GLOBAL ECONOMICS AND POLITICS
Leo Haviland provides clients with original, provocative, cutting-edge fundamental supply/demand and technical research on major financial marketplaces and trends. He also offers independent consulting and risk management advice.
Haviland’s expertise is macro. He focuses on the intertwining of equity, debt, currency, and commodity arenas, including the political players, regulatory approaches, social factors, and rhetoric that affect them. In a changing and dynamic global economy, Haviland’s mission remains constant – to give timely, value-added marketplace insights and foresights.
Leo Haviland has three decades of experience in the Wall Street trading environment. He has worked for Goldman Sachs, Sempra Energy Trading, and other institutions. In his research and sales career in stock, interest rate, foreign exchange, and commodity battlefields, he has dealt with numerous and diverse financial institutions and individuals. Haviland is a graduate of the University of Chicago (Phi Beta Kappa) and the Cornell Law School.
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The famous military philosopher and analyst Carl von Clausewitz states in “On War” (Book Two, chapter 3; italics in original): “Rather than comparing it [war] to art we could more accurately compare it to commerce, which is also a conflict of human interests and activities; and it is still closer to politics, which in turn may be considered as a kind of commerce on a larger scale.”
OVERVIEW AND CONCLUSION
In late 2012, the Japanese political leadership dramatically unveiled its three “arrows” of easy money, flexible fiscal policy, and structural reform to improve the country’s economic performance. In practice, those Japanese political authorities generally represent major financial (corporate; commercial) interests (“Japan, Inc.”). The Bank of Japan’s policies since late 2012, though nominally independent of political and economic power centers, in practice reflects the goals of Japan’s substantial entrenched economic groups and the political representatives and bureaucrats aligned with them.
Monetary policy of course is not the only factor affecting GDP, inflation, and other intertwined variables. Yet Japan’s ongoing government fiscal deficit, though somewhat helpful for promoting growth and inflation, is not the most noteworthy element in the country’s policy array since end-2012. Moreover, the general government debt burden remains massive and likely will remain so for many years. According to the International Monetary Fund, Japan’s general government gross debt as a percent of GDP was 236.4 percent in 2017 (contrast the G-7 average of 118.6pc that year) and forecast at 236.0pc for 2018 and 234.2pc in 2019, dipping only slightly to 229.6pc by 2023 (“Fiscal Monitor”, April 2018, Table A7; the October 2018 update probably will not change Japan’s government debt as a percent of GDP statistics substantially). And structural reform in Japan, which usually crawls forward slowly, has been unremarkable.
The extremely easy monetary policy arrow embraced by the accommodative Japanese central bank for almost six years is the country’s critical weapon. The central bank chief faithfully and repeatedly proclaims that sustained inflation of two percent is a praiseworthy goal (as essentially do the sermons preached by other leading central banks such as the Federal Reserve Board and the European Central Bank). The Bank of Japan’s ongoing tools to achieve its aims include sustained yield repression and massive quantitative easing (money printing). So far, the Bank of Japan, despite its determination, has not come close to achieving two percent inflation. The consumer price trend in recent months manifests merely minor progress on that front. And although Japan’s quarterly GDP for April-June 2018 may signal enhanced year-on-year economic performance, International Monetary Fund forecasts are not as sunny.
Yet what else has the Bank of Japan (as a representative and reflection of the country’s political and economic generals) really battled to achieve via its remarkably lax monetary strategy? A notion of improved and acceptable economic growth and frequent reference to an iconic two percent “price stability target” do not offer a complete story. Moreover, the enthusiastic declaration of assorted monetary policy plans and tactics does not directly reveal important aspects about the economic (financial; commercial; marketplace) landscape within which the interrelated GDP and inflation goals are targeted and such extraordinary easy money programs are designed and applied.
In practice, what are the intermediate connections (means; methods) to the achievement of the allegedly ultimate ends of satisfactory growth and sufficient inflation? One key approach of the Bank of Japan’s magnificent scheme relates to currency depreciation, the other to stock marketplace appreciation. Japan’s central bank sentinel quietly has aimed to achieve the related objectives of Yen weakness and Japanese stock marketplace strength.
In recent times, Japan deliberately has kept a relatively low profile in foreign exchange, trade, and tariff conflicts. Compare the furious racket nowadays, especially since the advent of the Trump presidency, around the United States and China (and also in regard to the European Union, Mexico/Canada/NAFTA).
Nevertheless, for several years, Japan has waged a trade war (engaged in fierce currency competition) without capturing much international political attention or media coverage. The Bank of Japan (and its political and economic allies) in recent years has fought vigorously to depreciate the Yen (especially on an effective exchange rate basis) and thereby to bolster Japan’s current account surplus. Japan’s overall economic growth relies significantly on its net export situation. The Yen’s substantial retreat and its subsequent stay at a relatively low level and the significant expansion in the country’s current account surplus are glorious triumphs.
Since late 2012, the Bank of Japan also has struggled ferociously to rally the Japanese stock marketplace (boost corporate profits). As of early autumn 2018, this guardian has achieved significant victories in this campaign as well.
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Japan- Financial Archery, Shooting Arrows (10-5-18)
“Danger always strikes when everything seems fine.” From the movie “Seven Samurai” (Akira Kurosawa, director)
OVERVIEW AND CONCLUSION
American stock indices inspire an assortment of competing stories regarding them, including reasons for their past, present, and future levels and trends. Narratives and explanations regarding a broad “national” stock marketplace indicator such as the S+P 500 often involve those of equity weathervanes elsewhere. Discussions of interest rates, currencies, commodities, and other financial indicators may interrelate with stock marketplace analysis. These tales frequently indicate the extent to which given marketplace domains converge and diverge (lead or lag) with each other.
Many descriptions and analyses regarding broad benchmarks such as the S+P 500 and Dow Jones Industrial Average appear relatively unique to the United States. However, economic regions and marketplaces around the world increasingly have intertwined during the course of globalization in recent decades.
Therefore the directional travels (bull and bear adventures) of America’s “overall” stock marketplace increasingly have tended to parallel (converge with) stocks of other significant advanced countries and regions. In the increasingly intertwined global economy, trends of emerging marketplace stocks “in general” have interrelated with and often (but not always) resembled those of leading advanced nations.
Various advanced nation and emerging marketplace stock indices achieved very important highs “together” early in first quarter 2018. However, in recent months, probably beginning around the end of first quarter 2018, the generally bullish trend of the S+P 500 and other noteworthy US equity marketplace benchmarks have diverged substantially from the bearish trend of emerging marketplace stocks. Climbing US interest rates and a renewed rally in the broad real trade-weighted dollar, plus increasing trade war rhetoric, encouraged the relative and overall feebleness in emerging marketplace stocks.
In addition, the S+P 500 and other US stock indices have diverged somewhat from those of other key advanced nations, though less substantially than relative to emerging stock marketplace realms. Nevertheless, important European and Japanese stock arenas currently remain under their January 2018 highs (and mid-May 2018 ones). The failure of these overseas stock battlegrounds to achieve new highs alongside American ones, when interpreted alongside the decline in emerging marketplace stocks (and in relation to other economic variables), further hints that American stock benchmarks probably are establishing an important price peak around current levels.
In this context, bearish indicators for American equities include the longer run trend of rising US interest rates (note the yield lows of July 2016 and September 2017), mammoth global debt totals, expanding American federal government budget deficits (aided by tax “reform”), and the rally in the broad real trade-weighted US dollar above a critical height. The Federal Reserve and other key central banks are not displaying signs of further easing; instead, the bias is toward tightening (even if only at a rather glacial pace). Also, United States stock marketplace valuations arguably are high by historical standards. A global trade war (tariff fights), or at least noteworthy skirmishes, is underway.
Populist pressures have not disappeared in America or elsewhere. Economic, political, and other cultural divisions in America are significant. What if the US mid-term elections this autumn return the Democrats to power in the House of Representatives (and perhaps the Senate as well)? Concerns about the quality of US Presidential leadership remain widespread.
The US tax “reform” legislation enacted in December 2017 has been a critical factor in creating the price divergence since around late first quarter 2018 between American stock price benchmarks and those elsewhere. The US corporate tax cut translated into higher reported earnings for American companies and thereby helped to rally American stocks. Other leading countries around the globe did not enact a similar generous gift for their corporations. Moreover, America’s tax reform likely further encouraged share buybacks by US corporations.
The second quarter 2018 blended earnings growth rate for the S+P 500 was 25.0 percent year-on-year (FactSet, “Earnings Insight”; 8/31/18). Thomson Reuters estimates S+P 500 2Q18 earnings soared 24.8pc (“S&P 500 Earnings Scorecard”; 8/28/18). Thomson Reuters data notes that 1Q18’s earnings likewise skyrocketed, up 26.6pc year-on-year (compare 4Q17’s boost of 14.8pc and 3Q17’s 8.5pc rise).
Both FactSet and Thomson Reuters forecast significant year-on-year earnings increases for the S+P 500 over the next two quarters of 2018. FactSet says analysts are projecting earnings will climb 20.0 percent in 3Q18 and 17.4pc in 4Q18. Thomson Reuters puts year-on-year earnings growth at roughly similar levels, with 3Q18 ballooning 22.3pc and 4Q18 up 20.3pc.
However, the rate of earnings increases slows in 2019. FactSet states earnings growth in 1Q19 will be 7.2pc year-on-year, with 2Q19 stretching up 7.5pc versus 2Q18. Thomson Reuters places 1Q19 growth at 8.2pc year-on-year, with that for 2Q19 up 9.3pc.
Perhaps the wonderful US corporate earnings of first half 2018 will be followed by the impressive earnings forecast for the balance of 2018. However, if notable shortfalls in actual earnings relative to such lofty current profit expectations occur, that probably will worry many stock bulls. Going forward, if forecasts for first half 2019 earnings for the S+P 500 are cut relative to current expectations, will that make S+P 500 bulls (“investors” and others) fearful. After all, the currently anticipated (conjectural) calendar 2019 earnings growth already dips significantly from those of calendar 2018’s quarters.
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Stock Marketplace Maneuvers- Convergence and Divergence (9-4-18)
“Our million hearts beat as one,
Brave the enemy’s fire, March on!” “March of the Volunteers”, China’s national anthem
OVERVIEW AND CONCLUSION
Although China’s era of miraculous economic growth has marched into history, the nation nevertheless achieved enviable real GDP increases in recent years. Benchmark predictions by numerous economic wizards regarding China’s economy remain rather sunny, especially in comparison with those for most other countries. In fact, most observers are fairly complacent about China’s current situation and future prospects. Faith in adequate global growth intertwines with belief that China’s expansion will continue to be substantial.
As the world has become more globalized and intertwined, China’s substantial economic expansion not only has boosted China’s international economic (financial, commercial, business) and political presence and power. It also has helped to ensure domestic political stability and protected the central role and authority of the Communist Party. The country’s leadership and other elites obviously desire and battle to protect such impressive accomplishments.
However, China has a significant debt problem, and one that probably will worsen. Most China watchers nevertheless ignore or downplay this, with analysis and concerns banished to obscure articles, back pages, and fine print. China’s strong economy in the past five years probably derived substantially from a substantial expansion of its overall national debt. Will China’s government (and other areas of the economy) need to borrow more and more and go greater in debt in order to sustain “appropriate” GDP growth? Probably.
Yet the Chinese debt explosion, with totals at or moving toward high levels relative to GDP (particularly in the government and corporate sectors), endangers prospects for continued robust Chinese economic growth. Creditor (lending) confidence probably is not unlimited, especially in regard to segments of China’s corporate, banking, and local government arenas.
Moreover, very elevated debt is not just a Chinese phenomenon, but a worldwide one. The International Monetary Fund’s “Fiscal Monitor” (April 2018; Chapter 1) stated: “Global debt [public and nonfinancial private debt] is at historic highs, reaching the record peak of US$164trillion in 2016, equivalent to 225 percent of global GDP [current levels probably are higher]. The world is now 12 percent of GDP deeper in debt than the previous peak in 2009, with China as a driving force.” See also the Institute of International Finance’s perspective on the expanding global debt as a percentage of world GDP trend (July 2018). Public debt has played an important part in the leap in global indebtedness. China obviously is not an island isolated from other nations. So if international economic conditions weaken, perhaps partly encouraged by prior or prospective interest rate increases, it probably will become somewhat harder for many entities, both public and private, to raise cash.
China’s glorious economic growth, and the related boom in its exports, has interconnected with increasing openness in international trade. Enthusiastic challenges to the free trade (globalization; multilateral) order and ideology, especially by the current American leadership (President Trump; “Make America Great Again!”), has raised concerns about trade wars and currency conflicts. The American Administration’s noisy criticism of China’s allegedly colossal (and supposedly unfair) trade surplus (at least in relation to the United States) and its willingness to impose tariffs on Chinese products has encouraged a rapid noteworthy depreciation in the Chinese renminbi relative to the US dollar in recent months.
Currency depreciation, not merely the running of large government deficits or tolerating (encouraging) jumps in corporate and household borrowing (and spending), is another strategy aimed at creating or sustaining adequate economic growth. Perhaps China’s currency depreciation relative to the US is to some extent a competitive plan designed to maintain its economic growth rate by ensuring continued substantial entry of its exports into the American marketplace. And the dollar/renminbi cross rate fascinates most marketplace observers in an environment excited by trade and currency war talk.
America of course is an important commercial counterparty for China. But it does not come close to capturing a majority of China’s overseas economic transactions. A review of China’s currency patterns and levels from a broad real effective exchange rate (“EER”) vantage point therefore offers superior enlightenment regarding the overall Chinese currency situation, and thereby its overall economic one.
The high level in China’s EER likely has tended to reduce exports and thus GDP growth to some extent from what they (all else equal) otherwise would have been. This consequently has tended to encourage China’s debt expansion as a means of achieving “sufficient” (official targets for) economic growth. Even allowing for the recent renminbi depreciation versus the US dollar, China’s EER remains rather lofty from the historical perspective. From China’s policy standpoint, its EER probably should depreciate even more than it has since its 2015 pinnacles in order to achieve desired economic growth and to handle its growing debt troubles.
Not only do China’s debt predicament and the renminbi’s feebleness relative to the US dollar (and the need for the renminbi to slump further on an EER basis) warn of underlying weakness in and the probability of slower growth than generally forecast for the Chinese economy. The sharp fall in calendar 2018 in the Shanghai Composite Index (and other emerging stock marketplaces) and declines in key commodity benchmarks also signal subsiding (slowing) Chinese GDP growth. The gradual rise in US interest rates (ongoing Federal Reserve tightening; underline climbs in the Federal Funds rate and the 10 year US Treasury note), given the links across global marketplaces, also probably is starting to curtail economic growth around the globe. In any case, given China’s major role in the international economy, a slowdown in its output relative to levels anticipated (hoped for) by economic pundits and financial pilgrims likely will injure expansion elsewhere.
China’s leadership probably is more fearful of inadequate economic growth than it publicly confesses. Why else has the country in the past few years further centralized political leadership and emphasized Communist Party control, embarked in well-publicized anti-corruption drives, and engaged in assorted territorial squabbles with its Asian neighbors? Such political programs suggest that real economic growth not only has slowed down (and perhaps to lower levels than official statistics indicate), but also probably eventually will ebb further than many high priests predict. A sharp deterioration in China’s GDP levels and prospects probably entails heightened internal political risks.
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China at a Crossroads- Economic and Political Danger Signs (8-5-18)
“(All down the line.) We’ll be watching out for trouble, yeah.”
The Rolling Stones, “All Down the Line”
NYMEX natural gas (nearest futures continuation) probably will remain in a sideways trend between 2.40/2.50 and 3.20/3.45 over the next few months. However, United States natural gas inventories from the days coverage perspective (stocks relative to consumption) are much lower than the historical average. Suppose economic growth remains moderate and that commodity prices in general (and those in the petroleum complex in particular) do not collapse. This natural gas inventory situation, assuming it persists, makes it probable that the marketplace eventually will ascend over 3.20/3.45 toward major resistance around 4.00/4.10. The most likely achievement of a flight to 4.00/4.10 is around winter, whether that of winter 2018-19 or thereafter. A colder than normal winter (or even belief such will occur) boosts the chances of such a spike. If widespread expectations of upcoming massive US natural gas production increases are disappointed, that also likely will rally prices above 3.20/3.45 and toward 4.00/4.10.
Over the past year or two, the natural gas industry probably has shifted toward a lower level of desired (“appropriate”, “reasonable”, “normal”, “prudent”, “sufficient”) stock holding relative to historical averages. Why? One factor probably is faith that calendar 2018 (and subsequent) gas production will remain far over that of calendar 2017. So many players probably believe there “always (or almost always) will be enough gas around”. Another variable likely encouraging lower inventory in days coverage terms is the substantial expansion of America’s pipeline infrastructure. Thus it has (will) become easier to move sufficient gas to many locations where it is needed. Moreover, the growing share of renewables in total US electricity generation arguably to some extent reduces the amount of necessary natural gas inventories.
These structural changes in the US natural gas marketplace apparently have shifted the natural gas inventory management approach to more of a “just in time” (lower inventories) relative to a “just in case” (higher stockpiles) method.
However, the natural gas inventory situation nevertheless appears somewhat bullish. Even if the “reasonable” level of industry holdings of natural gas inventories has tumbled relative to historical benchmarks in days coverage by a few days, prospective levels for October 2018 and October 2019 nevertheless appear “low” relative to “normal” totals, particularly from the perspective of the winter stock draw period.
Arguably many natural gas marketplace participants are overly complacent regarding the availability of supplies, particularly in periods of high demand. Imagine a colder than normal winter. Emerging worries that available supply (whether in days coverage or arithmetical terms) is or may be tight can inspire heated scrambles to procure it.
Energy Information Administration (“EIA”) statistics indicate that calendar 2019 US liquefied natural gas (LNG) net exports will be substantial (notably higher than net LNG exports in 2017 and 2018). This net foreign demand for LNG will tend to tighten the US inventory situation. Also note that in calendar 2017 and 2018, America was a net importer of natural gas via pipeline; in calendar 2019, the US becomes a net exporter via pipeline.
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US Natural Gas- Waiting for Fireworks (7-3-18)