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Abu Dhabi, UAEMonday 25 June 2018

Goldilocks and the global economic porridge

The financial metaphor is commonly used in the investment world, with many experts believing we are facing a Goldilocks global economy now

Illustration by Alvaro Sanmarti
Illustration by Alvaro Sanmarti

A lot of financial experts are talking about Goldilocks at the moment, but they are not discussing the children's bedtime story.

The story of Goldilocks and the Three Bears has become a financial metaphor, based on the little girl’s verdict on the bears’ porridge. The first bowl she samples is too hot, the second is too cold but the final one is just right.

It is the bowl that is “just right” that analysts are interested in. This is what they want to see: an economy that is neither so hot it drives up inflation or so cold that it triggers a recession.

It may surprise many to discover that economists believe that we could just be in a Goldilocks global economy today. If so, it would be a rare piece of good news in these troubled times. So is it true, or simply a fairytale?

The Goldilocks economy is typified by low unemployment, low inflation, rising stock and property markets, low interest rates and steady GDP growth, according to Investopedia. Does that sound familiar?

Unemployment levels

Unemployment is certainly low in many countries, for example, in the US, it is close to historic levels just 4.1 per cent in October, below what is seen as the natural rate of unemployment of around 5 per cent. In the UK, unemployment is at a 42-year low, despite growing Brexit angst.

Eurozone unemployment rates remain high but have now fallen to 8.9 per cent, the lowest since 2009. Unemployment in the UAE is the lowest in the world at just 0.4 per cent, according to the Dubai Statistics Centre.

As unemployment falls, workers have traditionally been able to negotiate higher pay rises that push up inflation, but this is not happening today.

John Hawksworth, chief economist at PwC, says the wage-price spirals seen in the 1970s are conspicuous by their absence. “Workers in most sectors have little bargaining power due to the decline in unionisation and the increased possibility of substitution by either smart machines or overseas workers if wages did rise faster.”

Inflation rates

The result is low inflation, with consumer prices rising 2 per cent in the US and just 1.2 per cent in Europe. In the UAE, consumer prices increased 1.15 per cent in the year to September.

UK inflation is higher at 3 per cent, at time of writing, but that is mostly due to sterling’s post-Brexit plunge, which has driven up the cost of imports. Even so, inflation is expected to start falling again next year.

Equities

Low unemployment: check. Low inflation: check. Goldilocks is happy so far but what about those rising stock markets? The fear is that they are a little too hot, with global share prices trading at near record highs.

Chris Beauchamp, chief market analyst at online trading platform IG, which has offices in Dubai, says indices continue to break records, both in terms of closing levels and winning streaks.

The confidence is seen in the largest merger in the history of the tech industry, Broadcom’s unsolicited US$130 billion mega bid for Qualcomm. “The news has brought out the usual chorus of doom-mongers and top-of-the-market callers, and comparisons with ill-fated tie-ups such as the $160bn AOL/Time Warner merger at the peak of the dot-com boom in 2000, or Royal Bank of Scotland buying Dutch rival ABN Amro for $99.9bn in 2007, just before the banking crisis.

"Yet the move remains an indication of how strong risk appetite is. This global expansion and bull market have much further to run.”

The tech-heavy Nasdaq composite in the US hit an all-time high in October, with Amazon and Microsoft soaring 13 per cent and 7 per cent respectively after posting strong quarterly results, and Apple and Facebook powering on.

Wall Street’s S&P index delivered a total return of 15 per cent in the year following Donald Trump's shock US presidential election victory, despite fears of a slump as nervous investors raced to safe haven assets, according to figures from Fidelity International.

European equities have done even better by returning 22.63 per cent in total, while Asia Pacific returned 20.36 per cent and emerging markets surprised by rising 19.79 per cent.

Tom Stevenson, investment director for personal investing at Fidelity International, says the market response to Mr Trump’s victory was measured and investors have remained optimistic throughout the first year of his Presidency. “Major markets have gone on to hit record highs driven by an improving global economic backdrop, particularly in Europe and Asia.”

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Property and interest rates

Naturally, stock markets could crash at any time, but right now Goldilocks has not burned her lips. So what about her other temperature gauges: rising property markets, low interest rates and steady GDP growth?

Again, it is mostly good news. Global property prices are slowing after years of double-digit returns but many will see this as a positive, while many major global cities continue to race ahead.

The latest Knight Frank Prime Global Cities Index shows Guangzhou in China up 36 per cent in the last year, with Shanghai and Cape Town up 15 per cent, and Madrid, Toronto, Paris, Seoul, Sydney and Melbourne all posting double-digit gains.

Roughly a third of the 41 cities covered in the index are falling, mostly by just 1 or 2 per cent. Brexit-hit London is down 4.6 per cent, Istanbul has fallen 4.8 per cent and Moscow is the worst performer at 9.8 per cent, yet there is no sign of a global property crash yet.

As for interest rates, the US Federal Reserve has hiked them twice this year, taking the benchmark target to between 1 and 1.25 per cent with a third increase likely in December, but they remain low in historic terms.

The Bank of England lifted rates for the first time in a decade in November, but few expect further hikes in the immediate future, and again, today’s level of 0.5 per cent is low, while eurozone rates are stuck at zero per cent.

Kenneth Leech, chief investment officer at Western Asset, a Legg Mason affiliate, reckons inflation may be bottoming out and rates will continue to creep up from here. “Global central banks are now signalling a slow, steady process toward interest rate normalisation.”

Inflation and interest rates may be a fraction cold but they are warming nicely, again, nothing here to trouble Goldilocks.

GDP

The final measurement, global GDP growth, adds a tasty dollop of jam to the porridge. In October the IMF upgraded its global economic growth forecasts by 0.1 points to 3.6 per cent for 2017 and 3.7 per cent for 2018.

It said a pick-up in trade, investment and consumer confidence should help to offset the sluggish US British and Indian economies, while revising upwards its forecasts for the eurozone, Japan, China, emerging market Europe and Russia.

Ian Pizer, head of investment strategy at Aviva Investors, says the threat of deflation has passed and inflation is slowly climbing, pleasing Goldilocks. “Robust global growth will continue to support these trends, justifying central banks’ decisions to start withdrawing stimulus.”

Mr Pizer says this should be good news for global stock markets, particularly in the eurozone and emerging markets, which offer better relative value than the expensive US stock market.

Craig Mackenzie, senior investment strategist at Aberdeen Standard Investments, which has offices in Abu Dhabi Global Market, says global growth is stronger and more balanced than it has been for five years. “However, it is still 1.5 per cent below pre-financial crisis levels, so we are a little cooler than we would like.”

The biggest question mark hangs over China. "The Communist Party is aiming for 6.5 per cent a year GDP growth, the problem is that much of this is sustained by rapid credit growth. Chinese debt has risen $22 trillion in the last decade, and cannot keep growing at that place.”

In August, the IMF warned that China’s economy is too reliant on debt and this could trigger a new financial crisis. It says the nation’s debt-to-GDP ratio should hit a massive 251 per cent this year and touch 300 per cent by 2022, yet the authorities have been slow to bring it under control.

Mr Mackenzie says China is the biggest global fear because a large chunk of that debt is going to be written down. “If the authorities seriously start to tackle debt issues we can expect slower growth.”

Yet for now, the world’s second-largest economy is still booming. Latest trade figures show imports surging by a remarkable 18.7 per cent to September, which suggests Chinese factories continue to see strong demand for their products. The news drove the MSCI’s All-Country World Share index to a new peak of 494.84 points.

The big question

Mr Mackenzie says the other big question is whether falling unemployment will eventually force up wages and inflation. "When labour markets get tight, wages typically rise. Manufacturing companies can of course outsource their operations to countries with lower labour costs, however, service-based economies such as the US can only go so far with that. Inflation could return.”

Politics is the biggest concern, with Mr Trump challenging North Korea, tensions growing between Iran and Saudi Arabia, and the UK in political turmoil. Plus there is the ever-present danger of a black swan event, something unprecedented and unexpected when it occurs, but in retrospect seems inevitable, like the black swans Dutch explorer Willem de Vlamingh discovered in Australia in 1697. Up to that point, all known swans were white.

However, for now, Goldilocks is in her element as the global economic porridge tastes just right. Perhaps that is what makes people so nervous. They find it hard to believe this story can really have a happy ending. So what happened to Goldilocks in the end? Nobody really knows.