Credit, Commodities, and Consumers: An Economic Update ROBIN J. ANDERSON, Ph.D. SENIOR ECONOMIST PRINCIPAL GLOBAL INVESTORS June 2015 All expressions of opinion and predictions in this report are subject to change without notice. This report is not intended to be, nor should it be relied upon in any way as a forecast or guarantee of future events regarding a particular investment or the markets in general. All opinions expressed are those of Principal Global Investors.
Outline Secular Trends The end of the EM credit cycle The end of the commodity super-cycle U.S. consumers are back in the driver s seat Near-term Outlook Investment Themes 2
Outline Secular Trends The end of the EM credit cycle The end of the commodity super-cycle U.S. consumers are back in the driver s seat Near-term Outlook Investment Themes 3
14 12 10 8 6 4 2 0 4 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Key Economic Driver of the Last 20 Years GDP Growth Rate with 10-year moving average Source: World Bank DataBank, IMF World Economic Outlook, October 2013, 2013-2015 IMF forecasts
Creates Winners Huge benefit to U.S. consumers Chinese manufacturers undercut competition Developing countries Losers first: Asian Currency Crisis 1997-1998 Then, winners in 2000s boom Fabulous economic growth Huge money inflows Spectacular equity outperformance Unprecedented commodity super-cycle Credit boomed 5
External Debt to GDP 40% Select Emerging Markets 35% Total External Debt Private Nonguanranteed 30% 25% 20% 15% 10% 5% 0% 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Sources: World Bank, International Debt Statistics, World Bank National Accounts Data and OECD National Accounts File Notes: GDP Weighted Average for Argentina, Brazil, China, Colombia, Hungary, India, Indonesia, Kazakhstan, Malaysia, Mexico, Philippines, South Africa, Thailand, Turkey, Ukraine, and Venezuela. 6
China s Debt to GDP 300 250 200 150 100 50 0 121 7 83 8 23 158 24 72 20 42 65 125 2000 2007 Second Quarter, 2014 282 38 55 Financials Non-financial Corporates Households Government 34% of that 55% comes from local governments! Sources: Debt and (not much) Deleveraging, Chapter 4, Exhibit 33, McKinsey & Company, February 2015, local government statistics estimated from the National Audit Office as of June 2014 (originally cited by Asia Credit Perspectives, PIMCO, March 2015) 7
The End of EM Credit Cycle Rapid growth in EM was fueled by a credit boom EM debt growth explained 47% of global debt growth since 2007 Low interest rates in U.S. made EM debt attractive Now, growth is slowing in EM Chinese growth could slow to the 5.5% to 6.5% range this year Demographics, slowing productivity, structural imbalances, and declining competitiveness contribute to slower EM growth EM debt is at risk as the Fed moves to raise rates EM has not had a crisis since 1998 8
700 600 500 400 300 200 100 The End of the Commodity Supercycle 9 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Broad Commodity Price Average Commodity Prices Rose 270% in the 2000s Source: Bloomberg
The Drop in Oil Prices is Significant $140 Crude Oil Prices $120 US dollars per barrel $100 $80 $60 $40 $20 $0 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 $ money of the day 2014 Dollars Source: BP, 2014 dollars calculated using the CPI 10
U.S. Consumers Back in the Driver s Seat Manufacturing returning to the U.S. All about unit labor costs Chinese companies opening up shop in the U.S. Labor s share of income is bottoming The unemployment rate is dropping fast Wage growth is coming Lower commodity prices boost real incomes Consumer confidence rebounding 11
Manufacturing Jobs Are Back, but Different 20 Productivity-driven losses Manufacturing Jobs (in Millions) 19 18 17 16 Lost over 6 million jobs! 15 14 13 Gained 866,000 jobs gained 12 11 10 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 Source: Bureau of Labor Statistics, FRED 12
Outline Secular Trends The end of the EM Credit cycle The end of the commodity super-cycle U.S. consumers back in the driver s seat Near-term Outlook Investment Themes 13
Europe, Japan Rebounding Europe s upside surprise Structural reforms are happening The banking system is healing Lower oil prices, devalued euro are tailwinds Populist risks Japan recovering from tax-hike induced recession Other tax hikes being delayed Growth okay this year Structural reforms are happening 14
U.S. Consumer Nation Back Chugging along at 2 to 2.5% this year Drags from stronger dollar and cuts to oil cap-ex Consumer confidence is decent Residential spending may surprise to the upside Job growth should range from upper 100s to low 200s Just enough for the Fed to start raising rates Global growth should rebound With DM growth decent, EM should be okay 15
Inflation and Rates Lowflation Excess capacity in China Declining commodity prices Structural adjustments in Europe Low rates Directly from low inflation But also, Lack of supply, lots of savings, QE in Europe in Japan Fed hikes, but not by much 16
Outline Secular Trends The end of the EM credit cycle The end of the commodity super-cycle U.S. consumers are back in the driver s seat Near-term Outlook Investment Themes 17
Investment Themes Fed exit Risks tilted towards EM The dollar has reached a new, stronger level Stocks okay this year Stocks are expensive, but bonds are more expensive Profit growth will be key Little recession risk in the U.S. 18
Conclusion Credit growth in EM is slowing Drop in oil prices is part of the unwind of the commodity super-cycle The global economy should expand this year Low inflation, rates to stay low Investment options are hard to find, everything is expensive 19
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