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Monday Macro: Turkey, core 12 month view, commercial real estate holds up, what next for natural gas markets
A quick note on the Turkish elections, plus why I think trickle up fiscal policy spells a decade of more redistribution, higher wealth taxes, and more handouts. It might even be good for investors.
I realize on Monday I usually focus on macro stuff but I felt I couldn’t avoid a quick observation on the Turkish result and what looks likely to be another win by President Erdogan. Like many, I think the result here is important for the rest of us largely because Erdogan, I would argue, has perfected a brilliant populist playbook that will be copied by many the world over, including in the West.
Long before Trump, Erdogan was working up his strategy and I think he’s an absolute trendsetter. So what does this playbook look like? I’d sum it up as follows:
strong nationalist posturing, strong on defense spending, strong on diverting spending to welfare programmes and spending on infrastructure, be damned to conventional monetary and fiscal policy, ramp up anti-elite talk and culture war language plus heaps of family values.
I’m absolutely not saying any of this is right or wrong – you’ll have your own views on this but I do think it is a brilliant electoral strategy, although as an economic one, I think it’s terrible as evidenced by the mess Turkey now finds itself in.
If I were Le Pen in France, eying up a post-Macron future, I’d be copying this playbook relentlessly. It works with lots and lots of people.
For investors I think it has an interesting impact – it will increase the number of governments in major economies determined to break away from conventional economic policy and try innovative solutions. My hunch is that most of these policies will be disastrous, as they have been in Turkey, but there’ll be enough vocal beneficiaries who are much more likely to vote en masse, thus ensuring that the majority concerns are ignored.
My 12 month forecast
Anyway, with that quick Turkish interlude out of the way, back to business. A few readers have asked me to outline what are my core 12 months’ predictions.
If I had to summarise it, I’d say I was growing more not less bullish though I’m still bearish about US valuations. As an aside, I have no great insights about the impending US government debt debate except to say that it will probably limp through, again. As for my other core views :
- US will slow down but not by much
- Especially in the US, there’s still a huge amount of hidden savings in the system. Combine this with the very obvious gains made by poorer workers in the US and the UK over the last few years and you have a much stronger consumer sector than expected.
- Housing markets will freeze over as sellers refuse to accept lower prices but defaults won’t rise too much
- The UK economy will probably chug along in 2023 suffering from below-average growth
- Energy prices will pick up later this year after falling sharply in the summer. In effect, energy prices will overshoot on fears of a slowdown in the US and the West but then overshoot as an economic rebound in late 23 or early 24 looms into view
- The odds of an equity rally in Autumn 23 are growing by the day
- Forward inflation estimates will start to rise in the autumn, as they wobble around in the 3 to 6% range
- Interest rates in the US will remain above 5% in 2023 and above 4.5% in the UK. No rate cuts for the foreseeable future
- AI is a big story but will really only matter in one respect: it will fatten corporate margins
- China is disappointing everyone including I suspect its leaders. The expected massive bounceback will be much less exciting than expected. Chinese consumers especially in the countryside have been scarred by Covid and are very cautious while simply pumping up infrastructure spending is now producing very fats diminishing returns
None of the above changes very much my actual portfolio positions except that I am resuming my drip feed of monthly purchases and I currently see no reason to sell down my US tech positions. I also still think the UK market is cheap and that there are lots of high-quality UK businesses and funds worth buying at almost distressed prices.
With that out of the way, I’ll turn to some useful updates. Most of these involve ideas I’ve discussed before in these notes:
Global liquidity matters. Most of the concerns surrounding markets seem to pivot on interest rates, but this misses - I think - an equally important story about the liquidity pumped into the system by global central banks.
Sure, they’ve increased interest rates but they’ve also radically pivoted on their balance sheets, slimming them down and withdrawing liquidity. That led to a dramatic decline in global liquidity measures.
But that might start to turn now we’re entering the next phase of central bank policy adventurism. A useful guide to this comes from Michael Howell and his team at Cross Border Capital. I’m inclined to go along with their current general investment outlook which is summarised below:
• Global Liquidity cycle bottomed in October 2022. Trend is higher but as always it will not be smooth • Policy-makers are starting to ease, but liquidity also rising as funds get released from slowing World economy
• World economy has already slowed markedly. Expect further downside in America and Europe, but credit worries look to us, so far, to be exaggerated
• US inflation is falling and should hit Fed’s target later in 2023. But it will remain choppy. Hence, policy rates will prove sticky
• Bond markets distorted by very negative term premia that mainly reflect collateral shortages. Heavy future debt issuance could change this
• US dollar in longer-term bull market, but will weaken another 5-10% in 2023
• Stocks are likely to gain from a re-rating as inflation expectations subside and liquidity expands
“The Global Liquidity cycle is turning higher partly because policy-makers are starting to add liquidity back into their markets. It is also down to a slightly softer US dollar and improved collateral, helped by the fall in bond volatility. But, it is also explained by factors that come with economic slowdown, such as lower oil prices and slimmer working capital demands.
Global Liquidity tends to rise shortly after economies begin to slow. On cue, we are now seeing the path of the Global Liquidity cycle match the inverted (and advanced by 12 months) World business cycle. It suggests that further sizeable gains in Global Liquidity lie ahead? A longer-term perspective reinforces this view. …. This fifty-year history identifies several recurring cycles, each lasting an average of 65 months. The latest readings have bottomed as expected and point to a coming liquidity peak in late 2025/ 2026.”
Pricing power and greedflation will continue to be a major topic moving forward. Let’s be honest, one of the reasons why US and UK equities have done as well as they have done in recent months is that major corporates have hugely impressive pricing power – and have thus been able to increase product margins even while inflation rages. On this subject it’s worth noting the graphic below, courtesy of Adam Tooze and via The Transcript which shows just how price inelastic many consumer goods prices are :
It looks like inflation rates in the US will remain anchored in the 3 to 7% range for the foreseeable future. That doesn’t mean we’ll get an exact replay of the mid-1970s when inflation suffered a double peak. But it does mean that inflation rates will remain well above the desired 2 to 4% range. The chart below from the Daily Shot shows that US 1-year inflation expectations have risen again to 4.5%.
Also, here’s a useful summary from The Transcript today:
“Inflation is slower than it had been, but there’s still a fair amount of inflation in the world. CPI was up 4.9% y/y, which is the smallest increase since April 2021, but still well above the Fed’s target rate and core inflation was higher. Stan Druckenmiller seems to be seeing the same trends as the Transcript: strong consumer mixed with weak leading indicators like transports and financial stress.”
This volatile inflation environment will in large part be determined by what’s happening in energy markets.
Most attention has focused on oil prices but in Europe, natural gas prices matter hugely – Goldman Sachs analysts created quite a stir recently when they forecast a trebling of natural gas prices by the end of the year. That sounds a little aggressive to me – I’m more inclined to believe estimates from the Guinness Energy equities team: they’ve just released a useful summary of what they reckon might happen. They start first with the supply side:
“On the supply side, given the lead times in construction of new LNG facilities, we have reasonably strong visibility on incremental new liquefaction capacity and thus we can say with reasonable conviction that supply growth over the next couple of years should be very subdued (1-2%) until we start to see the ramp up of the next phase of Qatar LNG and various new US LNG facilities from 2025.”
On the demand side, there are three factors:
“i) the re-opening of the Chinese economy, ii) the restart of Japanese and South Korean nuclear facilities and iii) the evolution of European natural gas demand.
China imported 79mtpa of LNG in 2021 but only 63mtpa in 2022 as a result of COVID lockdowns and higher global LNG prices. The re-opening of the Chinese economy and the moderation of LNG prices should see LNG imports rebound to more normalised levels (75-80mtpa in the near term) with growth continuing thereafter as China continues to reduce its reliance on coal in power generation. We note that the IEA “high case” for Chinese LNG demand growth in 2023 is 25mtpa, implying demand ahead of 2021 levels. Offsetting the potential for Chinese demand growth, Japan has used the war in the Ukraine as a catalyst to reverse its post-Fukushima trend of mothballing nuclear facilities and has started to re-open them. In 2022, Japan imported 72mtpa of LNG and we would expect demand in 2023 to fall around 63mtpa. A similar trend (but to a lesser degree) is happening in South Korea which, together with growing renewable generation capacity, will likely reduce broader Asian LNG imports by around 13mtpa in 2023.
Lastly, Europe, which delivered a record 19% reduction in natural gas demand in 2022 in order to maintain high levels of natural gas inventories in the absence of Russian pipeline imports (which used to represent 45% of the supply mix). We see this transition as being one of the most remarkable elements of global energy markets in the last couple of years and the evolution of European gas demand will be pivotal for LNG demand and international gas prices in coming years, since Europe has little opportunity to increase its own domestic supply.
Putting it all together, we are left with the conclusion that the LNG market is going to be quite finely balanced over the next couple of years. In the event of a moderate Chinese reopening and a “normal” European winter, LNG supply and demand appear to be roughly in balance and global LNG prices appear to be fairly priced at around $12/mcf. However, a delay in the Japanese nuclear ramp up or a colder than expected European winter could easily see LNG in tight supply and cause international gas prices spike this winter, although it is unlikely that they revert to the $40-$50 levels seen in winter 2022/2023.
Looking further ahead, we see international gas prices settling in a $10-14/mcf range. This price range should be sufficient to incentivise new US and Qatari LNG supply sources to come online from 2025. It would also allow Europe to displace permanently almost all its Russian gas imports. An international gas price in the $10-14/mcf is well down on the highs seen in 2022, but would leave the market at a c.50% higher price point than that seen in the few years prior to COVID and the Russian invasion of Ukraine”.
Next up we have the commercial real estate market. I’m very bearish on this asset class but it’s worth noting a recent forecast from Morgan Stanley property analysts in Europe – they seem reasonably optimistic that the major European developers will avoid the worst: here’s the summary
“Sustained resilience in operating metrics. The 1Q23results season has highlighted sustained resilience in operating metrics. This did not come as a surprise for German residential. But equally, we did not witness any slowdown in demand for logistics (which may come as more of a surprise given the backdrop of stagflationary pressures on many low-margin tenants' viability, and in the UK, the impact from business rates), shopping centres (with solid leasing from Unibail and Klepierre), or Paris offices (e.g. Gecina).
Not many assets changing hands. Few listed companies (other than in the UK), have seen their valuers mark down portfolios in a meaningful way. Bid-offer spreads in physical real estate markets remain wide, and so there are few forced sellers. That will take time to play out, most likely governed by refinancing schedules and balance sheet liquidity.
Higher rates are starting to bite for some. In Sweden, where companies tend to finance with shorter and more variable debt, we saw increasing pressure on earnings (e.g. Castellum and Fabege).For most continental peers this will also happen, with a lag, and will affect dividends at some point.
UK M&A deals: catalyst for peers? On 9 May, CK Asset made an offer for Civitas. This is the second offer for a UK REIT in less than a month after Blackstone made an offer for Industrials REIT. We see relative value in the UK listed stocks and we think these deals underscore this.
Have UK logistics values troughed already? After a material 20-25% correction in 2H22, UK logistics values have shown strength in the first months of 2023. This is creating debate whether December 2022 could possibly be trough NAV for Segro. We assume some further correction, but believe that if we are wrong, we are probably not sufficiently bullish.”
Last by no means least fiscal policy matters as well. The big story of the last few years is that we’ve seen a massive redistribution of government spending (much more of it in total, and more of it focused on poorer citizens). Covid sparked a transfer of cash to the poorer in society on a massive scale. This worked a treat, boosting growth in the US via handouts, which pushed growth higher and inflation higher.
Low-paid workers generally benefitted from what we might call Trickle Up policies as wage rates increased and shortages were felt in lower-skilled jobs. This I think validates a key Keynesian insight – that the wider economy disproportionately benefits from the higher multiplier on spending for lower-paid workers i.e. give more money to lower-paid workers and we all benefit.
This contrasts with the trickle-down policies which presume that boosting incomes and wealth for the top quarter of the population boosts economic growth. My own feeling has always been that trickle-up works a treat, while trickle-down is a lousy policy choice as most increases in wealth end up not being spent but saved, with some of it shipped offshore to tax havens. The Stone X strategist Vincent Deluard has looked at recent academic research which backs up this trickle-up idea:
“A recent NBER paper shows that the excess savings of low-income households linger into the economy until they “trickle up” in the pockets of high-savings rate billionaires.
“Our framework recognizes that one person’s spending is another person’s income. As we show, taking this fact into account implies that excess savings from debt-financed transfers have much longer-lasting effects than a naive calculation would suggest. In a closed economy, unless the government pays down the debt used to finance the transfers, excess savings do not go away as households spend them down. Instead, the effect of excess savings on aggregate demand slowly dissipates as they trickle up the wealth distribution to agents with lower MPCs.”
The Atlanta Fed’s wage surveys confirm that the young, the uneducated, the poor, and the non-white have been the biggest beneficiaries of the post-COVID wage inflation. The wages of the poor have outpaced that of the rich by 5%, and the young have out-earned the old by 18% since January 2021! The pace of these gains has moderated in recent months, but the gap remains positive.
Former Federal Reserve economist Claudia Sahm has collected an impressive series of statistics showing the real progresses achieved by the households which struggled the most after the Great Financial Crisis:
• According to the FDIC, the share of unbanked households dropped to 4%
• The participation rate of black men rose 4 percentage points to 70%, catching up with that of white men for the first time
• 23% of adults with disabilities are employed, up from 19% pre-COVID
it is undeniable that the COVID stimulus reduced absolute poverty and that low-wage workers, who had suffered the most in the low-growth era of the 2010s, have been the main beneficiaries of the hot labor market of the past three years. It would also be extremely unusual to cut social spending in an election year.”