2019_03_19 — “What A Difference A Year Makes, Or Does It?”
March 19, 2019
What A Difference A Year Makes, Or Does It?
- North Korea continues to be more of a Chinese pawn than a potential U.S. ally.
- China will grab headlines for the next couple decades, and rightfully so.
- The euro area is cementing its position as a post-growth empire.
- Brexit should finally be over by this time next year; the European Union has more to lose.
- Japan is as steady and exciting as a boulder, until it decides to shift and rattle the environment.
Approximately this time last year, North Korea, China, European growth constraints, and Brexit were headline investment concerns and people had relegated the malaise known as Japan to the back pages. Fast forward to today, and headline concerns seem similar.
NORTH KOREA: In March 2018, U.S. President Donald Trump accepted North Korea’s leader Kim Jong-un’s invitation to meet and Kim made a surprise visit to Beijing to meet Xi Jiping. Simultaneously, Beijing reasserted its influence over Kim with two meetings on Chinese soil as well as some senior leadership visits to Pyongyang. Soon, however, Trump would deliver Beijing a challenging list of trade demands (including sanctions on steel, soybeans, and pork) and thrust the U.S. versus China challenge for global and regional influence into a new phase. [How many suspected such a long ugly trade fight?]
- North Korea has become (or has been for a while) a denuclearization pawn in a multiparty negotiation to shift regional clout between China and the U.S. North Korea is likely to open itself further to Chinese investment as Kim seeks to bolster his governing authority through a stronger economy that pleases his party leaders and senior lieutenants.
- With officially only five communist countries remaining in the world — China, Cuba, Laos, North Korea, and Vietnam — politically and strategically, China would not like to see North Korea (which lies along its border) fall strongly under U.S. (or South Korean) influence. [Note: Technically, Venezuela is a federal presidential republic.]
CHINA: China’s economy still stands to suffer more than the U.S. on the trade front from full scale hostilities; however, over the last year investors have had time to realize how much fallout would also affect Europe and emerging market countries across the globe. In this light, China can still strengthen its super-power status while negotiating against Trump’s election pledges.
EURO AREA: The Euro Area (EA) still faces unimpressive profit growth. A year ago, temporary capacity constraints were blamed for a soft patch that limited the EA’s momentum, i.e. a shortage of skilled labor along with a lack of productive capacity from years of under-investment in capex. The hope was that bank loans and increased bank loan demand would feed more capital into companies and grow production along with global growth. However, global growth topped out in the first quarter of last year, and the EA once again has extra capacity (especially in the industrial powerhouse of Germany) because of declining global demand. A combination of aging demographics, declining population growth, generous social benefits, and an increasingly competitive world don’t bode well for stoking euro area growth.
BREXIT: The U.K’s potential exit from the European Union (EU), Brexit, and the accompanying EU negotiations and U.K. parliamentary fights continue. Prime Minister Theresa May has lost numerous votes on her directive, but opposing parties have not unseated her, I believe, because no other party (or leader) wants the full responsibility for Brexit thrust on their shoulders. The Bank of England raised rates from 0.5% to 0.75% on Aug 2, 2018, and have since hinted at fewer borrowing costs increases in 2019 (you can do the math on what fewer than one rate increase means) as the UK faces its weakest growth in a decade and many international firms move their EU head office off the island and onto the continent. The British pound, meanwhile has weakened slightly from 0.72 to 0.75 pounds to the dollar, but more recently has strengthened off of its December 0.8 lows. Understandably, the Bank of England has had trouble communicating rate direction (while maintaining the option to reverse course) amidst an ever changing macro outlook and volatile Brexit mood swings.
JAPAN: Japan remains the third largest economy in the world with a trillion dollars more GDP than 4th ranked Germany and $2.3 trillion dollars more than soon to be 5th ranked India. [Sorry U.K., you’ll soon slip to 6th or 7th place.] However, because Japan has economic growth under 1%, a declining population, huge dependency on global growth and exports, and a central bank bent on stretching monetary rules rather than helping reform corporate governance — in other words, it is as steady and reliable as a boulder — it often doesn’t grab headline attention outside of the occasional natural disaster. If global growth increases, Japan will grow; if it shrinks, so too will Japan. In other words, for all its size, Japan is the tail, not the dog. Meanwhile, China and South Korea are slowly chipping away at areas of Japan’s consumer, industrial and semiconductor dominance. At some point, the Bank of Japan’s ever growing balance sheet from its bond and stock buying spree will have to be resolved. Two decades of printing money to buy bonds and stocks has created its own set of issues, including marginally profitable banks with razor thin interest rate margins unwilling to lend. The Bank of Japan is holding short-term interest rates at -0.1% (they have been 0.1% or less for over a decade) and ten-year government bond yields at 0.0%. Even with such extreme easing, the central bank continues to miss its 2% inflation target; optimal inflation for Japan is probably significantly lower. As an investor, one rarely wants to fight a central bank; likewise, a central bank can fight reality for only so long. When the boulder that is Japan shifts, financial market reaction will be extreme and flummoxed.
CONCLUSION: In another year, Brexit should be resolved (at this point, the European Union has more to lose than Britain), Europe may further cement its post growth status, Japan will continue to befuddle, and China and North Korea will still be headline news.
Michael Ashley Schulman, CFA
Disclosure: The views and opinions expressed are those of Michael Ashley Schulman, CFA and are subject to change without notice. The views and opinions referenced are as of the date of initial publication, may be modified due to changes in the market or economic conditions, and may not necessarily come to pass. Forward-looking statements cannot be guaranteed; neither can backward-looking nor current-looking statements. This material is provided for informational purposes only and does not constitute an offer or solicitation to purchase or sell any security or commodity or invest in any specific strategy. It is not intended as investment advice and does not take into account each person’s or investor’s unique circumstances. Information has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed. Past performance is no guarantee of future results.