Great market summary from Bob Doll at Nuveen Asset Management:
Economic data remains strong and hurricane effects have been surprisingly muted. Real third quarter gross domestic product was reported to be 3.0%, with nominal growth hitting 5.2%. Both numbers came in higher than expected, with nominal growth reaching its strongest pace since 2006.
Home sales are increasing, demonstrating that economic growth remains broad. New home sales hit their highest level since 2007.
The Federal Reserve is on track to increase rates again in December. We expect the central bank will enact its third hike of the year, while continuing to reduce its balance sheet. Fed policy remains accommodative, but is clearly normalizing.
Corporate earnings are on track for another strong quarter. We are past the halfway point of reporting season, and the vast majority of companies have beaten expectations. On average, companies are ahead of earnings growth expectations by 4.9%.
Stock buybacks appear to have slowed, but companies are still deploying cash in shareholder-friendly ways. From our vantage point, we are seeing companies pour more resources into hiring and modest amounts of capital expenditures.
Tax reform prospects still appear uncertain, but we have seen progress on the regulatory front. While President Trump has struggled to enact his pro-growth legislative agenda, he has had success in rolling back regulatory enforcement. The financial and energy sectors in particular appear to be benefiting from less scrutiny.
It is possible that tax reform will focus on corporate rather than individual rates. The most controversial aspects of tax reform are focused on possible changes to individual tax rates (such as arguments over the deductibility of state and local taxes). In contrast, corporate tax reform appears less controversial, as Congress seems to have broad agreement on the need to reduce corporate taxes and solve the issue of overseas profits. While still a small probability, Republicans may choose to separate the two issues and proceed solely on a corporate tax bill.
Economic growth remains muted but earnings are exceeding expectations. High levels of stock buybacks in the last few years must be playing a part.
Rising home sales are a bullish sign.
The Fed remains accommodative for the present but I expect increasing inflationary pressure to temper this next year.
Slow rates of investment remain a cause for concern and could hamper future growth — buybacks are cosmetic and won’t solve the low growth problem in the long-term.
Corporate tax reform would be a smart move, creating a more level playing field, while avoiding the acrimony surrounding individual tax rates.
…The odds of a recession appear low, but so does a significant acceleration in growth. The regulatory environment is loosening, consumer spending appears solid and jobs growth remains strong. As such, we do not expect a recession any time soon. At the same time, however, we see no catalyst to push the economy into a higher gear unless the White House and Congress make progress on their pro-growth agenda.
China’s debt reckoning is coming. Maybe not this quarter or this year, but Chinese President Xi Jinping’s unbridled effort to keep growth from falling below the official 7.5 percent target is cementing China’s fate…..
Why then, with so many clear examples of financial excess leading to ruin, is Xi continuing down this road? Blame it on the ghosts of Tiananmen Square. In the aftermath of the crackdown on student protesters on June 4, 1989, China’s leaders made a bargain with their people: We will make you richer, as long as you no longer dissent. After the crash of Lehman Brothers, the regime had to go to extraordinary lengths to keep up its end of the bargain, pumping up what was already the world’s highest investment rate. In doing so, China itself became a Lehman economy…
Kyle Bass, founder and principal of Hayman Capital Management, on China’s debt bubble:
China’s banking assets have grown to over 100% of its GDP in the last three years, according to Bass. If the U.S. had engaged in similar policies – which he said would translate to $17 trillion in lending over that time period – it, too, would have achieved more than 7% GDP growth.
China’s banking assets now total approximately $25 trillion, or almost three times the size of its $9 trillion economy. Its low default rate on bank loans – about 1% – is about to rise, according to Bass. Much of that lending is construction-related. Bass said that 55% of China’s GDP growth has been in the construction sector. The marginal return on those loans must be very small, he argued.
“A rolling loan gathers no loss,” Bass said, “and that’s what’s been going on in China for the last few years.” He said it is impossible to believe China could “manipulate” the inputs of its financial system without losing control of the outcomes.
Deflation is also threatening China. Bass said that its GDP deflator is now below zero. He expects the PBoC to engineer a devaluation of the renminbi as a way to stimulate exports and avert further deflation…
China may well attempt to engineer a devaluation of the RMB, but neither the Fed nor the ECB are likely to tolerate China exporting their deflation to the US/Europe.
….The paper, written by staffers from the RBA’s Economic Analysis Unit says that a temporary 10% depreciation in the real exchange rate for the Aussie dollar can increase growth by between a quarter and a half of a percent over 2-3 years.
So what could the future hold for Prime Minister Abbott? Here I have a hunch that he’ll end up suffering a similar fate, not to the previous Liberal leader he admires – John Howard – but to ….. Malcolm Fraser.
Fraser, as noted, had the good fortune to take over from Whitlam after the bursting of the debt bubble was largely over, but the bad fortune that the revival in Australia’s bubble was considerably more anaemic than America’s. Abbott could well find himself experiencing a similar double-edged sword of fate. He will take over when the deleveraging that caused the GFC has come to a temporary halt, and demand will be rising in the US….. But this rise could peter out even more quickly than it did for Fraser, leading to anaemic economic performance that will be blamed on the politician rather than the times.
“Australia’s exposure to commodity demand from Asia, and China in particular, was a saving grace during the global recession of 2009. But by the same token it has become Australia’s Achilles’ heel,” the ratings giant [Standard & Poor’s] said.
“Particularly while mining investment remains such a large share of the Australian economy, and other sectors continue to lack growth momentum, Australia remains highly sensitive to a sharp correction in China’s economic growth.”
Michael Pettis argues that China cannot stimulate its economy out of trouble:
There are still bulls out there who insist that China is out of the woods and making a strong recovery, for example former Deputy Governor of the Reserve Bank of Australia, Stephen Grenville, who argues in his article strangely titled China doomsayers run out of arguments:
“The missing element from the low growth narrative is that unemployment would rise, provoking a stimulatory policy response. China would extend the transition and put up with low-return investment recall that when unemployment was the issue, Keynes was prepared to put people to work digging holes and filling them in rather than have unemployment rise sharply. To be convincing, the low-growth scenario needs to explain why this policy response will not be effective.”
It seems to me that the reason why simply “provoking a stimulatory policy response” won’t help China has been explained many times, even recently by former China bulls. Of course more stimulus will indeed cause GDP growth to pick up, as Grenville notes, but it will do so by exacerbating the gap between the growth in debt and the growth in debt-servicing capacity. Because too much debt and a huge amount of overvalued assets is precisely the problem facing China, it is hard to believe that spending more borrowed money on increasing already excessive capacity can possibly be a useful resolution of slower Chinese growth.
Michael J. Casey at WSJ interviews HSBC group chief economist Stephen King, author of When the Money Runs Out: The End of Western Affluence:
Mr. King’s thesis….. is that we in the West are in line for a shock when we discover that the high-growth rates to which we’re accustomed aren’t coming back. In the U.S., we’ve been wrongly budgeting for a return to 3.5% average real growth rates that persisted through the second half of the 20th century — an affliction suffered by both policymakers and households that he calls an “optimism bias” — and yet even before the financial crisis destroyed trillions of dollars of wealth the economy was only clocking gains of 2.5% per year. Forget worrying about the post-crisis onset of a Japan-style “lost decade,” Mr. King says. “We have been through a lost decade already. ”Among the reasons for this long-term shift to a slower potential growth rate, he cites the exhaustion of a various one-off productivity gains that boosted growth after World War II: the entry of women into the workforce; the liberalization of world trade; a tripling in rates of consumer credit founded on an unsustainable increase in housing prices; and education. These gains are no longer to be had, he says, but policymakers are blind to that fact and so are burdening the economies of the U.S., Europe and Japan with long-term debts.
While I agree that we are unlikely to see a resumption of the rapid debt growth of the last 3 decades, this should contribute to lower inflation and greater stability, without a credit-fueled boom-bust cycle, that could partially offset the negative effects. I also question whether productivity gains are really exhausted, or if this is a temporary after-effect of low, post-GFC capital investment. There is ample evidence that the global economy is slowing and productivity gains will fall — if one is prepared to ignore evidence to the contrary such as the rise of automation, advances in genetics, nanotechnology, sustainable energy and slowing global population growth — which should alleviate the poverty trap that many countries are still in. The researcher has to beware of confirmation bias, where they gather data to support a preconceived opinion.
Buttonwood of The Economist quotes Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School:
….take the records of 83 countries from 1972 to 2009 (the most comprehensive set available) and rank them by GDP growth over the previous five years. Investing each year in the countries with the highest economic growth over the preceding five years earned an annual return of 18.4%, but investing in the lowest-growth countries returned 25.1%.
The world’s largest economies are set to diverge in coming months with few signs that a broad-based recovery in growth is imminent, according to the Organization for Economic Cooperation and Development’s composite leading indicators.
The leading indicators for December, released Monday, point to a pickup in growth in the U.S., Japan, the U.K. and Brazil, but suggest growth will remain weak by historic standards in many other big nations [including China and India]……
Economic growth and recent legislation have cut the federal budget deficit in half in the past four years, but federal debt will still hit historic levels if more isn’t done, the Congressional Budget Office said Tuesday in the annual update of its budget and economic forecast.
The CBO said it expected economic growth to be sluggish in 2013, in part because of a sharp drop in government spending, but it sees a better economy in 2014 as the recovery takes hold.
Dan Mitchell reports on new research from the Bank of Finland:
Europe suffers from a growth slowdown. The GDP growth in Europe has lagged behind the GDP growth in the US and has been far worse than the GDP growth in the NIC countries, particularly China… However, what is the reason for slow or rapid economic growth? …In many respects, the labour market plays the key role in the economy because it determines both the use of the labour input and the level of overall competitiveness of a nation. Obviously, the functioning of the labour market is not independent of the public sector. A large government is almost inevitably associated with a large tax wedge, and the functioning of the labour market appears to be critically dependent on the size of the tax wedge. It may be fair to say that the harmful consequences of a high tax wedge are exceptionally well and unambiguously documented in the literature. …On the basis of the estimates derived in this study, the following guide for growth policies appears to be warranted: …Do not over-expand the welfare state. Larger governments are associated with slower growth rates.
What [Joshua] Shapiro saw two years ago, and other economists didn’t, is that the healing this time would be slower. He and his firm [NY-based forecasting firm Maria Fiorini Ramirez Inc.] have been among the more pessimistic forecasters of a U.S. recovery, citing data that show slow growth and relatively high joblessness persisting through 2013. Shapiro predicts the U.S. economy will grow next year by about 1.5 percent.
Shapiro sees monetary policy, with the Federal Reserve benchmark interest rate at almost zero, as having a limited near-term impact on growth. And he considers the $1 trillion U.S. fiscal deficit an important drag on future expansion.
The uncertain environment should ensure the private sector remains focused on paying down debt rather than expanding investment. And that will ensure that fiscal deficits continue for the foreseeable future. What we need to take into account is how those deficits are funded. If funded by offshore investment from China and Japan, the US manufacturing sector will continue to suffer from an artificially high exchange rate. More likely is Fed funding of the deficit through QE purchases of Treasuries and MBS. That injects new money into the economy, some of which will end up in the stock market. Rising stocks, out-stripping lagging earnings, would take valuations into over-bought territory. Over-valued stocks increase uncertainty, prompting the private sector to repay more debt…… As Yogi Berra said: “It’s like deja vu all over again”.
Excerpt from a paper by Israel Malkin and Mark M. Spiegel at the Federal Reserve Bank of San Francisco. The two believe that China’s richest provinces, Beijing and Shanghai, are experiencing a slow-down in GDP growth (per capita) as they experience a classic middle-income trap, while China’s poorer provinces continue to experience high GDP growth rates.
What evidence exists for middle-income traps in a group of Asian economies that, like China, experienced episodes of rapid growth? We pool data for Hong Kong, Japan, Korea, and Taiwan from 1950 to 2009……. growth of these economies slowed markedly after they reached middle-income status.
Growth rates for these economies are highest just below the $10,000 per-capita-income level and then slow down rapidly as income increases. …..[the] economies grew on average at a 4.8% rate when per capita income reached $17,000, down from a high of 7.2% at the $7,800 level.
Interestingly, the middle-income trap appears to arise in Asia at lower income levels than has been found for broader groups of emerging-market economies. It may be that large Asian countries with relatively low prevailing wages cause the dynamic of the middle-income trap to shift. In Asia, countries may begin to become uncompetitive for certain labor-intensive activities at lower income levels than in other parts of the world……
The GDP data this morning was a deep sigh of relief for those people who fear a recession may be coming. I don’t have that sense of relief. Perhaps its my own bias, but the details of the GDP report reveal not an organic growth period in a healthy recovering economy, but rather a tepid post-credit crisis expansion highly dependent on government largesse and Federal Reserve accommodation…..