Two topics today: the US and the EU. Unlike Monday, when it was the politics in the EU and the economy in the US, this time, I want to talk about the politics in the US and the economy in the EU.
European economic problems
I want to start off with a mea culpa of sorts. I believe that somewhere in the last couple of weeks, I said positive things about Europe and the economic data coming out of Europe. The way I remember it in retrospect is that I made it seem like Europe was on the same pre-coronavirus recovery trajectory that I believe the US was on. If so, that was an error. Europe has still not recovered from the global growth slowdown and manufacturing recession. Manufacturing PMIs did bottom below 46 in September. But they have only risen to just a hair below 48. So, the sector has improved, but is still contracting in Europe. That’s not a recovery.
Here’s how Trading Economics puts it:
The IHS Markit Manufacturing PMI for the Euro Area was revised higher to 47.9 in January 2020 from a preliminary of 47.8 and above December’s 46.3. The reading pointed to the 12th straight month of contraction in factory activity, although the slowest in nine months, final figures showed. Slower falls in output, new orders and purchasing recorded. Job losses were registered for the ninth month in a row and remained marked. On the price front, input costs fell for an eighth month in succession, leading to a fall in output prices. Looking ahead to the next 12 months, confidence about the future jumped at the start of 2020 to its highest level since August 2018.
The Composite PMI shows the same uptick, but from a higher base. The low point was just above 50 in September, with a recovery up to over 51 in January 2020 data. That’s a recovery, yes — but a fragile one. So, I would say the European economy is still at stall speed. And given recently revised data, Deutsche Bank actually expects Germany to fall into recession. Industrial production data for December was so weak, that they think a drop in Q4 GDP is likely. With the coronavirus cutting 0.2% off of Q1 2020 GDP, that would be a recession. Also note that the Eurozone wide IP numbers were equally weak. Eurozone IP dropped -2.1% month-on-month in December. And the decline was broad-based. The year-on-year number was even worse at -4.1%.
So what will this mean for asset prices? It’s hard to say because both Euro area stocks and bonds are rallying. European shares hit a record high for the second straight session today. And Greek 10-year bonds rallied to an all-time low below 1% – this despite Greece sporting a junk credit rating. Think about this for a second: you can get a 1% annual return for investing in a junk-rated sovereign bond from Greece, a country that just 5 years ago was in a sovereign debt crisis. This is the definition of risk seeking return.
But the question is whether European yields would decouple in an economic downturn. I tend to think they would. But it’s certainly not as clear they would as it once was. Stocks should obviously benefit from lower discount rates. But, you would think that would be offset by lower near-term earnings rippling through future earnings forecasts. After all, a 20% reduction in earnings reduces all future earnings by 20% unless you think there’s catch-up earnings growth in the future. I would be cautious about saying Europe should outperform because of lower relative price-earnings ratios. There’s a reason those PEs are lower.
The US Presidential election
We have had the Iowa caucuses and the New Hampshire primary now. On the Republican side, there’s no contest. The last I saw, Trump got 90% of the vote versus William Weld last night. There’s no competition there. It’s on the Democratic side where the competition is still fierce. So, here’s my view.
All of the Democratic candidates have chinks in their armor. None of them is obviously more ‘electable’ versus Donald Trump. And, it’s that fact which keeps the field large. A large Democratic field also means no one candidate is going to be able to amass a majority of the delegates. A lot of people have dropped out already, including Michael Bennet and Andrew Yang last night. But, the field is still incredibly large.
And last night’s New Hampshire results increase the likelihood that the field will remain large. Polls showed people were undecided until the last minute, often picking a candidate based on the last debate performance. This benefitted Amy Klobuchar, who cam in a strong third behind Sanders and Buttigieg. But, more importantly, it showed the benefits of ‘hanging around’ and not dropping out of the race. A lot of people are talking about Cory Booker and Kamala Harris today, saying they both probably rue the fact that they dropped out because they could still be viable candidates.
It looks like Elizabeth Warren is fading. My take here is that, early on, Warren had a choice in terms of positioning herself. She decided to go all in on progressive policies that rely heavily on increased government expenditure, Only Bernie can legitimately stake out that ground without explaining “how do you pay for it?”. Warren is a policy wonk. So, she was basically forced to explain the math behind her Medicare for All healthcare plan. And when she did, she was attacked mercilessly. Bernie doesn’t have to explain his plan because he’s an ideologue. That may seem like a double standard. But it’s the reality. Warren should have taken an anti-corporatist stance instead, because she has form there as an opponent of Wall Street. But, she’s made her choice and will have to live with that.
Biden, the previous frontrunner, is also fading. And the question is what that means for the race. Again, I think it means the field stays larger than it otherwise would – which is bad for the Democrats, by the way. And it also means there will be a mad scramble for Biden voters in the establishment wing of the party. Unless Biden can turn things around fast, I believe he has no chance, because his candidacy was premised almost entirely on his electability. And with that in question, he has no leg to stand on. Biden is the real wildcard here, particularly because of his high polling in the black community. If he permanently loses frontrunner status, as it seems he is doing now, he can effectively shift a large base of support to whomever he eventually endorses. And I think Biden’s endorsement would be meaningful because of his pull in the Black community. The real question is, if he fades, will he drop out? Or will he shift his delegates at the convention to a particular candidate, who he then endorses?
I mention shifting votes at the convention because the fractured Democratic field means we could have a brokered convention. First, as Dan Alpert put it, “the final results from the New Hampshire Primary are no boon to the progressive wing of the Democratic Party, at least for this cycle. Elizabeth Warren’s weak showing saw her and Bernie Sanders’ total drop to 35% of the vote, from 45% in Iowa. Voters seemed to be clawing for a moderate. Second, the moderate vote is now split between Biden, Klobuchar and Buttigieg, and Bloomberg, with none of them having any incentive to drop out anytime soon.
My view: this is almost a worst case scenario for the Democrats because it will mean voters will become heavily invested emotionally in their Democratic primary choices, only for many to have that choice lose at the 11th hour. This is a recipe for bad blood that reduces turnout or causes voters to vote for Trump. That’s what we saw with Sanders voters in 2016 when he lost to Clinton, by the way.
Let me know what your thoughts are here.