US economy faces ‘Wile E Coyote moment’
THE FTSE 100 is on course for its worst year since the financial crisis as economists warn that investors need to brace for a “Wile E Coyote moment” when the overheating US economy runs off a cliff edge in 2020.
Around $3 trillion (£2.3 trillion) was wiped off the value of global stock markets in a week-long rout sparked by fears of surging US borrowing costs. However, the Centre for Economics and Business Research has warned that its model suggests that US stocks are still overvalued by around 30pc even after this week’s sell-off.
The FTSE 100 has now tumbled 9pc in 2018 after markets were rocked by expectations of the Federal Reserve maintaining the brisk pace of its interest rate rises in an effort to rein in the booming American economy.
However, a “poisonous mix” of reduced fiscal stimulus, higher inflation, rising interest rates and protectionism could combine to slow the US economy in the coming years, Gregory Daco, US economist at Oxford Economics, argued. Economic “growth exhaustion could be the real Wile E Coyote moment in 2020”, he predicted.
Slowing growth in the world’s largest economy could add to existing restraints on the UK economy. The EY ITEM Club, which uses the Treasury’s model for the economy, has downgraded its GDP growth forecast for 2019 by 0.1 percentage point to 1.5pc as Brexit and trade war uncertainty bite.
The US 10-year Treasury yield – a benchmark borrowing rate for global markets – hit its highest level in seven years this week as markets scramble to adjust to strengthening growth and inflation in the States.
Markets are pricing in at least three more increases in US borrowing costs in the next year. The Fed is “underestimating the impact” of its rate rises, Michael Pearce at Capital Economics warned. He said its hikes have translated into “a larger than usual increase in market interest rates”, causing growth to “sharply” drop when Mr Trump’s fiscal stimulus wears off.
‘If Powell keeps up the fiery rhetoric, US stock markets will continue to fall, dragging all others with them’
Any politician who asks, like some kind of fund manager, to be judged by stock-market performance is going to end up disappointed, but that doesn’t seem to stop them repeatedly playing that game. When the Dow was soaring, Donald Trump was more than happy to claim the credit, and take it as a vote of confidence in his policies. Now it’s stalling, he blames the Federal Reserve for “going loco”.
Mr Trump has plenty of form when it comes to Fed bashing. Campaigning for the presidency, he would routinely accuse Janet Yellen, the chairman at the time, of holding rates low so as to benefit his rival Hillary Clinton. Now he’s in power, he expects the go-easy treatment. Rates should be held low, he argues, to counter any negative consequences from his trade war with China.
Jay Powell, his own supposedly compliant replacement for Yellen, is proving a big disappointment. Trump thought he had appointed a cheap money guy who would keep the stock market well juiced. Instead, Powell has so far proved a surprisingly independent hawk who threatens to murder Trump’s bull market in its bed. Every time he opens his mouth, he seems to grow fiercer still. The economy has been driven to boiling point by the President’s fiscal stimulus, he seems to be saying; the inflationary consequences need to be countered.
Stock markets can be difficult things to read, but on this occasion it is surprisingly easy. If Powell keeps up the fiery rhetoric, then US stock markets will continue to fall, dragging all others with them. If, on the other hand, Mr Powell is persuaded by a bullying Mr Trump to come grovelling on bended knee to the White House to repent his sins, then markets will enjoy some kind of reprieve. Reversal is what investors hope for. Hyped into bubble territory by the Fed, markets can also be saved by the Fed. But if he chooses that route, it will be curtains for any notion of Federal Reserve independence. He’ll be seen to have caved. He’s damned if he does, and damned if he doesn’t.
BAE Systems, Britain’s largest defence contractor, finds itself between a rock and a hard place over the disappearance of the Saudi dissident Jamal Khashoggi. Under a governmentto-government contract, BAE has several thousand staff working in the kingdom and is in the midst of negotiations to sell billions of pounds worth of Tornadoes to the Saudi military. Its exposure is mirrored in a wider sense by that of the UK Government itself, which relies heavily on intelligence cooperation with the Saudis and regards the kingdom as a key ally in the region.
Already grappling with the outrage of attempted assassinations on UK soil by Putin’s Russia, the UK cannot be seen to be turning a blind eye to what may very well be the same thing by the Saudis in Istanbul. Presumably, the evidence for what occurred will soon be available to all. Turkey claims to have a secret video recording. One hardly needs to ask how it might have come by such a smoking gun. If it exists, it can only be a matter of time before it gains universal exposure.
If the work of a Saudi hit squad, then the next question has to be who authorised the killing and at what level? Mohammed bin Salman’s grip on the kingdom has looked increasingly fragile in recent months, compounding suspicions that it goes all the way to the top. Absence of any response from the crown prince has only heightened the sense of disarray.
Is this just another piece of unfortunate Middle Eastern intrigue that will soon blow over, or is it something much more serious? Trump has suggested the former; he is determined it is not going to interfere with US defence orders. But Jeremy Hunt, the UK Defence Secretary, has been more forthright, as he must with the Salisbury nerve-agent attacks in mind. And even Trump could be forced by a plainly incensed Congress into applying sanctions. The dangers are obvious; as has occurred with Assad’s Syria, the moment the West vacates its strongholds in the Middle East, there will be others more than willing to step into the breach, not just Russia, but also an increasingly assertive China. Dangerous times indeed, and a virtually impossible judgment call for the UK Government.
Shell’s transitioning challenge
Over the next few years, Big Oil faces a major strategic decision; the biggest, in fact, since today’s six or seven “supermajors” came into existence. Do they accept that pressure to deliver a zero-carbon world means their time is drawing to a close, and beyond ensuring a basic level of investment in existing reserves, put themselves into run-off? Or should they capitalise on abundant cash flow to transmogrify into more sustainable general energy suppliers that have a long-term future?
Major investors tend to fall into three categories in answering this question. Some urge managements not to take climate change seriously at all, and stick to what they know best. Others say simply that investment in energy alternatives is valuedestructive and therefore not worth bothering with; it is for investors to decide which energy assets they hold, not managements. Still others take a more positive attitude, and in recognition that most other energy providers lack the scale to manage the transition, urge a more ambitious approach to the future. Support for this third case comes in new research from Goldman Sachs which argues that the oil majors have the opportunity to lead from the front in delivering a two-degree world. Not only would it ensure long-term survival, Goldman argues, but in adopting such an approach they could even enhance their returns to shareholders.
Any such transition is going to require immense skill and vision. Many investors will remain sceptical. But if the business case can be made for it, and if the returns are made demonstrable, then there is no reason to believe they cannot be won over.
Under chief executive Ben van Beurden (see Jillian Ambrose’s interview on pages 6 and 7) Shell already invests about $2bn (£1.5bn) a year in alternative sources of energy. This might seem small beer in the context of total capital spending of $25bn, but even so it makes Shell one of the biggest single investors in the world in addressing the climatechange issue.
As things stand, Shell is a dividend gusher without equal – a whopping great $16bn was paid out last year. It’s the ultimate income stock. It would be nice to see that sustained into the long-term future. Transitioning from Big Oil to Big Energy is a path fraught with danger; it could as easily prove the company’s undoing as its salvation. But it’s perhaps better to at least test that path than the alternative – slow death by a thousand cuts.
A trader reacts at the New York Stock Exchange as stocks extended deep losses in volatile trading on Thursday