Will markets in 2018 defy predictions again?
IT’S the time of the year. After Black Friday, it’s an insane time for the Wall Street community of economists, stock analysts and bond strategists as they go about defining year-ahead outlooks.
All this despite their near universal failure to predict what happened this year – 2017. Sure, forecasting is difficult. The future confounds even the experts.
The IMF, World Bank, OECD and private think tanks – for all their expertise – have consistently failed to predict growth and inflation 18-24 months ahead. Markets have since performed opposite of virtually all predictions.
In 2017, almost all was bullish about the prospects for higher bond yields, stock prices and the US dollar, driven by rising wages and President Donald Trump’s prospective tax cuts.
A year on, inflation hasn’t materialised, and the impact of the tax cuts remains uncertain; still most were wrong: benchmark 10-year Treasury yields are down, not up; US dollar is down, not up; and S&P 500 has gone wild – up more than twice the gains of even the most bullish on Wall Street.
Notably, this year’s lack of inflation was a “mystery” (including for the Fed).
Not surprisingly, investors became increasingly convinced that inflation would stay dormant, bringing down long bond-yields and the US dollar, even as the buoyant economic numbers boosted profits and stock prices.
Still, they did offer two useful lessons: prices can go only one direction – that’s dangerous; and, we really know a lot less about how the economy and markets really work.
Be that as it may, 2018 could be different. The global economy is in relatively good shape and inflation could begin to stir soon. The Fed may quicken its winding-down pace. The long-awaited bond bear market could be around the corner.
An interesting lesson from the failure of bond prices to pick up this year was that yields were held down by the US$4 trillion of bonds held by the Fed: it seems to me it matters to the market how much the Fed holds rather than how much it buys or sells.
But investors tended to focus instead on the flows. For 2018, the consensus favour inflation to quicken to 2% by end-2018, 10-year Treasury yield to rise to 3%, and the S&P 500 to gain a further 7%-8% to beyond 2,825 points.
And so, faster inflation and tighter monetary policy in the US, EU and Japan will have material consequences for “fixed income”. This could imply up to 2% annual loss for developed bond markets, the worst performance since 1994. Nevertheless, the much maligned annual outlooks do serve a useful purpose – a kind of mental exercise to make us step back periodically, re-think and revisit assumptions.
Ultimately, the value of year-end stock takes lies in the analysis they contain, not so much the numbers they predict.
The global economy is growing, this time in a synchronised recovery and continues to gather strength. Less than two years ago, the world faced stalling growth amid financial market turbulence. Today, we have continuing strong expansion in Europe, Japan, US and even China. Financial conditions remain buoyant across the world, with financial markets being stable and expecting little turbulence going forward – even as the Fed Reserve continues with its monetary normalisation process and as the European Central Bank prepares for its own.
The OECD now (as the IMF in October 2017) forecasts 3.6% growth in the global economy this year (up from 3.1% in 2016) and expects to reach 3.7 % in 2018, close to its 1990-2007 average.
Among G-7, only the UK expanded at a slower rate than in 2016. As to be expected, China and India are setting the global pace – GDP in China rose by 6.8% in 2017, with an expected 6.5% in 2018; in India, however, GDP rose 6.7% in 2017, rising to 7.4% in 2018.
As a group, emerging market economies (EMEs) in Asia performed the best: at 6.5% in 2017 and continuing at this pace into 2018; with the Asean 5 biggest nations (including Malaysia) expanding at 5.2% in 2017, and again in 2018. Consumer price inflation has softened as the boost to prices from the oil price recovery of 2016 faded. Despite stronger growth in domestic demand, core inflation remains muted. Inflation, however, is likely to rise only gradually in 2018.
Still, is growth sustainable? Considering that throughout G-7, (i) investment growth has remained sluggish; (ii) rise in labour productivity has been well below the 1995-2007 average; and (iii) high indebtedness continues to constrain the pace of growth.
Both corporate and household debt remain high. Similarly, EMEs are also plagued with high debt, especially corporate indebtedness, much of it in foreign currencies.
Corporate debt/GDP ratio in China is already the highest in the world. The associated risks are of concern, given that interest rates are likely to rise in the face of stronger growth and prospects of higher inflation. In all, high and rising debt makes sustaining growth more difficult. In addition, the world economy also faces serious political risks as well as threats to liberal trade.
United States: Growth in US, now in its 9th year, is running at full capacity for the first time in a decade. GDP in 3Q’17 rose 3.3%, slightly above the maximum sustainable level. Compared with a year earlier, corporate profits are up 10%. Looks like the year will end on a solid footing, with the 4Q17 2.5% GDP growth-pace continuing into 2018, amid plans to cut taxes. The unemployment rate is closing on to just below 4%. It is likely the economy is now in the late phase of its business-cycle expansion.
Still, disturbing longer-term trends overshadow the US outlook: rising public debt, weak productivity and widening income and wealth inequality. Under her watch, Fed Chief Yellen raised interest rates five times – three hikes in 2017. As I see it, next year is likely to be an inflection point for global monetary policy. Together, central bank balance-sheets have swelled by US$15 trillion over the past decade, with interest rates being cut to multi-century lows. The change in Fed leadership is unlikely to derail the scheduled balance-sheet reduction in 2018; while its European counterpart can be expected to finally begin to wind-down its bond-buy- ing program. The flattening US yield curve is bound to change as inflationary expectations build. The harbinger of recession? Too early to tell.
Eurozone: Current main indicators of growth and inflation point to an economy now firing on all cylinders. After a solid third quarter, latest data suggest a further pick-up in GDP growth to 3% in 4Q17. This pace is likely to continue into 2018, spurred mainly by Germany with its strong exports and accelerating investment outlays – despite the euro appreciating by more than 12% against US$ so far this year. Added to this is France’s recovery, as business confidence hit its highest level in nearly 10 years. The more robust economic outcome will mean less heavy-lifting by monetary policy. Overall, fast eurozone growth has since led to rising inflationary expectations.
Japan: GDP rose 2.5% in 3Q17, suggesting an economy expanding beyond its potential amid continuing weak consumption and a tight labour market, with unemployment down to 2.8%. Corporate investment remains robust. Growth was largely driven by exports. Modest inflation is returning, but is still far from the Bank of Japan’s goal of 2%, despite capacity constraints in the face of severe staff shortages. Latest data point to a strong 4Q17. However, the expansion should slow down before long.
China: GDP growth rose 6.9% in the first nine months of 2017, all but certain to reach its 6.5% target for the year as a whole (6.7% in 2016). But China is changing – the focus is now more on the quality of growth, instead of the speed of eco-
nomic expansion, i.e. a switch to emphasize quality, efficiency and dynamism. To pursue a growth path that’s slower but more sustainable. Industrial output growth has already begun to soften, reflecting disruption from the pollution crackdowns in the north-east as well as factory downsizing and coal mine closures in the north. The resultant blue-skies over Beijing have upended the conventional wisdom that local government would always give priority to growth over the environment. Factory output rose only 6.1% in November 2017.
Overall, economic growth heldup well in November, benefitting from stronger exports and resilient real estate activity, and the move to reduce financial risks as authorities seek to rein in state-owned enterprises debt.
EMEs: As a group, EMEs’ output expanded the fastest at 4.6% in 2017 (4.3% in 2016) or more than twice the pace of advanced economies (2.2%). Much of the growth reflected higher domestic demand in China and continuing recovery in India, Brazil, Russia and Turkey. In per capita terms, growth rates of EMEs far exceeded that in advanced nations, giving rise to a gradual convergence in GDP per capita between the two groups, although the rate of convergence has slackened over the past decade.
This process is likely to be sustained over the period 2017-22 by rapid growth in China and India, which account for more than 40% of the GDP and population of EMEs. For 2018, GDP is forecast to rise strongly at close to 5%, led mainly by EMEs in Asia, with many nations in Latin America, sub-Saharan Africa and Middle East still struggling with subpar performance.
What then, are we to do
Of late, reviews of Malaysia’s 2017 economic performance by the IMF and World Bank have been unusually upbeat, with the expectation of more of the same in 2018.
Indeed, both talk of GDP growth rates slackening towards 5%-5.5% in the coming year, building on continuing steady growth in the fourth quarter of 2017 (4Q17).
However, best available evidence suggests “a disconnect” between the reported broad macro-numbers and actual seat-of-the- pants experience – indeed, ordinary people don’t yet “feel” any of this upbeat lift! Other than the many, messy traffic jams.
House sales are generally down; so are house rentals in a moribund property market. Many feel there is already overbuilding. More important, retail sales are down.
Also car sales are sluggish. Mallsbusiness has slackened. The Malaysian Retailers Association (MRA) and Retail Group Malaysia (RGM) have been revising their forecasts downwards, reporting contracting retail sales for most of 2017.
Their membership has even expressed “not optimistic” sentiments for 4Q17 reflecting consumption fatigue.
Most cited falling “purchasing power” and intense competition as the main causes. One thing is for sure: the ringgit doesn’t go far these days.
Hawker-stall and street food prices are significantly up. That hit pocketbooks. It does appear the drivers of “strong” performance so far are probably transient. The structural foundations are weakening. In this sense, much of the euphoric “growth” reflects a sugar high! There has been no funda- mental lift across the economy.
The suggestion that underlying structures have improved is questionable because of continuing weakness in the ringgit: fallen 35% against the US dollar over the past five years; and 15% against the Singapore dollar.
If fundamentals have improved, there would have been significant capital inflows and an appreciating ringgit. The ringgit is weak when it keeps on struggling to break the RM4 = US$1 mark.
Fair value, in my view, is less than RM3.50. Indeed, it’s a shame we now have to pay more than RM3.00 for S$1. A weak ringgit does not serve the national interest. The objective of reaching high income status must be viewed in terms of its international purchasing power. Doubtless, a strong ringgit is best.
Of greater importance is whether growth is sustainable. Despite low capital costs and abundant corporate cash (both inducement to investment), productivity growth has been very slow.
Given low labour force growth, a significant acceleration in productivity will be necessary to maintain the economic state of expansion in the coming years. Even if growth can somehow be maintained, it is fundamental for a healthy economy that its benefits are widely shared.
Unfortunately, the tendency has been for inequality to increase, with much of the growth being captured by a small “few.” There can be no meaningful and sustainable growth in workers take-home pay without successful measures both to raise productivity and to achieve greater equality.
Only in this way, can there be healthy growth. And this can only be achieved through deep, structural reforms, including wide ranging institutional transformation; commitment to quality education and R&D, high standard of universal health care; greater open government, more reliance on private initiative, and zero tolerance of corrupt practices. These are desperately needed.
Ad hoc measures, however well-intentioned, merely prolong the sugar high.
Former banker, Harvard educated economist Tan Sri Lin See-Yan is the author of The Global Economy in Turbulent Times (Wiley, 2015) and Turbulence in Trying Times (Pearson, 2017). Feedback is most welcome.