By James Williams – Last week GLG Partners – now part of Man Group – hosted a “Bulls and Bears” breakfast roundtable. Ben Funnell, Chief Equity Strategist and portfolio manager for long only and UCITS-III global equity mixed asset funds, presented a bullish argument for Europe. Jamil Baz (pictured), GLG’s Chief Investment Strategist, gave a more bearish prognosis for global economic recovery.
Following the ’08 global financial crisis, countries like Ireland, which were positively booming prior to the crash, have cut their labour expense costs by some 20 per cent. This has helped stabilise the country and allowed it to redress the balance of paying its labour force. Meanwhile, Germany, Europe’s main economic powerhouse, has seen its labour force enjoy an 18 per cent rise in labour costs over the last eight or nine years.
Funnell says that at the moment, Germany seems to be gently reflating – the most that can be hoped for from a country that experienced hyperinflation in 1923. “Inflation could start creeping – there are negative real interest rates for the first time in a generation. There are signs of wage inflation starting to accelerate. Spanish real estate inflated in the 2000s because they had German interest rates. Now German real estate is inflating because they have Spanish interest rates,” said Funnell.
Due to restructuring, Spanish exports have taken off and become more competitive with Funnell commenting that “lots of progress” was being made in Spain. This is important for the country’s central bank TARGET2 balances, which “will probably deteriorate a little bit further before they start to improve”, noted Funnell.
TARGET2 is an interbank, real-time gross settlement (RTGS) payment system for cross-border transfers in the EU. These balances have grown among European central banks since ’08 as a result of capital outflows. However, Funnell was reasonably optimistic, stating:
“In total, excess liabilities versus assets for PIGS (Portugal, Ireland, Greece, Spain) was EUR500billion. This has now come down closer to EUR250billion. TARGET2 rebalancing should continue to improve and as Germany continues to inflate, the Eurozone will heal.”
Noting that dividend yield in Europe is 3.8 per cent, which may rise to 4.5 per cent by 2013, Funnell said: “On a relative basis equities look phenomenally good value compared to other assets. I would also argue that real estate looks attractive in a lot of markets, particularly the US and Germany.”
Funnell said he was concerned with US profits and that the country would need 4 per cent nominal GDP growth next year for earnings to increase. If not, profits won’t grow.
“I think the US will see some profit growth, but it won’t be the major catalyst for growth in 2013: Europe will.”
Jamil Baz then took a more bearish stance on the global economic outlook. The first point he touched upon was one of demographics. The 35-59 year-old bracket is the main contributor for economic growth but this ratio in the overall demographic pyramid is falling. Germany’s, for example, has fallen from 37.4 per cent to 27.4 per cent, noted Baz.
Even more disconcerting is China, as it moves away from investment to a more domestic consumption-driven economy. It has a dependency ratio of 6:1. “That means China consumption will need to grow 20 per cent each year for the next five years to maintain 7.5 per cent GDP growth,” said Baz.
Baz then went on to make three predictions for the global economy:
1. “If you think the crisis was caused by leverage then it hasn’t even started yet,” said Baz. Even if G7 countries delever diligently it could take them up to 20 years.
2. The process of deleveraging will have a negative impact on the economy, especially because most of the monetary levers have already been pulled. This will create a multiplier effect of 1.5 predicted Baz. “What does that mean? It means that a country like Japan would need to reduce its debt/GDP ratio by 15 per cent each year and could represent another lost decade.”
3. Baz then referred to the Kalecki profit equation (devised by polish economist Michal Kalecki) which says that profits are the sum of investments and change in leverage. “If you believe, like I do, that deleveraging hasn’t even started yet, that means that profit margins are only going to go one way: down,” said Baz.
The LTRO in Europe is a scheme through which banks are financing governments, which are then using that same money to finance the banks back again: a kind of financial Ouroboros.
Baz said that even though Italy’s debt/GDP is currently 125 per cent, it is likely to grow to 135 per cent by 2014 “even if the current problems are dealt with. I’m structurally bearish on Europe; the long-term trend seems very clear to me.”
The deleveraging process could last four to five years in Europe, seven years in Japan, and “even longer in the US”, said Baz.
Unsurprisingly, Baz predicts that going forward there will be a default of sorts given that 10 out of the 15 OECD countries are, in his opinion, on a “completely unsustainable course. Italy, Spain, the US will have to default one way or another. Japan will certainly default.
“I think the Lehman saga will seem like a walk in the park.”