We are midway through 2018 and based on McKinsey’s most recent survey of executives’ sentiment on economic conditions, there is an increase in those who are more cautious on economic conditions and prospects for growth. It should not come as a surprise that changes in trade policy is the most cited risk to domestic and global growth in addition to being a risk to their own companies. The Bank of England’s governor, Mark Carney, has warned global political leaders about the costs of putting up trade barriers. Based on the UK’s experience with Brexit as an example, Carney pointed to their recent underperformance as a lesson in the perils of deglobalization.
As we commemorate the fiftieth anniversary of Martin Luther King’s passing, we wonder about the progress we have made in America and the rest of the world in terms of equality and peace. The United Nations, an international organization founded in 1945 after the Second World War by fifty-one countries is committed to international peace and security. They also try to promote social progress, better living standards and human rights. Yet, the UN has certainly not been successful in protecting nearly 700,000 Rohingya citizens who have been displaced from Myanmar since August 2017. We are witnesses to another case of ethnic cleansing that seems to be taking place. When we presented on Myanmar post our visit to that country during their first free general election in a generation, we were genuinely hopeful that this country would emerge to become a better country for everyone under the leadership of Aung San Suu Kyi. Her silence on this subject is viewed as complicity in crimes against humanity. While discussing this with opinionated industry colleagues, we had an animated banter about this subject. They tried to convince me that Aung San Suu Kyi has no choice but to look the other way if she wanted to stay in politics and therefore, we need to accept the fact that principals are not a valid choice in the world of politics.
Our condensed version of the global macro review of 2017 can be done in four words: Trump, elections, terror and China.
It may be fitting to observe that the current number one bestseller is “Fire and Fury”, a title that refers to a quote by Trump about the conflict with North Korea which places an exclamation mark on what was an exacerbating year. Since Donald Trump became the 45th US president in January 2017, the world has not been the same. His war of words with North Korean leader Kim Jong Un calling him “Little Rocket Man” and comparing one another’s nuclear button sizes, reminds us of spoiled and ruthless children. But here’s the problem: these two bullies are dealing with the safety of millions, perhaps billions, of people’s lives, with little certainty of a solution in the near future.
Global Macro Review
As North Korean missiles flew over the Japanese island of Hokkaido in late August and then another one in mid-September, with sirens blaring and warning the Japanese people to hide in their basements, the markets were confronted with a potential global crisis. We can only imagine what was going through the Japanese people’s minds, perhaps fearing the nightmare of a nuclear attack on their soil again. Prime Minister Shinzo Abe capitalized on this fear with his strong stance against North Korea and his call for a snap election on October 22. Prior to North Korea’s threats, Abe’s standing in the polls was battered by scandal and his decision to call a snap election is aimed to take advantage of a recent uptick in ratings. A new twist is a new party, Party of Hope, created by the Governor of Tokyo Yuriko Koike, a former cabinet minister in Abe’s government until she resigned to run for Tokyo’s governorship. Koike may not actually run in the campaign, but her party and her platform of “Yurinomics” are considered a real challenge to Abe and his Liberal Democratic party. That said, there are more similarities than differences between these parties given their conservative stance and if Abe does win a strong mandate, he will undoubtedly bring up Japan’s postwar pacifism for discussion.
The European election cycle is turning out to be more of a feel-good story rather than being tension-filled as originally anticipated. With the Dutch and French elections behind us and the populist parties being defeated in both cases, the antagonists Geert Wilders and Marine Le Pen appear to have left the stage. We still have to wait until September for the German election to take place.
This year’s European election cycle reminds us of a tension filled three act play, with all the elements of edgy characters, criminal charges, voter insecurity, and the risk of disintegration of a political union. In this European play, the first act took place in The Netherlands. The leading character was Mark Rutte, the leader of the incumbent Liberal party (VVD) representing the old regime, who was astute enough to understand the discontent among the people. He won the Dutch election, thereby fending off the antagonist. In this case, the antagonist is Geert Wilders, a person with a checkered past including being found guilty of inciting discrimination against Dutch Moroccans back in 2014. Yet, his campaign platform continued to focus on an anti-immigration message. We consider Rutte’s win a large victory against populist rhetoric of anti-immigrant and anti-Islamic politics.
If you are a liberal in your political views, 2016 was definitely a discouraging year, highlighted by the Brexit vote and Trump’s victory, along with secondary events such as the loss by the Italian government in its referendum and the rise in popularity of the right wing National Front in France. The winning theme in 2016 seems to have been that globalization is a scam to benefit only corporations and the rich. Thus, with the rise in populist politics and resulting in potential protectionist policies, a key question we ask ourselves as global managers is whether globalization is dead.
We recently had the good fortune to attend a leadership lecture featuring Dominic Barton, the global managing director of McKinsey, a global consulting company. Barton, in his very Canadian self-deprecating manner, provided an interesting overview of how different countries can find stability and growth in an age of disruption. The overriding theme is that the next twenty years will be some of the most disruptive and exciting that we have seen, driven by four global forces: (1) shifting economic power to Asia, (2) accelerating technological change, (3) the aging population, and (4) system-wide transformation where the public’s perception is based on emotion rather than fact. We definitely witnessed this transformation with the Brexit vote and the recent rejection of ceasefire between the Columbian government and FARC.
The Brexit vote and its aftermath has dwarfed all other financial and political events during the past quarter. Immediately post the June 23rd vote, we shared with you our views on this event. After digesting the news for the past two weeks, our position has not changed much. Our overriding concern lies with the uncertainty this outcome has caused and the potential contagion to other markets globally. While we do not believe this will trigger a financial crisis in the order of magnitude of a Lehman failure, we do need to be cognizant of what appears to be a fundamental change in the environment.
If you went away at the beginning of the year and came back at the end of the quarter, you might think that not much took place over the last three months. Well, in a way, that is true. We ended the quarter about where we started, despite the wild rollercoaster ride in the interim, with main equity indices dropping to multi-year lows and then rebounding. The tumultuous first six weeks was caused by key macro concerns centered on China, oil uncertainty, geopolitical risks and skepticism around growth in general. Widening credit spreads in January, especially in the Energy sector added to the apprehension. 50% of distressed high yield debt is in this area! However, the WTI oil price moved back up to U$38 at quarter-end from the low of U$26 in mid-February, high yield spreads narrowed, and the China devaluation concerns also seemed to diminish. Global equities, which had formally entered a bear market in mid-February, quickly reversed into one of the best low quality trade rallies in recent memory.