Financial markets party as global trade wars begin

More people left poverty in the past 70 years than in the whole of history, thanks to the BabyBoomer-led economic SuperCycle.  World Bank and OECD data show that less than 10% of the world’s population now live below the extreme poverty line of $1.90/day, compared to 55% in 1950.

Globalisation has been a key element in enabling this progress, as countries and regions began to trade with each other.  But now global trade is starting to decline, as the chart from the authoritative Dutch World Trade Monitor shows:

  • After a good start to 2018, February saw trade fall 0.7% in February and 1.2% in March
  • The major slowdown was in Asia, particularly China, as its lending began to slow

And then on Friday, President Trump confirmed the opening of his long-planned trade wars:

  • He imposed 25% import tariffs on steel and 10% on aluminium from Canada, Mexico and the European Union
  • Similar tariffs were already in place on imports from China, Russia and other countries
  • America’s longest standing allies have since imposed their own sanctions in retaliation
  • The stage is now set for a developing global trade war as more countries join in

PRESIDENT TRUMP IS IMPLEMENTING THE POLICIES ON WHICH HE WAS ELECTED
None of this should have been a surprise, as it simply follows the agenda that President Trump set out in his Gettysburg speech just before the election.  His policy proposals then, which I featured here in depth in January 2017, were crystal clear about his objectives, as the slide shows:

  • Those policies marked in red are now being introduced
  • Only 2 of them – around China being a currency manipulator, and infrastructure – are still to be delivered
  • Yet companies, commentators and analysts have preferred to ignore the obvious

It was clear then, and is even clearer today, that Trump intends to abandon the policies followed by all post-War Republican and Democratic presidents including Eisenhower, Reagan and Clinton, and summarised in President Kennedy’s 1961 Inauguration Speech:

“To those old allies whose cultural and spiritual origins we share, we pledge the loyalty of faithful friends. United there is little we cannot do in a host of cooperative ventures. Divided there is little we can do–for we dare not meet a powerful challenge at odds and split asunder.”

As I noted after Trump’s own Inauguration Speech in January last year, he broke very explicitly with these policies:

“We assembled here today are issuing a new decree to be heard in every city in every foreign capital and in every hall of power. From this day forward, a new vision will govern our land. From this day forward, it’s going to be only America first, America first. Every decision on trade, on taxes, on immigration, on foreign affairs will be made to benefit American workers and American families.”

BAD NEWS HAS ALWAYS LED TO MORE STIMULUS IN THE PAST

Unsurprisingly, financial markets have chosen to ignore this rise in protectionism.  For them, bad news is always good news, as they expect the central banks to provide more stimulus via their money-printing policies.  As the left-hand chart shows of Prof Robert Shiller’s CAPE Index (Cyclically Adjusted Price/Earnings ratio) since 1881:

  • When Trump took office, the ratio was already at 28.5 – above the 1901 and 1966 peaks
  • Since then it has peaked at 33.3, above the 1929 peak
  • Only 2000 was higher at 44, when the end of the SuperCycle coincided with the Fed’s first liquidity programme to prevent any problems with the Y2K issue

The right-hand chart confirms the bubble nature of the rally:

  • It compares S&P 500 developments with the level of margin debt in the New York Stock Exchange
  • Until 1985, the Fed operated on the principle of “taking away the punchbowl as the party gets going
  • Since then, it has increasingly believed, as then Fed Chairman Ben Bernanke said in November 2010

“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

As a result, the S&P 500 has risen along with margin debt, which peaked at $659bn in January ($2018).

FINANCIAL MARKETS HAVE AN UNPLEASANT “SURPRISE” AHEAD AS CHINA SLOWS
It is therefore no great surprise that financial markets have continued to ignore developments in the real world.

Yet a decline in world trade, and the rise in protectionism, will inevitably produce Winners and Losers.  This will be quite different from the SuperCycle, when the rise of globalisation created “win-win opportunities” for countries and regions:

  • Essentially the deal was that consumers in richer countries got cheaper, well-made, products
  • People in poorer countries gained paid employment for the first time in history by making these products

History also suggests President Trump will be proved wrong with his March suggestion that:  “Trade wars are good and easy to win”.  Like all wars, they are easy to start and increasingly difficult to end.

So far, financial markets have ignored these uncomfortable facts.  They still believe that any bad news will lead to even more central bank stimulus, and a further rise in margin debt.

But as I noted last week, China – not the Fed – was in fact the major source of stimulus lending.  Now its lending bubble is history, the party in financial markets is inevitably entering its end-game.

The post Financial markets party as global trade wars begin appeared first on Chemicals & The Economy.

Consensus wisdom defies reality around the world

Wealth“Consensus wisdom” is a handy way of keeping up with events.  Nobody likes to be the person who says “I don’t know” when the boss asks a question about something important.  But unfortunately, “consensus wisdom” is often wrong, as Ipsos MORI confirm in their new ’Perils of Perception‘ survey,  As the authors note:

“It highlights how wrong the public across 40 countries are about key global issues and features of the population in their country.”

The chart above highlights one of the key results, which has major implications for companies and investors:

  It shows the actual percentage of wealth owned by the poorest 70% of the population in each country
  It also shows people’s perception of the percentage owned by this poorest 70%
  Only 3 countries have an accurate perception – the UK, Australia and Belgium
  India is the most inaccurate, with a 29 point gap between perception and actual
  Other major countries are nearly as bad – the US has a 21 point gap, Russia and China have a 17 point gap, Brazil and Germany have a 15 point gap

As Ipsos MORI note, the problem is that middle class people usually think:

The rest of the population is more like them, than they really are….On average, just 15% of total wealth is owned by the bottom 70% across these countries – but the average guess is almost twice that at 29%. (My emphasis)

“Some countries are incredibly inaccurate: Indians think this group owns 39% of the country’s wealth when actually only 10% do. The US is also significantly out: Americans think the bottom 70% own 28% of the country’s wealth, when it’s actually a quarter of that at 7%.

The Ipsos data helps to explain why companies and investors are often wildly over-optimistic when planning new investments.  This has become a major problem in the Emerging Markets (EMs), where many senior executives have assumed after visiting the chosen country that vast numbers of people are becoming “middle class”:

 They stay in good hotels, company-chosen for safety and service, with other guests from similar backgrounds
 Their local colleagues and partners are usually middle class and suffer from the over-optimism recorded by the polls
 They rarely visit areas where most people live, as colleagues and the hotel often tell them these are “too dangerous”

The past few years of high profile stimulus policies has only added to the confusion.

Most visitors were immediately impressed to find an expensive new airport when they landed.  They were similarly upbeat to find shopping malls filled with western luxury goods.  Naturally, they assumed this meant the economy was booming. And, of course, the major international banks were happy to supply them with imaginative and glossy reports on the country’s potential, in the hope of winning lucrative project work.

In reality, however, they have been fooled.  This appearance of “middle class living” was financed by debt, not wages:

 Average GDP/capita in the world is just $10k according to the IMF
 Wealthy G7 countries such as the US are at $56k, with the UK at $44k, Germany at $41k and France at $38k
 The EMs are very much poorer, and will take decades to catch up, even if they continue to do well
 Russia is the richest BRIC country at $9.2k, followed by Brazil at $8.7k, China at $8.1k and India at just $1600

The end result, unfortunately, is that many companies have effectively been wearing rose-tinted spectacles when making investment decisions.  They now face a very difficult time as these plants all start to come online.

President-elect Donald Trump has made it clear he will impose tariff barriers to force US manufacturers to reshore production back to the US.  In turn, many EMs will no doubt put up trade barriers to protect their own industry.  Supply chains will be hit from two angles at once.  Not only will imports from the EMs reduce, but exports to the EMs will also decline:

  Ford’s decision this week to abandon its planned $1.6bn Mexican investment is a clear sign of what is to come
  They were at least able to cancel. If it had already been built, it would probably now become a “white elephant”.

Unfortunately, this creates a further problem for “consensus wisdom”.  Much of what appeared to be true during the SuperCycle is no longer correct.  As I noted on Monday, economic criteria are no longer the key to future profitability.

The next 12 months are therefore likely to see more change than we have seen in the past 20 years.  Companies and investors that fail to quickly realign their perceptions with reality will risk finding life very difficult indeed.