“At all times, in all markets, in all parts of the world, the tiniest change in US interest rates changes the value of every financial asset.”

Warren Buffett. American Business Magnate, renowned investor and philanthropist.

Economic update – assessing global growth

Despite worries about activity in the US and Europe, the global economy has not stopped growing. The International Monetary Fund forecasts that the global economy will expand by almost 20% over the next five years.

20% global growth compares with a forecast of a 5.4% increase in the world’s population. So, despite an increasing world population, average GDP per capita is forecast to grow by nearly 15% by 2028 with the strongest gains being seen in emerging and developing economies.

This represents the next stage of a process of economic expansion that has been underway since the Industrial Revolution. Of course, what is far more recent is understanding the connection between growth and carbon emissions, a realisation that is transforming economic policy – but has yet to arrest the rapid growth of emissions.

Growth has been in short supply in many European countries, especially the UK, for over a decade. But for all the angst about declining productivity growth in the West, the dominant global story remains one of growth, not stagnation.

China has been the engine of global growth for the last 20 years, making an outsize contribution to the doubling in size of the global economy over this period. Despite a shrinking population and slowing growth, China’s sheer scale, some 1.4 billion people, combined with an annual growth rate of around 4.0% means that the Chinese economy is likely to expand by a quarter by 2028.

Such growth in the world’s second largest economy would see China accounting for more than a quarter of global growth between 2022 to 2028. Chinese GDP exceeds America’s when using Purchasing Power Parity or PPP—currency exchange rates based on spending power in different economies– but on market exchange rates the US is the world’s largest economy and is set to remain so in the medium term.

If you Google the term ‘US decline’ you will find plenty of articles arguing that America is a power in economic decline. The opponents of such a view can take some comfort from the fact that the IMF reckons the US will be the fastest growing G7 country over the medium-term even though it is already richer on a per capita basis than any other G7 country.

A recent article in The Economist deployed a range of data to argue against the declinist view of the US. On the question of living standards, one of the most remarkable ones was that “a trucker in Oklahoma earns more than a doctor in Portugal”. Less graphical, but equally striking, is the fact that that GDP per capita is about 20% higher on a PPP basis in the US than in Germany according to the IMF.

The IMF forecasts that the US will account for 20% of global growth up to 2028, in part because its population is forecast to increase by 13million.

As China’s growth rate slows, we are likely to hear more about growth elsewhere in Asia. The Indian economy is now more populous than China’s and its growth rate is forecast to eclipse China’s over the next five years. Growth elsewhere in Asia, particularly in Vietnam, Bangladesh, Indonesia, the Philippines, Malaysia and Cambodia, also looks set to outpace Chinese growth. Vietnam and Bangladesh are growing particularly quickly. The IMF forecasts their economies are likely to expand by almost 50% between 2022 and 2028.

These countries have benefitted from companies looking to shift their supply chains outside of China. For many of these countries, their labour costs are now far below those seen in the manufacturing hubs of China.

South Korea is perhaps the clearest example of a development success story. As recently as 1980, South Korean GDP per capita was just 20% of that of the UK. By 2024, the IMF expects South Korean GDP per capita to exceed the UK’s. Yet South Korea is still classified by some as an emerging market, a description that now seems hopelessly out of date.

Many of the fastest growing countries over the next five years are likely to be in sub-Saharan Africa. Uganda, Tanzania, Ethiopia, Rwanda, Kenya and Senegal are just some of the African countries which the IMF sees growing by an average of over 5.0% a year between 2022 and 2028.

Several advanced economies including notably Japan, Italy and Germany are predicted to see very slow economic growth rates over the coming years, in part because of ageing populations which are forecast to fall in the next 5 years.

For all the problems of the West, the global economy is continuing to grow, and that growth is helping improve the human condition. The number of people living in extreme poverty has fallen from almost 2billion to 0.66 billion since 1992. This achievement is even more remarkable when one considers that the world’s population has expanded by almost 3.5 billion in this period.

The poverty-reducing effects of growth are clear. But so, too, are its impacts on the environment and world temperatures. The quest for carbon-free growth is arguably the greatest economic challenge of this century.

Stock Markets

Booming Britain

Well not quite, but a pleasant surprise, nonetheless.

UK GDP expanded 0.5% in the month of June, well above consensus expectations.

The Office for National Statistics (ONS) attributed the expansion to a recovery in activity following May’s extra bank holiday. This was most noticeable in manufacturing, where output grew by 2.4%, the strongest monthly rise in almost two years. Growth in pharmaceutical output and the manufacture of transport equipment both helped. This means that in Q2 2023 the UK economy expanded by 0.2%, above the Bank of England’s most recent forecast of 0.1% growth.

The UK consumer seems to have a split personality; low on confidence but prepared to spend. Problematically for economists, it is difficult to identify a representative UK consumer; consumption patterns represent the amalgamation of myriad situations and choices. So, it was interesting to come across a new term – Generation Guppies “Give up on owning Property” – that headlined recently.

According to Zoopla, four out of ten adults aged 18-39 who don’t own a home say they’ve given up on the idea of buying one in the next ten years. Perhaps, this is a factor in higher leisure spending. Or it may be that the generations that have benefited from house price inflation” Baby Boomers” and “Generation X” are being helped by higher savings rates – having substantially reduced their mortgage obligations over time and sitting on significant housing equity.

Unfortunately, the disjointed nature of government housing policy over decades – whose main thrust has been to prevent any downward move in capital values – has protected the strong, frustrated the young and enriched housing company directors. A sub-optimal outcome I would say.

Back on the data front where US inflation was centrepiece. In truth, there was little that was unexpected. The headline CPI rate rose from 3.0% to 3.2%, whilst the core rate edged down from 4.8% to 4.7%. Investors took these readings pretty well, sensing that the underlying inflation outlook is improving. One feature stopping the CPI data from declining more sharply is housing costs – a lagging element in CPI. With house rental inflation now showing signs of moderation it is expected that the housing component, which is a significant part of CPI, will be on a downward trend through the rest of the year, helping to take headline inflation lower.

China remains an outlier, with inflation going negative in July. It has not followed the pattern seen in other economies of an inflation spike as lockdowns ended. One clear difference is that China has not seen a surge in food prices – with domestic production coping with demand and cost pressures. In addition, it appears that Chinese manufacturing companies geared up for a global surge in demand for their products that has just not materialised. In consequence, goods price inflation has dropped with more production diverted to domestic consumption.

There was more bad news in the Chinese real estate market with Country Garden, a leading property developer, missing payments on bonds

Greedflation or Scapegoat

There is a small art gallery on the Wirral that houses a picture painted in the mid nineteenth century by William Holman Hunt, a leading pre-Raphaelite artist. It depicts “The Scapegoat”, an animal that carries away human sins. It is a striking image. The gallery is named after the Lady Lever, the wife of the founder of Lever Brothers, and is situated in Port Sunlight. Both the gallery and model village are worth a visit and are a good reminder of the philanthropy undertaken by leading Victorian entrepreneurs.

Having lived in Cheshire for many years, I have always been interested in companies with roots in the area. The dismantling of ICI in the 1990s came with a sense of regret – one of the few giant manufacturing companies that could compete globally. But before becoming too nostalgic it is worth remembering that, as at end June 2023, both the UK’s largest quoted company and the largest private company have roots in ICI.

Another company with Cheshire roots is Unilever, the result of a merger between Dutch margarine and English soap in the 1920s. I would guess William Lever, back in the 1890s, had an eye on keeping his workforce productive. Port Sunlight may not have been all altruism but whatever the motivation the village stands as testament to long term thinking.

Unilever was in the news last month. Results beat expectations and the share price moved up 4% on the day, adding nearly £5bn to its market capitalisation. What is striking has been the ability to increase margins over time. Is this Greedflation?

Well, Unilever’s operating margin compares favourably to UK supermarkets. But coming back to “The Scapegoat”, it is not Unilever’s job to protect the public from inflation. So, we shouldn’t castigate the company for higher Magnum prices. It is, after all, the Board’s responsibility to oversee the business in the best interest of shareholders.

But what about the long term? I think William Lever had a generational focus, but it has to be acknowledged that the nature and tenure of corporate leadership has changed a lot since then. Ownership and management have become more divorced, and incentives focus on the short term – not surprising when the average term of a UK CEO is about five years.

Governments have a part to play in tackling inflation – not through price caps but ensuring that competition is robust and that new challengers are not strangled at birth by over-regulation. Big companies see regulation as a handy “barrier to entry” to ward off bothersome competitors. And consumers, like me, have a part to play by switching to cheaper or own brand products. Time to cut back on the Magnums anyway!

Back to the markets

As expected, the Fed, the ECB and the Bank of England all hiked rates by 25bps. In the US the increase took the US Fed Funds target range to 5.25% – 5.5%. Whilst the Fed left the door open to another rate hike, markets are positioning for a peak around current levels. Chairman Powell commented that real rates as are now positive and are expected to put downward pressure on inflation and activity. Less helpful was the message that inflation is not expected to fall back to 2% until 2025. A soft US landing scenario seems to be the consensus.

The ECB took its deposit rate to 3.75%. Overall, the messaging was dovish, and markets sense a change. A further hike seems likely but the ECB’s emphasis on expected inflation declines and reference to tighter financial conditions implies a row back from its previous hawkish stance.

In the UK the Bank of England increased rates by 0.25% to 5.25% with markets expecting rates to peak early next year at around 6%. Andrew Bailey said it is too soon for the UK to declare victory in the battle against inflation and that the “last mile” will require a prolonged period of restrictive interest rates. The Bank forecasts that inflation will fall to 5% by the end of this year but does not expect it to fall to the target of 2% until the second quarter of 2025.

However, the biggest potential impact on debt markets came from a central bank that kept rates on hold. The Bank of Japan adjusted its Yield Curve Control (YCC) policy – in effect letting ten-year government bond yields rise above 0.5%, with a new cap at 1%. There is scope for further weakness in ten-year Japan government Bonds and this will have ramifications for other markets – as Japanese bond yields become more attractive. The latest data shows that Japanese investors hold $1tr in US treasuries and account for 15% of foreign holdings.

US Debt

Gold and other safe haven assets rose after the US was stripped of its top-tier sovereign credit rating by Fitch, echoing a move made more than a decade ago by S&P. The credit assessor downgraded the US to AA+ from AAA, citing “repeated debt limit political stand-offs and last-minute resolutions have eroded confidence in fiscal management”. The agency expects fiscal deterioration over the next three years. Biden administration officials objected strenuously, and Janet Yellen criticised the decision as “arbitrary” and “outdated.” Moody’s still rates the US triple A, its top rating. Lawrence Summers said it’s “absurd” to think there’s a risk the US will default on its debt.

Meanwhile, the latest figures pointed to a tight labour market and a slight improvement in manufacturing activities, supporting the view that the US will avoid a recession.

Wise words

We are slowly emerging from a prolonged period of distortion born of zero interest rates. The process of unwinding the excess will take time and requires patience on the part of investors. This is frustrating as market volatility makes the waiting uncomfortable and can entrap investors into making rash decisions which they later regret. We must remember that volatility is a symptom of the fact that investors are trying to establish the market value of an asset which often happens at times of significant economic shift and uncertainty.

Howard Marks, the legendary co-founder of Oaktree Capital Management made the case recently for only making big pronouncements on market direction very rarely. In an investor note, he said he had spotted meaningful moments in this space, only five times in 50 years.

“Once in a while, perhaps only once in a decade, markets go so high or so low, that the argument for action is compelling and the probability of being right is high. What if I tried to make 50 market calls in my 50 years…or 500? One key is to avoid making macro and market calls too often. You must pick your spots and most of the time you have nothing to lose by abstaining from trying to adroitly get in and out of the markets. You should sit back and do nothing and merely participate in their long-term trends, and those have been very favourable. Don’t be distracted by short term noise and the Pessimist brigades. Stay invested. Stay committed. Stay loyal to the belief that over the long term, equity investing is the best way to build wealth.”

With those wise words ringing in your ears, park yourself on a sun lounger somewhere and chill or go and sit in an air-conditioned cinema and watch the Barbie movie whilst enjoying a Magnum!

As always, we thank you for your continued support and we look forward to updating you regularly throughout 2023. Please get in touch if you have any questions.

Keith W Thompson
Clarion Group Chairman
August 2023

Creating better lives now and in the future for our clients, their families and those who are important to them.

Risk Warnings

Any investment performance figures referred to relate to past performance, which is not a reliable indicator of future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments, and the income arising from them, can go down as well as up and is not guaranteed, which means that you may not get back what you invested. Unless indicated otherwise, performance figures are stated in British Pounds. Where performance figures are stated in other currencies, changes in exchange rates may also cause an investment to fluctuate in value.

The content of this article does not constitute financial advice and you may wish to seek professional advice based on your individual circumstances before making any financial decisions.

Stock market and economic commentary August 2023