Brexit, the US elections, and now the Italian vote have reframed the investment scenario, setting new challenges in an already hostile environment for yield starved investors. Economist and author, George Magnus, discusses his outlook for 2017 with Giada Vercelli.
Giada Vercelli: Following an eventful 2016, what is the risk backdrop that you envisage for 2017?
George Magnus: Ironically, the economic backdrop for markets doesn't look so bad in 2017. The US is ending the year on a high, china is stable and even the Euro Area looks to be picking up. Yet, the political turbulence on the world is if anything becoming more intense, and risky. So far, markets have been more than resilient but investors will need to pay close attention to political upset tensions and possibilities and the consequences they might have. These span such areas as US China relations, trade and currencies, and European elections.
GV: Are you more concerned about the implications of an unpredictable Trump foreign policy, the South China Sea, or the future of Europe?
GM: If Trump's foreign policy raised the risk of overt conflict with China or Russia, rather than heightened tensions, then all bets are off. Otherwise, I'd say the biggest known unknown that would change the environment beyond anyone's imagination would be something that triggered European disintegration.
GV: Is the Monetary Union history?
GM: I don't think it is, because the political glue that makes it stick together is harder than we think. At the same time I don't see it surviving as currently constituted. Greece cannot surely survive in the Euro as a ward of Europe as current policies are constituted. But the existential threat lies in Italy or France or even Holland - if and when people should ever be given the opportunity to elect parties that were determined to leave.
GV: Where is the next bubble coming from?
GM: The next bubble may be a more traditional inflation in goods and services, rather than in asset prices. That could be good for gold for example, and precious metals. But in the more conventional assets such as property and bonds and commodities, I think the bubble story is either tired or almost over. Equities interest me because they seem impervious to unsettling news. Keep an eye on them because if they keep rising against all the odds, this might be the next asset beneficiary.
GV: With interest rates on the rise in the US and the announced tapering of unorthodox measures by the ECB, is the global economy stable enough to deal with a higher cost of money?
GM: To be fair, the only place where interest rates look likely to rise is the US - and there the economy is doing ok and the new government want to rev it up a bit more. Rates aren't going up in Europe, or Japan or the UK and so the higher cost of money worry looks a bit premature. Though, of course, bond yields may end up higher.
GV: Are we beginning to toy with the idea of an inflationary environment, given the expected fiscal dimension of the Trump administration and the increased cost of living in post Brexit UK?
GM: I definitely think there's a whiff of inflation in the air for the reasons you mention. It may not be uniform yet, but commodity and energy prices are up a decent amount off their lows. A little bit of inflation would be one of my main 'watch list' items as policy makers sideline monetary policies and supplement with fiscal measures.
GV: The US economy is expected to grow by 2% in 2017, driven by a healthy consumer sector due to a consistent decline in unemployment and a steady increase in wages. Can we expect these trends to continue underpinning growth under the new administration?
GM: The US consumer has been doing ok, sustained as you point out by steady gains in employment and modest wage gains. The weak spot had been capital spending, and if the government can get companies to pick up their capital spending, that'll turn out to have been a major accomplishment. In any event, the fiscal stimulus we are all guessing at right now should lift growth in 2017, if not longer.
GV: Trump may have the firepower to expand fiscal policy, but what is the trade-off for Trump to deliver infrastructure spending and an overall fiscally aggressive plan to the austerity preached by the traditional Republicans?
GM: This is one of our known unknowns, namely how fiscally conservative Republicans will behave. It's possible they might try to moderate Trump's more aggressive plans or tweak what they see as his excesses. On the other hand, they may lack the guts or the organisation or will to stand up to a president who has defied all the predictions, including their own. In fact that's my suspicion.
GV: Less encouraging is the picture of weak levels of industrial production and of weak capital expenditure, with American corporates sitting on a volume of surplus liquidity amounting to a record 3 trillion dollars. Apple alone is sitting on 237 billion dollars. Is weak productivity still a major concern?
GM: Weak productivity is a problem viz expectations of rising living standards and incomes. But at the same time a lot of digital tech companies like Apple generate more cash than they know what to do with capex-wise. That said, the US and many other countries have a major corporate governance problem in having allowed listed firms to build up so much idle balance sheet cash. Governments need to reach a pact with companies that unwinds excess cash holdings either in favour of dividends or capex or wages or all three.
GV: The Trump administration is poised to introduce tax breaks to make it advantageous for companies to bring cash back to the US, as about a third of American corporates liquidity is held offshore. What will be the consequences for the dollar?
GM: Well of course it all depends how those balances are held. If they are largely dollar balances, then transferring these back into dollar accounts at home won't have any impact on the currency. If they're held in euros or Yen, though, then they'll be sold for dollars and push up the value of the currency. I'd expect the overall effect to be positive for the dollar, all things considered.
GV: America is the worlds biggest oil producer, along with Saudi Arabia and Russia. Oil prices have risen with the OPEC agreement to move forward on production limits. Production is recovering in Libya, Nigeria and Iran, all of which will likely be exempt from future agreements. However, in the US, oil reserve data released pointed to higher crude stockpiles than initially estimated, increasing fears of a long-drawn supply glut. Have weaker hydrocarbon prices bottomed out?
GM: I think they've probably bottomed out in view of an incremental rise in global aggregate demand that seems to be taking shape, and ahead of the OPEC production agreements scheduled for January 2017. But both might look much more tenuous on a 2 tier view. So I'm a bit wary to be honest. The surge in global growth in the 2000s is over, the China miracle is over, and the openness in trade and investment that fuelled global growth over the last 30 years is now under real threat. If you twist my arm, I think hydrocarbon prices are on a temporary roll, but will ease lower again by 2018-19.
GV: Is OPEC fighting against history, given the irreversible impact on prices of the shale revolution?
GM: I'm not sure the shale revolution is forever, but I'm not saying that from the standpoint of expertise, just what I hear. My view though would be that the combination of shale pro tem, and green and alternative energy sources will eventually compromise the cartel's raisin d'etre.
GV: What should the world economy find under the Christmas tree for a better 2017?
GM: Under the Christmas tree? Only good things lie under the tree. And if you look hard right now, I'd say the world economy is looking up at the moment and that 2017 may see us cheer better economic growth - even as we groan at political developments that may be harbingers of, not least, a turn in the economy in due course.
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