"Kee" Points with Jim Kee, Ph.D.

Today in Kee Points I wanted to take a quick look around the world by focusing upon the “Big 4,” namely, the US, Europe, Japan, and China:


US: Last week the Bureau of Economic Analysis released the “Advance Estimate” for second quarter GDP growth, which came in at 2.3%. Also, first quarter GDP was revised upward from negative -.2% to positive .6 percent. That’s nothing stellar, and it is consistent with the current, mediocre expansion. The Atlanta Federal Reserve Bank’s “GDPNow” model, which is updated weekly based upon statistical analysis of current data (known as “nowcasting”), was expecting 2.4%, and that’s about as close as you can get to hitting the nail on the head! On our previous two webcasts and in several Kee Points, I have discussed the Atlanta Fed’s new GDPNow model. It has, along with the Leading Economic Indicator index, been one of the better indicators during this expansion.


And why is the current expansion so mediocre? There are really three possible explanations, and I think each one has some merit and plays a part. The first is that growth rates in the US have been coming down for a while now, not just during the current expansion. Annual growth during the 1990’s expansion averaged 3.8%, but only 2.7% during the 2001-07 expansion. And the current expansion is averaging 2.1%. Possible reasons for this deceleration in growth is due to declining productivity of prior innovations (the “new normal” hypothesis), uncounted GDP contributions from technological advances, and the impact of increased globalization and competition. The second explanation has to do with the fact that financial crises-led recessions like 2008-09 tend to be followed by weaker expansions because private sector balance sheets have to be rebuilt. That requires more savings and less spending, and I think we’ve seen that as well. The third explanation has to do with the impact of voluminous, hastily passed legislation, like the Sarbanes Oxley Act of 2002, the Patient Protection and Affordable Care Act of 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, and various temporary tax/spending schemes (all of these fall under the “policy uncertainty” category). In my opinion there is some plausibility to all of these explanations. That is, it’s more “all of the above” than “either, or.”


Europe: Greece is still the headline-maker in Europe as it continues negotiations with creditors. Greece opened its stock exchange Monday after a 5-week hiatus, and Greek stocks promptly sold off, losing 22%. That obviously wasn’t a surprise to the rest of the world, as global markets remained largely unaffected (Associated Press). In his Brookings Institute blog, former Fed Chairman Ben Bernanke chastised the rest of Europe for its lack of reform, and argued that Greece’s reform targets should be based upon European growth. Specifically, slower European growth makes it tougher for Greece to grow, and they should be given more leeway under such circumstances. Bernanke also reiterated the idea that Germany has been a big beneficiary of the euro as it has a much more competitive exchange rate (i.e. lower) than it would if it were a stand-alone country (dramatically increasing the global price competitiveness of its exports). That’s a pretty good answer to the question, “Why doesn’t Germany just break off from the euro and go it alone?” Germany’s unemployment rate is less than 5%, while the euro zone ex Germany unemployment rate exceeds 13% (Germany makes up about 30% of Eurozone GDP).


Japan: Japan’s growth rate appears to be hovering around zero again, influenced no doubt by lower growth from its key trading partners, China and the US (BofA Merrill Lynch). I’ve mentioned before that the story in Japan is corporate governance reform, or a possible change to managing for shareholder value in Japan. Right now that is almost non-existent. The vast majority of Japanese companies haven’t really been profitable (i.e. earned their cost of capital) for decades. The promise of Japanese reform has always been to make it easier to hire and fire in Japan…to jettison underperforming assets and managers, etc. Prime Minister Abe looks to be pushing such reform, and while there have been a lot of false starts in this direction in Japan over the past 20 years or so, it is definitely worth watching. As an aside, a BIG observation here is that, when it comes to international investing, you often hear a lot about overseas growth and various positive dynamics (emerging consumers, etc.), all of which are true. That’s the case for looking abroad as well as at home for investment opportunities. But you almost never see a discussion ranking countries by how shareholder friendly their policies are. My quick stab at this? In the developed world, the US is the best for shareholder returns, followed by Europe, which tends to favor workers more, followed by Japan, which is the worst but has the most potential for positive change. In emerging markets, the economies and companies are in general far less diversified. There are a handful of world-class companies in emerging markets that create shareholder value, and a lot of firms (mostly local) that do not.


China: The sharp 30% correction (decline) in Chinese stocks is a function of the near 150% one-year run up that preceded it. I’ve mentioned before that the Chinese stock market is heavily manipulated by government policy, and I don’t think it is the key to what’s important in China right now. What’s important about China is that growth continues to slow. Five to six percent growth estimates are very common now, as opposed to a year ago. In a client update two years ago I displayed a quote from the McKinsey Global Institute stating that no country had grown as China had without a slowdown that surprised even the pessimists. McKinsey felt that the next several years would see China heading towards the 4%-5% growth range, and I think that’s what we’re seeing. I felt 2014 was the last year in which China would be able to hit its ~7.5% growth target, and I think China’s slowing growth is being felt by all emerging markets, not just commodity producers.


Puerto Rico debt update: Puerto Rico has missed a $58mm debt payment, and Moody’s now views Puerto Rico in default. There are some interesting nuances to this, but for now I just want to reiterate that STMM does not hold any Puerto Rico bonds in client accounts!