The financial markets do not like uncertainty
The stock markets are at a low ebb, a trade war between the United States and China remains possible and Europe is suffering from major political uncertainty with the endless negotiations on Brexit and the financial concerns regarding Italy. We discussed these subjects with Evert Van Meeuwen, portfolio manager at NN Insurance.
The financial markets have been in a negative spiral for several weeks now. What is this due to exactly?
Evert Van Meeuwen: There is not just one reason. The current correction is the result of several economic and political elements.
Economically, the situation may be qualified as being relatively decent for some time. The United States is experiencing the longest period of economic growth in its history, with the current cycle beginning in 2009. This has contributed to bringing unemployment in the United States to a very low rate of 3.7%. In the past, the same level of unemployment was often followed within a year by wage inflation and a recession, a scenario which several economists are also considering today. But at the same time, although the growth period is long, the growth itself is relatively weak. There are therefore still a lot of people who are outside the labour market in the United States, i.e. people who do not work but are not included in the unemployment figures. The American labour market is therefore not as good as what the figure 3.7% might lead one to believe. Wage inflation therefore remains limited, which, according to some, suggests that there is not a recession in sight.
It is also impossible to dissociate the fall of the stock markets from the world monetary policy. In the United States, the federal government is in a cycle of a rise in rates. American stocks are relatively expensive for the moment. And the trade war with China is still a threat.
The period of economic growth in Europe has not been as long, but there is also the question of the disappearance of a certain number of monetary stimuli. The process of 'quantitative easing' should be over at the end of the year, but the interest rates will in all likelihood not be raised before the summer of 2019. There is a feeling of uncertainty in Europe with the budgetary problem in Italy, Brexit, the past financial situation in Turkey and the economic relations between the United States and China, as well as the growth and the debts in China today. All of this leads to a certain apprehension in Europe, including among investors. The fundamentals of the economy, the macroeconomic indicators such as business and consumer confidence, and company profits are nevertheless still decent. We cannot say that the economy is not doing well. Only the stock market is on the decline. And the stock market often heralds what will happen at economic level. The question is therefore whether we are headed for a recession, which does not only concern Europe. Two thirds of corrections whereby the stock markets lose at least 10% are not followed by a recession. This was not the case in 2016. We must therefore wait and see.
What is the impact of the cooling of economic relations between the United States and China?
Evert van Meeuwen: This impact is currently estimated at a 0.3 or 0.4% drop in growth for the world economy. It is therefore not insignificant, but it is not huge either.
It is important to dwell for a moment on the relations between the United States and China. Since World War II, the United States has been the world's leading power and has more or less forced their vision on the rest of the world. In the past 20 years, China has experienced an impressive evolution with its economy centred on exports. Thanks to these exports, the huge population and an increase in domestic consumption, the Chinese economy is expected to become the world's leading economy as of 2030. There is therefore a battle taking place to be the world's biggest economy. It is a power struggle with many different aspects: geopolitical influence in southeast Asia, creation of artificial islands by China in order to take over the South China Sea, and many investments by China in order to recreate a sort of Silk Road. This financing of major projects by China extends even into Africa.
There is also a macroeconomic aspect. When everybody is becoming specialised in the framework of international commerce in specific activities, trade is a means for all of the stakeholders to progress. But another economic effect is that it creates more and more inequalities: certain professions or categories of the population benefit more than others from open economies. In western countries, we often see that lower paid/skilled jobs are often neglected, as they can easily be filled at a lower cost in developing countries. International trade is also the reason why a country has less control over its own economy and depends more on international rules, which is sometimes a very sensitive issue. This is why more and more populist rhetoric is being heard, such as that of Trump and La Liga, pleading for a reinforcement of the control of the national economy.
In this case, Trump has often referred to the commercial deficit of the United States with respect to China. This means that the United States imports much more from China than it exports to China. Trump is also annoyed with China's non-compliance with certain rules, such as rules relating to intellectual property rights. All of this has led to American taxes on Chinese products, which currently amount to 10%, but could increase to 25% within a few months. According to calculations, this could have a negative impact of 7% on American stock markets. And of course, China has taken countermeasures, although they are less radical for the moment. This is a clever move at this stage, which could predict where all of this will end up. If both countries find a middle ground, the impact on the financial markets will be rather positive. But if the conflict degenerates and results in an international trade war, there will be a far greater problem.
Brexit negotiations are still getting nowhere. Does this affect the markets?
Evert van Meeuwen: Yes, in the sense that there is uncertainty especially among investors outside the euro area who observe the markets from a distance. Several scenarios are also possible for Brexit, with either a 'no deal' or a solution. In the first case, there will be very serious consequences for British companies.
Italy is also a major factor of uncertainty.
Evert van Meeuwen: Yes. Italy is the third biggest economy in the euro area and is therefore important. Economic growth in recent years has been weak, and the public debt has increased to more than 130% of the GDP. Unemployment is also high. All of this leads to a complex situation for the Italian government. The economy has to grow, but the monetary room for manoeuvre is small. The monetary policy is determined by the ECB, which looks at the global situation in Europe and not only in Italy. Fiscally, the government could stimulate growth, but that is not simple either: reducing taxes would further decrease the amount of money available in the state coffers and would keep increasing the budget deficit, which is too high according to European standards. To sum up, the Italian economy must grow, but the Italian government does not have the means to support it. The debt must decrease, but for the moment, Italy has had a government deficit each year. The Italian government has made several proposals, but they are not sufficient for Europe. Discussions are therefore dragging on. Italy's only advantage is that a large part of the debt is borne in Italy. Therefore, there is certainly some hope that the trend will reverse, but the uncertainty clearly plays against the European financial markets.
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