Base Case for 2018 is Continued Global Growth: Based on the reviewed projections, we expect global growth to be around positive 3%. The “synchronized global growth” theme is not unusual these days; however our perceptions to the risks are unique. To start, China should continue to help the averages at +6.4% forecasted officially but there are some political considerations that will be outlined in the risks section below. For the US, GDP growth should match the average annual +2.2% experienced since the mid-2009 crash and perhaps sustain the +3.0% forecasted for Q4 2017 by the Atlanta Fed. Negative impacts by interest rates going higher (but still not historically high) are likely offset by front-loaded tax cuts for some (still under negotiation but expected) and very, very low unemployment (see right). US deficit spending is effectively unconstrained as the debt ceiling should be reset at a notably higher level (up by at least $1.5 trillion to $22.0 trillion) to get the current Congress past mid-term elections in 2018. If China powers forward, then those countries that are tied to that growth will also put up good GDP numbers – Russia, Germany, Australia, Japan, South Korea, Taiwan and so on. The Middle East will also likely benefit as long as oil prices stay supported at the same price levels (or higher if OPEC has its way). Chinese industrial production (growing at +6%), retail sales (growing at +10%) and trade (+10% or so recently) have been at stable levels for two years – lower than the go-go days of the past decade but the envy of everyone else (apart from India which has continued upward too). Even old-world Europe is expected to grow over 2% in 2018, and that includes sub-par projections for the UK over Brexit. Case in point, The Eurozone’s jobless rate has dropped to 8.8% which is the lowest level in almost nine years. Even Greek unemployment is down – to 20%. In short, the base case for growing economies is in place, though growing financial markets may be a different matter.
Four Main Risks: China, Central Banks, Oil and Politics
- China as our primary risk to global growth should be no surprise given its centrality in global trade. All of the Pacific Rim (including North and South America) and the Middle East and Europe (Russia and Germany particularly) have China as their core trading partner either directly or as setting the prices for their products (imports or exports). That China’s last five plus years of growth is largely due to the expansion of debt (going from 160% of GDP in 2008 to 260% by the end of 2016 per Bloomberg) has spawned the usual excesses: over-employment and over-production in stagnant “zombie” industries, bailouts of banks, new forms of unregulated credit (“shadow financing” and “wealth management products”), property speculation, corruption and so on. In response, the People’s Bank of China recently warned of a possible “hard landing” as it raised rates (ten-year bond yields are above 4% while they were below 3% a year ago) and “AAA” corporate bonds yield over 5.3% now versus 3.3% at the end of 2016. Historically, there has been a close tie between rates and home sales (a popular speculation vehicle) as shown in the graph to the left. But the Chinese government would never allow the economy to miss its growth targets, right? We posit that they may decide to endure some pain now to avoid it later. Why? The most important two events in China’s government are in a few years: in 2021 is the 100th anniversary of the Chinese Communist Party and in 2022 Xi Jinping will be ready for an unprecedented third term as General Secretary. A credit crisis and economic slowdown (let alone recession) during those years would be an existential threat to the credibility to the Party and Xi politically (and possibly personally). Therefore, an engineered “soft landing” in 2018 and 2019 with a jump-started recovery and positive momentum to resume in 2020 to be in time with the above events may be a rational tradeoff. For fiscal ammunition, China has over $3 trillion in foreign exchange reserves and easily more than double that in national debt capacity – the question is the timing to deploy these assets.
- Central banks are slowing quantitative easing programs and one big one (the Federal Reserve) is actually reducing its balance sheet, providing less of the monetary stimulus that has been keeping interest rates artificially down and stock markets up. Every trader knows it is happening but its impact is uncertain. Our view is that it will actually have little impact in 2018 as central bank intentions and programs have been well-covered and appear to be set for the year. Most individuals had modest direct benefits from QE programs (via lower mortgage or other interest rates) with the wealthy (asset holders generally) and financial firms primarily benefiting (banks, private equity firms, real estate developers, etc.). The main impact from this slow change in policy is the reduction in credit growth but as the residential real estate bubble in the 2000s taught us, this slowdown can take a year or two (or longer) to filter through the economy and cause pain. Only those on the edge that have to keep borrowing to pay for operations are likely to be affected in the coming year.
- Oil prices are likely to stay low ($55 plus or minus $5) as OPEC / Russian cuts are met with western hemisphere (US, Canada, Brazil) production increases. Of course, after the Aramco IPO (mid-year 2018?), the Saudis will have less incentive to keep the cuts going but they certainly want to ramp oil prices beforehand to maximize the value of the stock offering. How to best do that? A pretend war with Iran would do the trick – or a real one (perhaps in Yemen). While a spike to $80 or higher may not last long depending on the circumstances, it could assist both parties (as well as any producer who can hedge at higher levels). Of course, high oil prices may cause a global recession – which may be okay with China based on the above as the government can blame external influences. Of course they would not want a deep recession, but just a tactical slowdown. So crazy that it may come true.
- Politics is overstated as a risk to global growth for next year in our opinion but it has to be on the table. Trump/Congress/mid-term elections, Brexit negotiations, North Korea aggression, Chinese maritime expansion, Russian meddling in the Middle East and Europe, the Middle East as its own factor, a divided / weak German government and who knows what else.
David Burkart, CFA
Coloma Capital Futures®, LLC
Special contributor to aiSource
Additional information sources: BBC, Bloomberg, Financial Times, The Guardian, JP Morgan, PVM, Reuters, South Bay Research, Wall Street Journal and Zerohedge.