Optimism reigns

Global stock markets ended 2016 near record highs and have started 2017 in a similar vein. Optimism about global economic growth, employment and incomes has bounced.

The latest data on manufacturing, as measured by the so-called purchasing managers’ index (PMI), the view of companies on their sales, exports, employment and orders, show a rise in December across the board and particularly in Europe and the US. PMIs measure whether manufacturing companies think that their activity is expanding or contracting. Anything above 50 suggests expansion. In Europe, the PMIs suggest that manufacturing is now expanding at a record pace (from a low level), while the global average PMI has now reached levels not seen since 2013.

Gavyn Davies, former chief economist at the infamous investment bank, Goldman Sachs, now blogs in the Financial Times and produces a measure of global economic activity with his Fulcrum Nowcast model. The latest monthly estimates show that economic growth has recovered markedly from the low point reached last March. Then fears of global recession were high. But Davies says now “not only were these fears too pessimistic, they were entirely misplaced. Growth rates have recently been running above long-term trend rates, especially in the advanced economies, which have seen a synchronised surge in activity in the final months of 2016.”

According to Fulcrum, the growth rate in global economic activity is currently running at 4.1 per cent, compared with an estimated trend rate of 3.8 per cent. This represents a vast improvement on the growth rates recorded in 2015 and early 2016, when growth dipped to below 2.5 per cent at times. The latest estimate for the advanced economies shows ‘activity growth’ running at 2.5 per cent, a rate achieved only rarely during the post-crash economic expansion.

JP Morgan investment bank is also more optimistic, if only a little. “Our global economic outlook calls for a 2.8% gain in global GDP in 2017 (4Q/4Q), a few tenths above potential. The year-ago rate bottomed out at 2.5% this year (during 1Q16-3Q16, we think), so the forecast represents a modest though still meaningful improvement over recent performance.” Goldman Sachs takes a similar view in its look ahead to 2017: “We expect global growth to improve modestly, from 2.5% in 2016 to 2.9% in 2017, with looser fiscal policy and still easy monetary policy in key countries.”  goldman-sachs-isg-outlook-2017

As I argued in my forecast for 2017, optimism that the world capitalist economy is now getting permanently out of its depressed state is driven by the possibility that the new US President Trump will activate a Keynesian-style fiscal stimulus of corporate tax cuts and infrastructure spending that will ‘pump-prime’ the US and other economies out their weak growth.

At the same time, China, having been close to a financial crash, according to mainstream economics this time last year, has steadied and is also picking up some traction. Indeed, China’s pick-up has confounded mainstream expectations that China’s seven-year credit boom, during which the debt/GDP ratio rose from 150% to 250%, would inevitably end in 2016. Almost all non-Chinese economists anticipated a significant slowdown, which would intensify deflationary pressures worldwide.

But the Chinese economy is a weird beast, not understood by mainstream (and even Marxist economists). President Xi may have endorsed in 2013 “the decisive role of the market,” but that hasn’t diminished the leading role of the state. As Aidan Turner put it recently, “Suppose that a full quarter of Chinese capital investment – currently running at around 44% of GDP – is wasted: that would mean China’s people are unnecessarily sacrificing 11% of GDP in lost consumption: but if the remaining 33% of GDP is well invested, rapid growth could still result. And, alongside obvious waste, China makes many high-return investments – in the excellent urban infrastructure of the first-tier cities, and in the automation equipment of private firms responding to rising real wages.”

Thus, according to Fulcrum, emerging economies are currently growing steadily at close to their 6 per cent trend rate, or 2 percentage points higher than achieved in 2015. They have therefore ceased to be a drag on the global expansion. No wonder stock markets are off to the races.

I won’t repeat myself with the arguments I presented against the view that capitalism has turned the corner and is entering a new boom period. I made these in my last post. But let me now add some caveats to the optimism of the banks, hedge funds and other financial institutions in investing our pension funds and savings in the stock market.

First, the expert financial consultants are notoriously wrong in their forecasts. Since 2000, they have predicted the S&P 500 would gain about 10% a year, grossly overshooting the market’s actual performance. And, on average, the consensus always has predicted annual gains, missing all five down years in that stretch. A study by CXO Advisory Group collected more than 6,500 forecasts from 68 so-called market gurus. More were wrong than right.

Second, in the last analysis, stock market prices depend on the expected earnings (profits) of companies. The ratio of the market valuation or price of the US stock market is now pretty high compared to profits by historic standards. When profits are set against the value of a company’s assets, the so-called return-on-equity for the top five listed companies in each industry is double that of the rest. And indeed, if you exclude the top five companies in each sector of US business, profitability (return on stocks purchased) is near 30 year-lows. In other words, earnings are concentrated in the very big oligopoly firms. Most American corporations are scratching a return.

And third, as I have pointed out before, corporate indebtedness has also been rising. A company’s value is measured by investors by its liabilities (net debt and stock value). Currently, those liabilities are at levels compared to earnings not seen since the dot.com collapse of 2000-1.

Finally, the US stock market relative to GDP is nearly back to the level seen just before the global financial crash in 2007-8. In other words, it is reaching extremes compared to the sales revenues and profitability of companies.

Stock prices are being artificially driven up by corporations using their profits to buy back their own shares or make higher dividend payments. According to research by WPP, a global communications firm, among companies listed on the S&P 500, share buybacks and dividends have exceeded retained earnings (that is, profits withheld by companies and generally earmarked for investment) in five of the six quarters up to June 2016. Moreover, the ratio of payouts and buybacks to earnings has risen from around 60 percent in 2009 to over 130 percent in the first quarter of 2016.

The locus of what is going to happen to the global economy over the next year or two is to be found in the US. This remains the largest and most productive economy in the world, including manufacturing, and of course so-called services and finance. And the ‘recovery’ after the end of the Great Recession in 2009 has been weakest in post-war US economic history.

US investment and consumption have still not recovered to levels relative to GDP seen before the Great Recession.

So my mantra of a Long Depression is confirmed by these figures – even for the US, which has had the best ‘recovery’ of the major capitalist economies.

Moreover, the duration of this US recovery is the fourth-longest, at 30 quarters of a year, only exceeded by the recoveries in the ‘golden age’ of the 1960s and the profitability boom periods in the ‘neoliberal era’ after the slumps of 1980-2 and 1991.

So the US is due for another slump on the law of averages, within a year or two.

But all mainstream economic forecasters rule out a new recession in 2017. The mantra is that recoveries ‘do not just die of old age’. Something must happen to stop them. As Goldman Sachs puts it: “Recessions in the US have been triggered by Federal Reserve tightening of monetary policy; by economic imbalances such as the bursting of the dot-com and housing bubbles in 2000 and 2008, respectively; or by external shocks such as the Arab oil embargo in 1973. The first two triggers are unlikely to occur in 2017, and the third, a shock, is not something that we can typically anticipate.”

GS goes on: “Historically, since WWII, the odds of a recession occurring over a 12-month period have been 18%. Our composite recession model, incorporating end-of-year financial and economic data, estimates the probability of a recession in 2017 at 23%.” So slightly higher than average. But “once we incorporate the likely passage of a fiscal stimulus package of tax cuts and infrastructure investments in the latter half of 2017, the probability of a recession this year declines to about 15%.”

The question is whether the optimism of markets and mainstream economists of an extended and permanent boom in global production based on fiscal spending and corporate tax cuts in America is justified. As I have argued in other posts, Keynesian-style policies have miserably failed in Japan to get that economy out of its long depression.

And I have argued that sustained growth depends on increased investment in productive sectors and that depends on corporate profits in the US rising, not falling as they have done up to the second half of 2016. This measure is ignored by Goldman Sachs, although not by others.

Trumponomics, in cutting corporate taxes and delivering tax breaks for infrastructure investment, might boost profits for some sectors. But as the data above show, the vast majority of US corporations are seeing the profitability in their investments falling, not rising. The odds of a new recession may be higher than Goldman Sachs thinks.