In talking with investors, I find four concepts prevail among the consensus that I believe may be wrong. In the interest of full disclosure, it is fair to say that at various points in time I have subscribed to each of these ideas. They are:
1. American Exceptionalism is a thing of the past.
2. The price of oil is likely to stay low for a long time.
3. Europe’s economy is in a slow growth deflationary trap.
4. Abenomics is not working, and Japan is in danger of falling back into a recession.
I decided to explore each of these to see whether the ideas are sound, or more in the realm of myths that have somehow gained credibility among investors, without significant factual support.
Economic Exceptionalism
There are many observers who believe that, from an economic viewpoint, the United States is no longer the exceptional country it was at the end of the Second World War. There are some good reasons for this belief, including its declining share of global GDP, the rise of Emerging Market economies, and disappointing public school performance.
Looking at the performance of the U.S. equity market, you would certainly think that American companies have a competitive advantage. Since the spring of 2009, the U.S. market has risen over 200 per cent, compared to 108 per cent for the Eurozone, 118 per cent for Japan and 111 per cent for the emerging markets, according to a Goldman Sachs study. The dollar has outperformed every major currency except the Swiss franc. The Goldman study points out that U.S. GDP is 12.9 per cent above its 2009 trough versus 3.8 per cent for the Eurozone and 8.9 per cent for Japan. This economic improvement has been achieved in spite of a reduction in government spending as a percentage of GDP. Unemployment has declined significantly. Energy has been an important stimulus. Proven oil and gas reserves have increased 55 per cent and 35 per cent respectively, with the U.S. accounting for 80 per cent of the total world increase in energy production. Significantly, the International Energy Agency projects that the U.S. will be the largest oil producer by 2020.The U.S. accounts for 52 per cent of the value of the world’s publicly traded equities. Since the recession, earnings per share growth has been better in the U.S. than in other countries, with higher return on equity and less leverage. The United States even has some competitive advantages in terms of manufacturing. Only India, China, Thailand and the Philippines have more efficient unit labor costs, and only Norway has an edge on electricity costs.
Oil
The prevailing view now is that the price of oil will remain low for a prolonged period because of slow world-wide economic growth and increased production. Since the price of oil peaked, the rig count has declined from 1900 to 1300 units. A low rig count usually means that future production will fall off as existing wells mature. The first low in the oil price is usually followed by a test of the price when storage facilities are filled, as they are now, and production continues. The oil has to be sold somewhere. If that pattern is followed, we should see the lowest point soon. A reason for the possible more rapid recovery in the oil price is the continuing increase in demand from the emerging markets, primarily China, India and the Middle East, as well as some modest growth in the developed economies.
Europe
In Europe, the European Central Bank’s new monetary easing programme, should signal a growth pickup. At the beginning of the year it looked like problems in Greece and Russia would push Europe into a recession and the continent would experience deflation as well. I was sceptical that monetary easing by the European Central Bank would change this course. Now, three months later, the outlook has improved. The combination of lower oil prices and a decline in the euro has helped the consumer and increased exports. In Germany for instance, the most important European economy, the Industrial Production Index now is in growth territory.
Two developments have taken place over the past month that have improved the European outlook. The first is that a ceasefire has been declared in Ukraine which looks reasonably firm. That is because Russia has, in effect, taken over the eastern territory the separatists have gained in battle. The second is that a Greek default or defection from the European Union is more clearly not going to be the catastrophe it was thought to be in 2010.
Japan
The increase last year in the value added tax in Japan dealt consumers a powerful blow, but the drop in the price of oil was the equivalent of 2.1 per cent of GDP, and this was, according to a study by Observatory Group, bigger than the impact of the tax increase. The decline in the yen versus the dollar has given a boost to Japanese exports. Wage growth should result in modest inflation (1 per cent) and encourage Japanese consumers to start spending their $10 trillion (Dh36.7 trillion) cash hoard instead of parking it in bank deposits. This will take the pressure off the Bank of Japan to provide additional monetary easing. In addition, Japanese corporate profits were strong in 2014 and look even better for this year. Finally, the second increase in the value added tax planned for this year will be postponed.
Byron Wien is the vice-chairman of Blackstone Advisory Partners LP
