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“There are two kinds of forecasters: Those who don’t know, and those who don’t know they don’t know.”

Summary

In the 1930s, for over eight and half years, the US ran a trade surplus. Presumably, had Donald Trump been US President at the time, it would have made him a very happy man. Or maybe not. The 1930s will be remembered for the Great Depression, the worst economic downturn in the history of the industrialized world. President Trump likes to blame “tariff barriers and unfair trade practices” for America’s trade deficit. However, the key issues that are prevalent in the US since the 1980s, are a high domestic consumption rate, a low savings rate and a low investment rate. America has a deficit because it consumes more than it produces and spends more than it earns, both privately and as a nation. The obsession that every country’s policymakers has with running a trade surplus ignores one basic reality: All governments cannot run a trade surplus. For every surplus, there has to be a deficit. For the sake of the US Dollar and the US itself, Trump should focus on the budget deficit and the national debt and not obsess excessively with the trade deficit. If the recent tax cuts fail to accelerate US growth, let alone reach +4% as Trump has suggested, the deficit will soar and make fiscal conditions worse. How long will foreign investors then continue to finance the US deficit? Every indebted economy has a day of reckoning. For the US the risk may not be immediate but it certainly is rising. It was debt that caused the UK and Sterling to lose their crown to the US and the Dollar. The enormous post-war balance of payments deficit was just too much for the UK. Debt had taken its toll.
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“What kind of society isn’t structured on greed? The problem of social organization is how to set up an arrangement under which greed will do the least harm; capitalism is that kind of a system.”

Summary

From haggling over the price of tea on a quayside in Guangzhou in 1784 to trading in electronics and t-shirts today, over the course of more than two centuries, trade between the US and China has grown beyond imagination. This trade relationship is now the most significant in the global economy.

The world’s two largest economies account for 40% of global GDP, a quarter of all exported goods, and 30% of the world’s Foreign Direct Investment (FDI) outflows and inflows. Their fates are inextricably linked. In a way, they complement and need each other. The US cannot compete with China when it comes to manufacturing and China cannot compete with the US when it comes to product design or research and development capabilities.

The world’s most cost-competitive and largest electronics industry supply chain is in Shenzhen, China. China’s manufacturing capacity is so well honed and organised that it accounts for more than 25% of global manufacturing. It is my firm belief therefore that there will be no US-China trade war on the scale that may worry us all – and tariffs are just a negotiating tactic, albeit a necessary one. I see China opening itself up more to US exports. The US-China trade deficit will start to close meaningfully when the prosperity of China’s middle-class increases and they demand services that the US can export to China. Therefore, it is not just in the US and China’s, but also in world’s interest, that a China –US trade war is averted
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“The more the State “plans” the more difficult planning becomes for the individual.”

Summary

Despite its high debt to GDP ratio, Italy’s main problem isn’t that it borrows too much – the issue is its non-existent growth. Italy, the third largest economy in the Eurozone hasn’t grown in any meaningful way for over two decades. Tinkering on the edges and paying lip service to reform mean that the outlook isn’t very bright for Italy. The European Central Bank’s (ECB) easy monetary policy over the last five years, may have pushed the recent GDP growth rate in Italy to +1.5%’ but what will happen when the ECB winds down its Quantitative Easing program and interest rates begin to rise? A re-run of the rising sovereign bond yield and questions about the viability of Italy’s economy are bound to resurface. In terms of equity markets, I don’t believe we have entered a new market regime, despite the recent market move. We are probably entering a transition phase and despite the market rhetoric, it is premature to conclude that the US Federal Reserve is behind the curve. The steady rally up we have seen over recent years may be behind us and what we will see going forward are moves both up and down i.e. welcome back to the two-way market. I still expect the S&P 500 Index to notch an +8-9% return this year – at least 200 points higher from the current level. What I am more concerned about is the rapidly deteriorating political equation in Germany. For the first time, the Far-Right Alternative for Germany (AfD) party has now surpassed the centre-left Social Democrats (SPD) in a national poll. How long before the AfD becomes the largest party in Germany? Inconceivable one might say, but not impossible. As Angela Merkel has moved leftward to occupy the space formerly taken up by the centre-left, the AfD has little competition for anything right of centre.
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“You can easily judge the character of a man by how he treats those who can do nothing for him.”

Summary

That was a very brief US Government shutdown this week. It lasted two days. Not that I am complaining. The agreement reached keeps the US Federal government funded through February 8, but it does little to resolve the contentious issues of immigration and government spending. The deal doesn’t preclude a similar shutdown next month. Markets care more about economic data than political “noise” and the data continues to be good. On the back of US tax reform, US growth is expected to accelerate and hopes have risen of wage increases. Global GDP growth is set to accelerate to over +3.5% from +3% in 2017. The global output gap is forecast to vanish in 2018 – the first time in a decade. The International Monetary Fund (IMF) estimates that, last year, 150 out of 176 countries managed to increase their exports. That is the highest share of nations on record and slightly higher than the peak reached in 2005.

So what could go wrong? The answer is: Trade wars. We got a taste of it on Monday when the US slapped steep tariffs on imports of solar panels and washing machines. President Donald Trump now seems ready to start implementing his “America First” trade policy. Be prepared to see more such trade-enforcements in the coming months. As top exporters, Europe, South Korea, Mexico, China, and Japan are all vulnerable to US trade tariffs and the “America first” policy. However, if trade wars become a global “thing,” with nations responding with tariffs and counter-tariffs of their own in a free for all, then the European Union (and Germany in particular), Korea and Mexico are most vulnerable, given their higher reliance on exports.

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“Just because you do not take an interest in politics doesn’t mean politics won’t take an interest in you.”

Summary

2017 was yet another superb year for the S&P 500 (SPX) index and the eighth full year of the current bull market run that began in March 2009. However, sluggish wage growth in the US has been a consistent theme of this economic cycle, confounding many, who believe a falling unemployment rate should herald higher pay for workers. Hopefully, the proposed cut in corporation tax in the US will drive investments and hence wages. If corporations however, use the tax cut to buy back stock and pay a dividend (as many have done so far), the impact of the cuts on GDP growth will not be so dramatic as consumption fails to take off. Unless the coal miner in West Virginia or the single mother in South Side Chicago has more to spend, businesses will have fewer reasons to invest. This equity market Bull Run will only come to an end when the US Federal Reserve starts raising interest rates aggressively, as was the case in 2006/07 and the yield curve inverts. The rule of thumb is that an inverted yield curve indicates a recession in about a year’s time. Yield curve inversions have preceded each of the last seven recessions. On Brexit, a breakthrough last Friday in the gruelling “divorce” talks between the UK and the European Union (EU) has paved the way for talks on trade. The agreement has significantly reduced the likelihood of a “no deal” scenario when the UK leaves the EU in March 2019. Bitcoin was and still is a gamble. At this point all I would say is: A fool and his money are soon parted. A fool and his Bitcoin may take longer, but they will be parted.
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“Never appeal to a man’s ‘better nature.’ He may not have one. Invoking his self-interest gives you more leverage.”

Summary 

Angela Merkel has loomed large on Germany and Europe for the last 15 years, yet, if Edmund Stoiber had not lost the 2002 German election to Gerhard Schroder by the thinnest of margins, the world wouldn’t know of Merkel the way it does now. Merkel’s pro-migrant policy in 2015 divided the centre-right in Germany and fuelled the rise of the far-right, which entered the national Parliament for the first time after September’s elections. While Germany is clearly going to feel the pain of an unstable political environment, following the collapse this week of coalition discussions, the bigger casualties are the Eurozone and the European Union (EU) who have come to rely on a steady and stable Germany for leadership and direction. Without Merkel it will be like the EU has lost its “good shepherd”, as it deals with growing populism in Eastern Europe and with Brexit. There is little appetite in Germany for “more Europe.” Merkel’s stint as the “leader of the free world” has been very short-lived. A wise leader knows when it’s time to go. Does Angela Merkel?

In the US, the Federal Reserve (Fed) released the minutes of its last meeting. These confirmed what the market already anticipates – an interest rate increase at its next meeting in December. All eyes, however, are on the US tax reform Bill which, if passed, could alter both the growth and the inflation outlooks and push the Fed to raise rates more aggressively than currently forecasted.
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“Real knowledge is to know the extent of one’s ignorance.”

Summary:

The all-important 19th National Congress of the Communist Party of China (CPC) kicked off last week in Beijing. In his bold 3 hour and 23 minute address, President Xi Jinping, outlined the party’s priorities for the next five years. If Beijing has its way, China is on a track to becoming an economic power the likes of which we have not seen in a long time. It’s not the Japan of the 1980s, it’s much larger. It’s no surprise then that even the US National Intelligence Council warns that the era of Pax Americana is “fast winding down.” To the Western eye the ascendant power of Beijing may seem a disruption to the status quo, but to students of world history and China, it is the restoration of a millennia-long equilibrium. China was the biggest economy in the world for most of the past 2,000 years, only to be overtaken by Europe in the 19th Century. The ramifications of this Chinese growth are significant. America will almost certainly come out second best if it doesn’t change tack – with Europe a long way behind.
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“One of the symptoms of an approaching nervous breakdown is the belief that one’s work is terribly important.”

Summary:
Something remarkable happened two weeks ago. President Donald Trump, with the help of Democrats in the US Congress, managed to strike a deal on the US debt ceiling. An impasse on lifting the debt ceiling would have caused a disaster much worse than any hurricane. The agreement stunned seasoned political experts who, for years, had become accustomed to bitter partisanship and dysfunction in Washington. Trump showed once again that he does not belong to any party or ideology. He is in the White House to promote his legislative agenda and he is ready to make deals. If the establishment Republicans dislike this, then so be it. Trump likes to do deals. However, since this is politics, there will unlikely be a longterm Trump-Democrat lovefest. Democrats (and the media) will be back to hating Trump again quite soon. With the US debt ceiling suspended until mid-December, the major macro-risk for US equities has receded. As the hope for US tax reform is raised, it is hard to see what could stop the S&P500 Index (SPX) from continuing to climb till the end of the year. One main theme last week was better than expected inflation numbers in the US, the UK, China, and India.
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"There is always a well-known solution to every human problem — neat, plausible, and wrong."

Summary:
The financial markets seem very complacent regarding the looming debt ceiling debate in the United States. I am however quite concerned and anticipate a period of sustained volatility during September and October, as the debate intensifies. If the “debt ceiling” were not raised in time, the government would run out of money to pay interest on the debt, write Social Security checks and make millions of other routine payments. I don’t see the US missing payments on Treasury debt, as that would be catastrophic, however, I suspect missing payments on social security would also be not taken kindly and could send financial markets into a tailspin. US House Minority Leader Nancy Pelosi has called for passage of a “clean” debt ceiling bill without any conditions. You can be sure there are enough Democrats who want to extract concessions from the Trump administration and enough Republicans who want to cut federal spending – that this could thwart raising the ceiling in time. US Senate majority leader Mitch McConnell likes to tout he has his troupes under control, but as we all know, he couldn’t get Trump’s Healthcare bill passed. Nothing about the performance of this Republican Congress to date offers any reason for optimism that it can now deal with this issue. Beware a sell-off in risk assets starting mid-September, if not before.

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"There are no facts, only interpretations."

Summary:
The US unemployment rate, currently at +4.3%, has now hit a 16-year low and shows that the labour markets are tightening. However, wage growth is still stuck at a low level. The US Federal Reserve (Fed) is still faced with a disinflation problem. The European Central Bank (ECB) is not ready to commit to any timescale on tapering or to provide any “forward guidance” on it. In fact, there appears to have been very little debate at the ECB meeting last week about how much more easing may or may not be needed going forward. Recently the media has been abuzz with reports that central bankers in the US, Canada, the Eurozone and the UK had signalled that the days of easy money are nearing an end. Sounds like wishful thinking to me! The Fed, the ECB and the Bank of England (BoE) have all pulled back, after sounding hawkish temporarily. The easing bias is set to continue and, therefore, there is little risk of an equity market sell-off anytime soon. If President Trump could do anything to ease the regulatory burden that the US economy carries, it would be a big boost to the GDP growth. Americans spent an eye-watering $1.9 trillion in 2016 just to comply with federal regulations. If it were a country, US regulation would be the world’s seventh-largest economy, ranking behind India and ahead of Italy. The regulatory tab of the US is nearly as large as the total pre-tax profits of all its corporations.​

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