From the CEO – December 2018
As 2018 draws to a close, an outlook for the coming year is usually expected. It’s almost unavoidable.
Yet as a firm that has led the world of quant-driven political and country risk rating and analyses for 40 years – 2019 will be PRS’ 40th anniversary, incidentally – we tend not to provide the usual ‘top ten forecasts’ for the year but rather generate forecasts/probabilities throughout the 12 months to the 140 plus countries we cover.
These include probability outlooks affecting regime scenarios and related actions injurious to business and investment, quasi-Type II forecasts over one-year and 5-year time horizons, and a variety of analyses underscoring the extent to which our data correlates with the behavior of the main asset classes.
But looking forward to 2019 our models do present some developing scenarios that I will mention later in this note.
Let me address first, though, about what’s on everyone’s minds: The impact of US monetary policy and trade tensions on global market volatility.
As we all know, the market turbulence that we’ve seen since October has been made worse by a number of factors, including some political risk events coming largely from the US and by computerized trading platforms (Treasury Secretary Mnuchin has attributed the increased equity market volatility on the Volcker Rule and systematic trading, which apparently accounts for about 50% of all trading). Yet, we also hit a point in the business cycle where valuations became quite stretched and some retreat was expected. I mentioned this to investors in NYC in September, and our models have been indicating since the middle of 2018 that a number of economies were in danger of sliding into recession, including Japan, Italy, and Switzerland.
To be sure, the shape of the yield curve doesn’t bode terribly well for the US, and slower economic growth – around 2% – has been posted by our models, with the American economy slowing as the year progresses. Credit growth will continue to be sluggish and new bond issuances will also follow a similar trajectory. This includes bond sales globally. Two additional rate hikes by the Fed in 2019 would not be surprising, but everyone now seems to know that the Fed itself has admitted that it would entertain some flexibility given that it’s driven by data!
Generally speaking, once the economy slows sufficiently, the fiscal stimulus of earlier in the year fades further, and the Fed pauses, it is quite conceivable that Chairman Powell, et al. will lower rates at least once and suspend the reduction of the Fed’s balance sheet. Some of us have been around long enough to remember the market effect of the Greenspan put. Markets usually rally significantly after the Fed cuts rates. This would bode well for the emerging market class, even though some have done surprisingly well over the past month, such as Brazil, Mexico, and Indonesia.
On the trade front, the tenor of the talks between China and the US will soften in the first quarter but a substantive agreement on tariffs is not likely. The time period is too short. But some meeting of minds will help reduce market anxiety and the strength of at least one of the major political risks facing business and investment. The US will also focus on its trade relationships with Europe and Japan and we don’t expect the Trump administration to be any less aggressive than it has been with China on tariffs and – arguably – with Canada and Mexico on the new NAFTA agreement. American unilateralism in trade and many other policy areas will continue throughout the year.
Turning to Europe, our outlook is less than sanguine. The December ICRG ratings showed continued weakness in consumer and business sentiment. In Germany, jostling over who succeeds Merkel won’t help overall political stability and there are no positive yields as far out as seven years along the curve. France’s Macron has been weakened by the December protests, and our clients have told us they entertain serious concerns over the short-term about whether Macron’s political forces will be able to push through their policy reforms amid a weakening economy in 2019.
Despite tweaking its budget to appease the EU (I mentioned this on CNBC as a likely response to the body’s threats of sanctions) Italy remains a concern as its debt burden will enlarge while its economy also weakens in 2019.
Turning to the UK and Brexit, the House of Commons will vote in mid-January on the Withdrawal Agreement and we are penciling-in the slight probability that it will be rejected. We think the Agreement will get more votes than is commonly believed at the moment. In any event, a rejection will likely trigger a new referendum, which will be more precise in its terms than the original plebiscite. It’s also possible the UK will revoke Article 50, which set the departure in motion. If the UK decides to remain in the EU – at least for a while – we expect the pound to appreciate and the broader equity market to do well, too. The pound would also benefit from likely rate increases if the UK were to remain for the time being.
Much of Africa is doing quite well from a country risk perspective. Of course, there are some dark spots (e.g., DRC). But most countries don’t have the external debt loads that characterized their balance sheets in previous years/decades, and growth expectations in many countries for 2019 are quite impressive.
Politically, we’ve seen generally peaceful transitions of power which have important implications for investors. For example, the new government in Freetown appears very committed to improving the business and investment climate in the country by, inter alia, eradicating graft. On this score, clients should note that PRS and the government of Sierra Leone are in early-stage discussions over a number of initiatives that will encourage investment into the country and improve the business landscape. Stay tuned for more information on this as 2019 unfolds!
PRS is quite bullish on Brazil and Argentina, although the latter is a concern as President Macri’s chances of re-election are questionable. From a populist perspective, we are impressed with AMLO’s policy focus in Mexico but have some concerns about the security of contracts and creeping expropriation under the new regime. Peru’s president, Martín Vizcarra, and his policy agenda to reduce corruption continue to impress and his popularity ratings in the country have eased that part of the country’s political risk profile. However, Vizcarra will continue to face hurdles in the legislature and a slowing global economy will do little to help the government’s balance sheets.
Finally, we see some bright spots in Asia (e.g., Vietnam, Indonesia) and in Eastern Europe (e.g., Armenia). In the Middle East, PRS sees more relaxed fiscal regimes, better conditions overall for private business, but economic sentiment and growth curtailed by lower oil prices. On this score, clients and friends are encouraged to receive PRS’ Political Risk Letter (https://epub.prsgroup.com/products/political-risk-services/political-risk-letter) as it provides monthly updates on select countries as well as present and future estimates of a range of regime probabilities and the outlook for a number of balance sheet items (growth, inflation, current account).
Finally, we have planned a number of new products and services for 2019, including preferred client tiering of our proprietary ICRG risk data, and an outstanding political risk platform based on a number of artificial intelligence and machine learning platforms.
Additionally, I’ll be releasing a series of weekly videos updates on the world of political risk, and a new book on political risk going into the next decade is planned for release, with myself (www.christophermckee.net) and Peter Marber (www.petermarber.com) both co-editing the collection of essays and authoring a few chapters. Notably, the book will contain some interviews with key personnel in the political risk, investment and business landscape that cannot be found in any similar publication.
So Happy New Year, and I look forward to a very exciting and prosperous 2019 for everyone.
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