Or not. Because, let’s face it, Monday’s financial news was dominated by a bunch of things that have dominated it for months. Like Scotland’s upcoming independence vote, China’s wobbly economic data, politicians pledging to do something about US corporate inversions, Japan’s struggling economy and yet more EU/Russia sanction talk. Headlines might promise some of these developments are game-changing, because that’s how you get eyeballs, but in our view, none should cause long-term investors to radically shift course.
We start in Scotland, where a weekend poll showed the “yes” vote pulling ahead for the first time, 51 to 49—and all manner of speculating and hand-wringing followed. Never mind that the pollsters simply tossed out the still-sizeable chunk of undecided voters, making its findings a wee bit dubious. And never mind that the other five major polling sources still show a sizeable (though narrowing) lead for the unionists. One poll was good enough to kick another round of “what if?!” speculation into overdrive—with much of it speculating on the political future of Prime Minister David Cameron and the opposition Labour Party (much of whose traditional support base is in Scotland) should independence win.
Last week, we wrote:
The more time markets have to price in winners and losers, the smaller the chance of some massive surprise—and where Scotland is concerned, time is abundant. Two years have passed since the referendum was scheduled, which means two years of speculation and warnings of the risk associated with independence. Two years of questions about currencies, UK debt management, taxation, North Sea oil revenues, RBS’s address, the future of Team GB at the Olympics, Scotland’s potential EU and eurozone membership and all the rest—and two years of speculation over the answers. Thanks to the widespread discussion, markets are already well aware of most (if not all) possible winners and losers and the wide array of possible outcomes. Every open letter from Scottish business leaders warning of the dire consequences of independence—and every letter from another group of Scottish execs who claim independence will be a boon—is a little gift to the efficient market elves.
All of that is still true. Markets have paid plenty of attention to the rancorous campaign and speculation, and with UK stocks underperforming since mid-May, it seems fair to say markets have started pricing in the narrowing polls and accompanying noise. Monday brought more narrowing and more noise (and more pricing in, judging from the pound and Scottish companies), but not more clarity—this will still go down to the wire, and if it passes, we’ll still have ages to see exactly how the remaining union and Scotland will change.
Over to China, now, where August trade data showed a 9.4% y/y rise in exports and -2.4% y/y drop in imports, the second straight year-over-year contraction. Many interpreted negative imports as a potential sign of falling demand—a fair point, philosophically—and resurrected those long-running (though briefly on hiatus) hard-landing fears. We still find this outcome highly unlikely, though. While falling imports would ordinarily be cause for concern, in this case, they appeared tied to a fall in commodity prices and an ongoing investigation into firms’ questionable practice of importing copper to use as collateral for financing. Plus, there is already talk of more targeted stimulus, with officials easing financing restrictions on some property developers over the weekend.
Though many other metrics have wobbled, too, it still seems hard to get too worked up over 12.2% y/y growth in retail sales and 9% in industrial production. And we’re hard-pressed to come up with a different take than we had in May:
In our view, there just isn’t any reason to believe those hard-landing fears are any more valid than they were in 2011, 2012 or 2013. Yes, China slowed each of those years, with GDP growing 9.2% in 2011, 7.8% in 2012 and 7.7% in 2013. But it has been a gradual slowing, not a sudden drop to 3-4% (or worse). Based on what we’ve seen so far—and based on the continued, steady rise in China’s Leading Economic Index, the most likely outcome in 2014 is just a continuation of that gradually slowing trend. The same old thing headlines have hashed and rehashed for years now.
The latest on some US politicians’ battle against corporate inversions—US companies buying smaller foreign competitors so they can get a new address and avoid double taxation on foreign earnings—is even less of a change. In July, we wrote:
Treasury Secretary Jack Lew wrote a letter to key members of Congress urging legislation to all but ban the practice, later saying a ban was tantamount to “economic patriotism.” In practice, however, seems to us it would be more like another ism: protectionism, which is generally negative for markets. If the proposed ban were to become law, it wouldn’t be great. However, the probability is slim in a gridlocked Congress, limiting the risk this disrupts the bull market.
Seven and a half weeks later, we have more chatter but zero concrete developments. Treasury Secretary Jacob Lew says the Treasury is preparing regulatory changes to “limit the economic appeal” of inverting, but the Treasury can’t do much by fiat. A sweeping change would have to come from Congress. One Senator proposed back-taxing some inverted companies’ earnings all the way back to 1994, but this has almost no chance of overcoming gridlock.[i] Seems to us a full-on ban remains unlikely.
So is a material turn in Japan’s fortunes. Q2 GDP growth was revised down Monday to a -7.1% seasonally adjusted annualized drop—with steeper-than-estimated falls in consumer spending and business investment. It’s still abundantly clear April’s sales tax hike hurt, it still isn’t clear whether Shinzo Abe and his government will pursue tax hike part deux next year, and policymakers’ expectations for a quick(ish) recovery still seem a bit too high given the accompanying rise in inventories—even if spending rebounds, it’ll take a bit of time to work through that supply glut.
Notably, policymakers are optimistic for the same reason as last month, when Q2’s preliminary results were announced: Quantitative easing. Or, as we put it then:
And it’s not just the government. Headlines and investors broadly are still rather optimistic. Most of them for one reason in particular: Abenomics! (That’s the three-pronged economic revitalization strategy championed by Prime Minister Shinzo Abe, for those of you who have better things to do than follow this saga.) One plank of Abenomics is quantitative easing (QE), similar to the US and UK, and investors are convinced this will prevent a repeat of the 1997 recession. And if things look dicey? The BOJ will just QE some more! (Yes, we just made that a verb.) Never mind the similar tax hikes already scheduled. The BOJ has already set expectations for more asset purchases if necessary, making investors believe they needn’t fret further economic weakness. But in our view, this is a tad hasty.
It’s still hasty! The sales tax hike hurt because it raised people’s costs without a corresponding rise in income. QE also raises people’s costs by making imports—particularly imported energy—more expensive without a corresponding rise in income. Based on everything we read today from Abe’s cohorts, we are fairly certain the administration doesn’t see this basic disconnect. Which makes us skeptical they’ll see more QE isn’t a substitute for deep economic reform when it comes to restoring Japan’s economic prowess.
Finally, sanctions. Apparently Europe agreed to some today but won’t publish and apply them for a few days, just to give Russia and Ukraine a chance to end the conflict on their own. Reportedly, though, the sanctions target Russia’s state-run energy giants—not with a trade ban, because the EU needs Russian energy, but with restrictions on EU capital markets financing. Prime Minister Dmitry Medvedev has already said Russia will retaliate—not with a gas trade ban, because Russia needs to sell the EU energy, but by banning EU commercial flights through Russian airspace. That’ll show ‘em?
For the global economy, these measures don’t much change matters—the impact here is minimal. Just add some higher air traffic costs to this analysis from last month:
We won’t argue Russia’s move has zero economic impact, but with a $70 trillion-and-growing global economy, it takes far more than trade barriers against a few billion in foodstuffs to end a bull market. … Yes, it’s a tit-for-tat move, which is how trade wars usually start. But a severe trade war—something along the lines of the Smoot-Hawley blowback in the 1930s—would require significant escalation from here. If Putin were to raise embargoes that could do real damage, he’d basically commit economic suicide at home. If the worst he can do without causing a major recession is say no to apples and chicken, the likelihood this escalates into major trade barriers worldwide is basically nil.
Overall, if there is one common thread between all these stories, it is this: Beware headlines promising game-changing news. Sometimes, news really is new! But much of the time, small developments don’t change the status quo.
[i] Good thing, too. India’s recent adventures in back-taxing foreign M&A deals—in their case, back to the 1960s—highlights just how harmful this can be to investors’ and businesses’ confidence in a country as a good place to do business.