Q1’s 6.8% decline in profitability. The thing to watch with earnings is the outlook for the rest of the year.  Markets will be keying in on what CEOs have to say about the business environment for the second half of 2016. Our view is that they will be saying what they have been stating over the last several quarters – it is difficult to forecast due to weak global growth, slowness in wage expansion in the US, and political uncertainty. The exclamation point on all of this was the tragic, racially-charged violence that very recently marked the US in Minnesota, Louisiana and Texas. It is, therefore, easy to look at the world through the lens of the Talking Heads song, some of which is quoted above. The path forward is through a fog of uncertainty and risk. If political and economic conditions deteriorate further, the issue facing investors is increasingly going to be not one of a getting a higher rate of return, but preservation of capital. Cash remains attractive and gold, gold stocks, utilities and US Treasuries are likely to have a good run as we sift through the variables in challenging markets and investors are driven to safe harbors.