investorpolitico

Inflation is coming back. What does it mean?

From an in depth study of Mckinsey  you can gauge that returns from shares and bond have been very healthy from 1985 to 2014 (respectively 7.9%pa and 5.4%pa).

Why?

-inflation declined steadily

-real interest rates fell

– Demographic (including Russia and China becoming Westernized)

-productivity gain due to automation

-profit growth due to globalization

The next 20 years will be different (and nothing to do with Trump)

-inflation is so low it cannot fall

-demographic decline as old age takes over the developed world

-technology allows much more competition

Under this condition McKinsey sees a share investment producing circa 5.5% annually and a bond investment 2-3%.

I do agree with their vision, with some modification.

The report is correct, but aimed to institutional investor, so it does refer to mega blue chips and government bonds where there is enough liquidity for the instos to operate.

A nimble no large cap (which are most of the index) can still work.

But the hottest item that this report highlights is a “funding Gap” for industry fund and large institutional investors.

As industry fund are still forecasting a 7%pa to 9%pa return to fund their expenses (our pensions or insurances), a funding gap is a big issue.

A decline of 3%pa of the overall portfolio of an industry fund worth say USD425 billion dollars would provoke a funding gap of USD13 billion over 30 years even in the best scenarios (in the worst – 10 years).

This will be a big issue that people will start talking in 5 to 7 years. But the game starts in 2017.

PS. It is far, but not too far….in a post in August 2013 I posted that in 2017/2020 Europe will have a big issue with the anti Europe parties. It seemed so far!

In France, the center right has elected Francois Fillon has candidate.

As the Left is in complete disarray, the only choice is Center Right and Right.

Most probably the French election will be Fillon versus Marine Le Pen (Front National).

In one way, this is the hardest candidate for Front National (anti European – Pro Frexit) as there are a lot of commonality between the two candidates (Anti Muslim, Pro Russia, family and regional oriented).

In a different way,  Monsieur Fillon is the easiest candidate. He is a Margaret Thatcher follower against unions and pro decreasing the public service, pro ultra liberalism and industry, often critiqued to be anti feminism and pro Europe.

If played well, this could be the dream opponent for Marine – it could sway the Left to support Marine as at least she is populist (and over 500,000 French public servant will not like the idea of losing their jobs).

In the worst case scenario the Left will abstain from voting as they hate Fillon, in the best case some Left supporters will support Le Pen.

My personal view that this outcome is Pro Front National due to the idiosyncrasy of the French electoral system.

It is a two stage election, where, in the second stage, the main parties coalesce against the outsider (Front National). Fillon will not appeal to the Left at all.

One certain winner of all this is Putin – as both candidates have a pro-Russia policy.

And as the Hunger Games say…really may the fortune be with you. If Marine Le Pen gets elected everything will change.

Brexit, Trump and Frexit.

With Italy, it starts the scary year for Europe, probably from next week (this week is Thanksgiving, so the US is half asleep).

We say there is no three without two…and we had two (Brexit and Trump).

The Italian referendum is quite complex (practically it is asking the people to increase the power of the central Government), but practically is a YES or NO on PM Renzi.

The polls this time give a win to the NO and a fall of Government and this is indicated also in the Italian stock exchange performance and Italian bond yields.

No it is probable, but Italy allows also Italian citizen living abroad to vote and this factor has been an incognito factor in a few voting rounds.

A fall in Government, taking it literally, would take us to a new election. At this point in time an election could lead a win of the anti-Euro party M 5 Stars hich wants to renegotiate the agreement with the EU and do an ITALEXIT referendum.

Most likely, the governing party will resign, but try to appoint a technical government (so a government guided by an independent – for example a previous Bank of Italy chairman) until the mandated election 2018.

So the referendum probably could be a bit of scary moment, but not an “Eurexit” moment- if the technical Government is elected. Actually this result will push the European Central Bank to keep its Quantitative Easing with devaluation effects on the Euro and rally for the market.

If PM Renzi wins the market will shrug the event.

During the campaign, Trump called for various expenses

US$1 trillion for infrastructure

US$5 trillion in tax cuts

Increase in military spending

Cut to Obamacare (presumed cost $350 billion over 10 years)

And he promised not to touch Social Security or Medicare.

The current US Debt stands just below USD19 Billion and by April will automatically arrive to the$20 trillion borrowing limit (so without implementing the Trump policies).

Plus, the inflationary policies make the cost of borrowing increase as the FED will have to keep a close watch  (every 25bps cost an extra USD50 billion a year!!).

And nobody (not even Clinton) talks about how to deal with this issue or where to contain expenses (welfare, pension, medicare entitlements).

And this is not a Trump or Clinton issue.

it is an Obama legacy issue – he doubled the US debt to USD20 trillion in a near zero per cent environment (it would had been close to 27 billion, if we were at normal interest levels).

And debt is financed by issuance of US Treasuries – but, since September, the three biggest buyers (China, Japan, Saudi Arabia) have become net sellers (by the way that is what spiked the yields in reality) for their own reason (debit issues and wars).

So you know, the “Market loves Trump”mantra will last at most until April 2017.

Unless the FED decides to monetize everything and go “negative rates”

Trump is galvanizing Marine Le Pens (Front National).

Where polls gave her practically no chances before November the latest polls for the Right side pre Sunday gave her a 29% lead. The second was Sarkozy with 21%.

Sarkozy has just been beaten so it is out of the races.Francois Fillon (ex PM under Sarkozy) came in the lead of this round of primary elections.

As the Left is in disarray, it will be centre right against right (Le Pens).

May and June (French elections are in 2 rounds) will be interesting to say the least.

Since August there have been 2 state visits, numerous phonecalls and a number of military visits.

Naturally there is no information, but as Erdogan is distancing himself from the US/EU alliance it seems logical that Putin and Erdogan would be discussing how to share Syria.

Maybe it is not an alliance, but just a letter of intent. In the future Erdogan and Turkey could go back to disagreeing – but the most likely is an alliance. Interesting to see how does it sit with NATO. But President Obama in 8 years has lost a huge channel practically from Iran (or Pakistan that is China leaning)  to Syria (and maybe Turkey) to Russia.

Let’s now see how Trump fares.

Some of the Trump changes good for his voter base.

Apple is considering relocating manufacturing in US.

Ford called Trump saying that they will not move the Licoln car factories in Mexico.

In 2016, GS had to abandon 5 of its 6 prediction for the year by March. This follows such a common path of the GS predictions that sometime I even think there is a malicious intent.

Whatever it is …usually works!

That is a constant “contrarian” for me – usually right.

For 2017 their main predictions are:

-Returns slightly higher

-Fiscal Policy Pro growth

-US Trade Policy overdone

-Emerging Markets will be OK

-Chinese Yuan continues depreciating

-Credit creation and a kinder and gentler cycle overall

-More revenue for corporation

-higher inflation

-More aggressive Fed behavior

Now historically 70% of these calls prove wrong by March…choose your pick arefully

From September inflation started to perk up.

Then it came Trump and his plans will stoke inflation.

Inflation leads to higher yields in automatic or as Fed response.

The growth in assets value (shares, real estate etc) has been driven by the search foe yield.

So Trump looking for growth has techically accellerated the phenomenon that will burst the asset price bubble.

Inflation has a time lead of approximately 8/12 month before appears in the system. 

President elect Trump started very well with a conciliatory talks after the election, but as he is forming its “advisers” team – he starting to select very divisive people. Also they are not experts in their field – which is quite worrying per se.

Also the Ultra rich Democratic donor (Aka Soros and friends) are starting to regroup and plan revenge.

And the Trump Trade (USD dollar up, Goold down, reflation trades) is starting to wane.

Trump has been always not really precise in the policies definitions, but something start to be clarified.

Tax cuts are easily passed via Congress as they are a main Republican staple.

Regulatory simplification (red tape) – this is hard to pass.

Infrastructure – it will pass as it has bipartisan support. Probably in a decreased form.

Protectionism – Difficult to pass as there would be a lot of backlash and also a lot of US companies would suffer.

Obamacare – already is not repealed, but to be modified.

All this pose a big question on the fiscal side. Already the US Debt is ballooning and there is no trace in what are his intention on how to finance these expenditures.

Already the US Treasury Bond 30 years (which set the mortgage rate in US and all over the world) is 0.7% higher than 2 months ago.

This fact could bring inflation and stop the hand (at least in initially of the FED…so it will be probably rate hike in December…but then stop)

Apart the initial market rally…I see a lot of uncertainty and volatility in the future