The Key Risks to Synchronous Global Growth

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The Key Risks to Synchronous Global Growth
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History tends to repeator at least rhymein the
investment world where Sir John Templetons
oft-quoted cycle of pessimism, skepticism,
optimism, and euphoria has stood the test of
time. Todays market environment is almost
undoubtedly somewhere between the optimism and
euphoria stages of Templetons bull market cycle.
A cornerstone of this late cycle bullishness is
the ongoing synchronous global economic expansion
and the associated uptick in corporate
profitability and business sentiment (see Exhibit
below). Alas, we can be certain that the
expansion will endeventually. Here are the five
factors that we believe are most likely to derail
the expansion (from least likely to most likely).
A geopolitical crisis and/or trade war. It is
impossible to ignore the rising number of
potential global hotspots (e.g., Iran, Syria,
North Korea, Russia). Of course, that has
generally been the trend for several years and
the cumulative market and economic impact has
been negligible. Historically, thats been far
more the norm than the exception. Still, markets
have occasionally been lulled into a false sense
of complacency, such as prior to the Arab oil
embargo of 1973, the Iraq invasion of Kuwait in
1990, and the September 11, 2001, terrorist
attacks.
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While the US has its fair share of political
uncertainty these days, it is unlikely to
experience major near-term policy changes, even
if there is a strong blue wave in the November
mid-term elections. A geopolitical crisis appears
more likely in Europe, where recent economic
growth trends have decelerated. Fears of a
European populist wave largely failed to
materialize in 2017, but recent elections in
Italy, continued uncertainty regarding Brexit,
and uncertainty regarding Spains elections and
tensions with Catalonia could reignite those
fears. In addition, the same structural
challenges that have weighed on the Eurozone
since the founding of the common currency remain
(e.g., monetary union without fiscal union and
tensions between Germany and the wealthier north
versus the less prosperous south). Furthermore,
Europe remains highly export dependent amidst
weak internal demand. Elsewhere, could there be a
second Arab Spring, that would cause a further
spike in oil prices? Surging oil prices are a
very common precursor to a global economic
downdraft.
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On the trade front, President Trump clearly has a
more protectionist orientation than his recent
predecessors. The Wall Street consensus is that
the Administration is increasing the pressure on
China, Mexico, Canada, the EU, and others
primarily to negotiate better deals and that no
one has a desire to reprise the Smoot Hawley
experience of the 1930s. However, the art of
these particular deals is far more multi-faceted
than any standard business negotiation. For
example, the interplay between exacting trade
concessions from China while also persuading the
Chinese to pressure North Korea to end its
nuclear program.   Emerging market contagion.
Emerging markets have a long history of spreading
contagion to the global economy (e.g., the Latin
America sovereign debt crisis of 1982, the
Mexican peso/Tequila crisis of 1994, the Asian
Tiger crisis of 1997/98). More recently, even a
relatively modest US dollar rally has intensified
fears related to countries such as Turkey and
Argentina, although neither is likely large
enough in isolation to pose a systemic risk to
the global economy.
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• 4) Diversity reduces risk
• Investors have traditionally under-valued the
  contributions of women in the economy. Investment
  strategies are emerging that recognize the
  growing influence of women, as well as the more
  general economic value of diversity.
• Jean Case, chief executive of the Case
  Foundation, commented that when the composition
  of a group is more diverse, it produces a broader
  range of ideas and breakthroughs. Investors
  should not want more diversity merely because it
  checks a box they should want it because it
  leads to a better economy.
• Athena Capital recently released a white paper
  that offers our thoughts on investing to achieve
  gender equality, including specific gender
  inclusive investment strategies that seek to
  empower women by increasing their access to
  capital, advancing workplace equity, or creating
  new products and services. The full paper can be
  accessed here.
• 5) There is no clear consensus as to whether the
  public or private sectors should take the lead in
  driving change
• Many speakers and attendees (based on audience
  polling) believe that the private sector should
  take the lead in implementing impact-oriented
  strategies.

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They argued that the best talent typically wants
to work in the private sector where innovation
can thrive (e.g., electric automobiles). A
similar number of participants came out on the
other side, noting that government, as the
largest investor in the economy, has the best
tools to drive social progress. Not surprisingly,
the discussion pointed to several examples
highlighted where the private and public sectors
intersect. For example, if the coral reefs of a
tourist-oriented city are in danger due to
climate-related activity, why not form a
business/government partnership to increase
awareness and seek to take action to stabilize
the reef? Would governments be more likely to
combat the effects of climate change if, for
example, private rating agencies downgraded
government debt in situations where a local
government has not taken action to reduce the
risk of wildfires?   Looking Ahead The subjects
addressed at the Investing for Impact
conference were challenging and
thought-provoking. It is clear that impact
investing has already achieved considerable
progress and has plenty of room for further
growth.
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China is a very different story though. The world
got a glimpse of what a hard landing in China
might look like in late 2015/early 2016 when yuan
devaluation fears sparked global growth concerns
and a sharp global equity correction. There is no
shortage of bear arguments for a forthcoming hard
landing in Chinasurging household and corporate
debt as a percentage of GDP, a murky shadow
banking system, a potential housing bubble, and
many others. That said, the naysayers have been
persistent for over a decadeand, on balance,
persistently wrong.   A known unknown. Some
risks are perpetual but unpredictable, such as
terrorism and cyber-terrorism. Heres just one
other example suppose that markets decide that
central banks are behind the curve, or perhaps
fears of an inverted yield curve trigger a run on
bonds similar to the 2013 Taper Tantrum. Even
in the last five years, there has been a dramatic
increase in the use of passive fixed income
vehicles, including ETFs. There is also a lot
more leverage in the system. A technically-driven
liquidity crunch exacerbated by passive vehicles
that fail to meet liquidity needs could rile
markets, create a negative feedback loop, and
weigh upon global economic growth (somewhat akin
to how the bursting of the tech bubble led to the
2001 recession more than the other way around).
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An inflationary surprise The widespread fear of
deflation that gripped global markets during the
height of the Great Recession appears to be gone.
Even the post-financial crisis fears of secular
stagnation and disinflation seem to have
withered. Still, the consensus is that central
banks will continue to telegraph every
exceedingly gradual step toward interest rate
normalization. A spike in inflationthe kind that
has occurred in most previous economic cycles
consistent with the Phillips Curvemay not be as
far-fetched as it seems. That is why the market
reacted so violently to the uptick in US wage
inflation data this past January. While some
inflation pressures have remain muted, largely
due to the impact of technology, one simply has
to take a look at current gasoline prices or, if
you are more industrious, the most recent
Richmond Fed Wage Component data that reached its
highest level since 1997 to see that inflationary
pressures may be building. Inflation is a true
game changer for central banks and could further
diminish the case for historically rich equity
market multiples. At a time of rapidly rising
debt. A bona fide global tightening of credit
would come at a difficult time for both
sovereigns and privates who have taken ample
advantage of sustained low interest rates.
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Since 2000, US government debt has more than
tripled to 20 trillion and corporate debt has
more than doubled to nearly 15 trillion.
Meanwhile, global non-financial public and
private debt is now 245 of gross GDP, 20 higher
than the pre-financial crisis level. Rising real
rates could unleash a default cycle for weaker
credit and the attempt to normalize interest
rates in the face of rising inflation in the US
and/or globally could crowd out growth and
unleash a default cycle for weaker credits.
  Business cycles often end when macro
imbalances or a major economic shock cause policy
makers to aggressively tighten monetary and/or
fiscal policy. However, the recent rise in
populism in the US, Europe, and elsewhere argues
against a near-term fiscal tightening. The risks
appear far higher on the monetary policy side
given the extraordinary liquidity injected into
the global economy since the financial crisis of
2007-2008. The two major pillars of support for
synchronous global growth have been bond buying
from global central banks and credit expansion
from China. While the 2017 US tax cuts may well
have extended the global growth cycle, neither
pillar is sustainable in the long-term. As such,
the risks highlighted above deserve ongoing
scrutiny.   Article Resource -
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o-synchronous-global-growth/