The global economy is in an abnormally optimistic state as we enter 2017, despite falling well short of economic growth targets over 2016. To provide context, the global economy grew at an estimated 2.3% in 2016 according to the World Bank, down from mid-year expectations of 2.4% and well below the original expectation of 3.4%.
Even the U.K. has demonstrated resilience, with optimism abounding despite concerns about Brexit
This backdrop also defies the super cycle of monetary stimulus, with strong quantitative easing programs over the past seven to nine years inducing a significant spike in money supply but a lack of genuine progress in the global economy. In fact, the amount of cash in the U.S. system has more than doubled from $1.4 trillion to $3.3 trillion since the beginning of 2008, yet the economy has only grown by 28.6% in nominal terms.
Similar spikes in money supply are notable in countries including China, up 23.9% year-on-year, the U.K. up 10.8%, Europe up 8.2% and Japan up 8.9%, without the commensurate progress in their respective economies.
If we are to believe the headlines, this may be changing. We have witnessed an increase in inflation expectations, as well as an expectation for stronger economic growth due to the prospect of fiscal stimulus taking the baton from monetary policy. This has provided an added layer of confidence for central banks to envisage ending the ultra-loose monetary policy of the last 8 years. In this sense, the fourth quarter unsurprisingly saw the Federal Reserve hike U.S. interest rates for just the second time in 10 years. More subtly, the European Central Bank also announced its decision to taper quantitative easing, although it is far too early to know if this will materially impact the economy.
A related development garnering the attention of the public are some persuasive unemployment trends. There has been a gradual improvement across Europe, but more spectacularly, unemployment rates are at or near all-time lows in the Japanese, U.S. and U.K. economies.
To date, this has not yet transpired into wage growth. If anything, wage growth appears to have actually deteriorated over the fourth quarter, with U.S. wages slowing to 3.5% at the end of November. Italy is faring worse, with wage growth slowing to 0.4% in the fourth quarter and marks the slowest wage growth since records began in 1983. To put the importance of this in perspective, Japan failed to grow wages from the 1989 crisis and remains anaemic at 0.2% today.
Many commentators are talking to short-term optimism as the so-called ‘leading indicators’ have turned decisively positive. Specifically, the last few months we have seen stronger activity data and relatively optimistic markets. The positive momentum is supported by industrial activity and confidence, along with somewhat better trade volume and new orders in manufacturing. Retail sales also indicate that private consumption is robust.
Leading this sentiment, developed countries have generally done better than emerging economies. In the U.S. Trump’s victory has unexpectedly lifted confidence. The apparent stabilisation of China’s short-term outlook, plus improving trade, have helped Asian emerging markets. Latin America, on the other hand, is weighed down by Brazil’s slow exit from recession, as well as negative sentiment regarding Mexican trade.
Even the U.K. has demonstrated resilience, with optimism abounding despite the overhanging concerns about Brexit. Theresa May is boldly looking for a ‘have your cake and eat it too’ approach, which appears misguided against a European Union that looks defensive and protectionist. With no clear path yet to be established, a pragmatic view must be maintained.
Looking at the longer run perspective, economic growth has remained well below historical averages since the global crisis of 2008. Even in the decade prior to that, the rate of growth was generally disappointing, if one considers how much leverage was needed to produce it.
While the post-crisis deleveraging has notably depressed the aggregate demand, it has not been the sole driver. A richer – and messier – narrative, can better explain the full picture by looking at longer-term “structural” forces such as productivity and the ageing population. These developments get less attention than they should.
Long-Term Economic Perspective
In a world dominated by headlines about the implications of Donald Trump and Hard-Brexit, it is inherently difficult to conserve a long-term perspective on the economy and financial markets. However, the long-term fundamentals are far more important than short-term guesswork.
Our goal is to adhere to our valuation discipline and resist the temptation to let recent economic trends or headlines divert us from engaging in appropriate investing behaviours. In this sense, resolutions take prominence over forecasts.
This is a mental minefield that should not be underestimated. For instance, in the shorter-term the World Bank expects every single country in the G20 to experience economic growth in 2017, 2018 and 2019. If this transpired, it would be a celebrated outcome for a global economy that has experienced intermittent recessions in a range of countries at any given time. In fact, the World Bank has become increasingly optimistic about the state of the world, with growth expectations for 2017, 2018 and 2019 all exceeding or equalling the growth rates of 2012, 2013, 2014, 2015 and 2016.
The reality is that a large part of this outcome will be the extent that reflation is sustained and the capital cycle progresses. For example, if reflation and trade relations are managed appropriately, it could provide a solid footing for the global economy and theoretically lead to stronger wage inflation.
However, the long-term result is far from guaranteed. For it to play out as the World Bank expects, it will require all ducks to line up correctly whilst avoiding the black swan events that can attack at any time. Good luck with that.
