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

Every so often I put together a few points for media interviews, and I usually share them with Kee Points readers (they’ll sound familiar!). I am also including a few salient points on the European Union that I wrote down for an upcoming panel discussion. These are things that everyone should already know, but if you write down all of the things that everyone should already know - just in my field of economics and investing alone - it would be encyclopedic!

European Union: The European Union is a group of 28 countries, 19 of which use a common currency called the euro. The Union grew out of the European Coal and Steel Community and European Economic Community formed by six countries in the 1950s. The United Kingdom joined the community in 1973 (Greenland joined but left in 1985). Also in 1985, an agreement was made in Schengen, Luxembourg (known as the Schengen agreement) to allow movement across borders without passport controls. In 1992 in Maastricht, a city in the Netherlands, the European Union was officially established. Criteria for joining (democracies respecting human rights, rule of law, etc.) were fully defined in 1993 in Copenhagen and Denmark, known as the Copenhagen criteria (a “pooling of sovereignty”). In 2009, some reforms were agreed to in Lisbon, the capital of Portugal, which are known as the Lisbon Treaty. There are seven governing institutions (European Commission, European Parliament, European Central Bank, etc.). Militarily, 22 EU countries are also members of the North Atlantic Treaty Organization (NATO, established in 1949). The euro, a common currency fully established in 2002, was eventually adopted by 19 EU member states, and quickly became the world’s number two currency used in transactions behind the dollar (a claim that could also be made of China’s yuan). The common currency had been an objective since 1969. In a nutshell, the point of all of this was to limit the extreme nationalism of the pre-war (pre WWII) era and to ensure the “free movement of people, goods, services, and capital" (European Council, Wikipedia - various sources). Compared to the pre-war era, the Union has been quite a success relative to these stated goals, but at the cost and challenge of a growing bureaucracy. More recent challenges have included debt crisis, refugee crisis, Russian aggression in the Ukraine, and Brexit, the vote to exit the union by the United Kingdom (to be initiated at earliest in 2017, which initiates a 2-year window). Finally, Switzerland, Norway, Iceland, and Liechtenstein are not members of the European Union but comprise instead the European Free Trade Association.

Brexit implications will take time to show up in the data (hesitancy to spend/hire) in UK and Europe, but should also force a discussion of the positives of the EU – like gains from trade and 60+ years without major wars. It also forces a discussion of the negatives, namely bureaucratization. Britain has always had one foot out of the EU canoe, having never adopted the euro currency, and is probably more similar to the US than Europe anyway. A key overlooked point in all of this is that these populist movements are somewhat anti-bureaucrat; whereas most populist movements in past century have been anti-capitalist. I’m hoping that another form of populism, “anti-globalism,” doesn’t gain too much traction and unwind some of these hard-earned “wins."

Near-term, markets seem to be helped both by an accelerating economy and a below-average growth rate (which lowers the probability of near-term fed rate hikes). Nothing in the economic or inflation numbers is remotely pushing the fed to act, and the fed of course understands the nuances of unemployment numbers (i.e. falling labor force participation rates, etc.). With interest rates on ex-US sovereign debt low or negative, global arbitrage (money seeking the highest return) should put a ceiling on how high rates will go in the US, which, in the short run anyway, seems to be putting a floor beneath stocks. That is, when you sell stocks, where else are you going to put your money? US and global equities appear to be the most attractive asset class for long-term (>5 years) investors.

Oil: Forces from both global supply (increasing) and global demand (slowing global growth) indicated that the likely direction of oil prices was down. But it was the Saudi-led collapse of the OPEC cartel that seemed to be the trigger. “Weakened and divided” is perhaps the best description of that organization. OPEC will hold informal talks in September (Nasdaq) in an attempt to “restore stability and order to the oil market,” that is, to reach agreement on output restrictions. That’s about the only possible catalyst I see right now for an upward (or no downward!) movement in oil prices.

Equity Valuations: Valuation levels are on the higher side of normal, but the market in the US is really up only about 40% above prior 2007 peaks. That was almost 10 years ago, and valuation levels were far from bubble territory then. Globally, or outside of the US, it’s been one shock after another, from onset of European debt crisis, to Arab Spring and Middle East unrest, to continuing deceleration of Chinese growth rate, to multiple recessions in Japan, to terrorist attacks. Not surprisingly, international stocks (ex US) are about 30% below 2007 peak levels. So, rather than being disconnected from reality, markets are reflecting reality. Adjusting for exchange rates doesn’t change this story much.

China: Increased government investment spending right now is covering for the fact that private sector investment spending is flat, but that won’t be sustainable, and China should resume its long-term, slowing growth rate trend. Corporate debt loads are sizable and need restructuring, while the private sector is nearly the opposite with high personal savings. That should lead to debt restructuring rather than crisis. The long-term transition to a consumer economy will continue, but I expect 4-5% growth, not 10-13%.

Election:  The media is hyping this as some sort of colossal decision, as it always does, but the key point for investors is that, from the perspective of business, there is less difference between Clinton and Trump than there is between either of those and Obama, who is seen by many as anti-business (I’ve seen almost no surveys the contrary). That may be the most important thing to keep in mind as we head into the Fall.