Throughout his campaign and first 100 days as President, many of Trump’s proposals have been indisputably controversial. From the 11% decline of the Mexican Peso immediately following the election to the 25% increase in U.S. construction materials, it may seem clear that Trump’s presidency has resulted in increased volatility in the global financial markets. This is surprisingly not the case, as Trump’s administration has resulted in the most stable equity markets since President Kennedy (1961-63) [1]. However, the fundamentally radical nature of Trump’s platform raises speculation as to how the markets have maintained this stability. His most recent point of contention results from his intended $3.6 trillion cut in government spending over the next decade in the following departments [2]:

Radical claims such as this, alongside the general consensus of underperformance in his first 100 days [3] have led to recent discussions involving impeachment. Political uncertainties like this typically result in slower market growth and increased investment in Treasury Bonds or in commodities such as gold. Despite this uncertainty, the S&P 500, DJAI, and the NASDAQ have all shown significant growth since the November election, as shown in the graphics below. The growth achieved across each major equity market index suggests investors have confidence in the Trump administration’s economy.

S&P 500Dow Jones

NASDAQ

The performance of U.S. financial markets alongside the 3.97% [4] growth in GDP is reassuring for most investors. However, the bond market may tell a different story. 10-year Treasury yields have remained consistently low, with a decline of 3.1% over the last 6 months. The yield curve is a common indicator used for predicting recessions in the U.S., and should therefore be evaluated alongside the apparent growth of the U.S.’s capital markets. In simple terms, the slope of the yield curve is defined as the difference between a short and long-term rate of U.S. Treasury issues [5]. Generally, increasing short-term rates indicate that the economy is slowing down. Eventually, if these short-term rates rise high enough, the yield curve may invert and lead the economy into a recession. To strengthen the validity of this indicator, it is important to highlight that an inversion of at least 100 basis points or more has predicted 6 out of the last 7 recessions [6]. By viewing the graph below, it may become clear that a major inversion is currently underway in the U.S. Treasury Bill market.

The graphic above features a comparison between short and long-term U.S. Treasury Bills, where green demonstrates the rates of 3-month T-Bills and blue demonstrates the rates of 10-year T-Bills. It is clear that there has been a significant increase of short-term T-Bill rates, from 0.5% to nearly 1.0% since March. On the other hand, the 10-year T-Bill rates have seen a sharp decline from 2.7% to 2.25% during this time. These shifts have immediately followed Trump’s proposed budget cuts made on March 16th. Referring back to the yield curve, the trend of this inversion of short and long-term rates may be a clear sign that the U.S. economy is heading towards a recession.

What does this mean for the global financial markets? The stability of these markets will be dependent on the decisions that President Trump makes over the next few months. Although globalization has facilitated economic development, it has also resulted in increased interdependencies between the global financial markets. The implications of this became clear in the 2008 financial crisis, when countries such as Iceland reported bankruptcy as a result of the U.S. subprime mortgage crisis. If the U.S. is to suffer a financial crisis, the entire global financial system will suffer. Despite the fact that the U.S. has maintained stable GDP growth rates and bullish trends in their market indices, it will be important to proceed with caution when evaluating the strength of the U.S. economy and the global markets as a whole.

[1] http://www.cnbc.com/2017/04/28/trump-has-presided-over-the-calmest-first-100-days-since-kennedy.html

[2] http://www.cbc.ca/news/world/trump-budget-breakdown-1.4027472

[3] http://www.newyorker.com/magazine/2017/05/01/a-hundred-days-of-trump

[4] http://www.multpl.com/us-gdp-growth-rate/table/by-year

[5] http://www.investopedia.com/terms/y/yieldcurve.asp

[6] https://www.fdic.gov/bank/analytical/fyi/2006/022206fyi.html

After the surprising result of Brexit, there are more and more doubts about the feasibility and efficiency of Eurozone system. Brexit uncovered major concerns, such as the European single market’s lagging global trading competitiveness, immigration issues, risks on unitary regulations and laws. This event triggered the alarm for Eurozone countries to reconsider whether it is beneficial to stay in Eurozone.

Let’s take a close look at the actual economic changes to those Eurozone countries to judge which countries are better off within the Eurozone, and which are worse off. We build an Economic Scorecard Model (final data as below) based on 20 years of data from 1997 to 2016. The seven economic indicators used are real GDP, unemployment rate, inflation rate, government debt, industrial production, retail sales index, and trade balance. Based on the characteristics of each economic indicator, we have analyzed each variable from absolute and relative levels.

Ireland is the best-performing country in Eurozone with an overall score of 69.51. Ireland aces real GDP and unemployment rate metrics and ranks second for industrial production. Belgium, Malta, Germany, and Finland rank from second to fifth place with scores of 62.59, 57.32, 55.79, and 55.6. Looking at the bottom of the rank. Slovakia, Cyprus, Greece, and Portugal have overall scores below 40. Unsurprisingly, Greece only has an overall score of 32.04 with worst performances in real GDP and industrial production metrics. The Economist would agree with our model when they state, “As it turned out, the super-responsible ECB spent the 2000s making a monetary policy that fit the laggardly German economy, and which was actually too loose for Greece’s economic situation” [1]. Portugal has an extremely low score of 19.57with zeros and single-digit scores for five factors out of seven.

Now, on to the more dominant countries. Germany, as the largest manufacturing and exporting country in Europe, has the highest world rank at 4th place with a score of 55.79. Eurozone brings plenty of benefits to Germany, and as Fortune would put it, “Germany’s gains in competitiveness were immediately translated to gains in trade, since the freedom of goods, services, persons and capital allowed German products to circulate freely and quickly throughout the European Union” [2].  The Euro helps Germany offset the effect of booming export on currency appreciation. Their ability to keep good prices competitive relative to other European markets gives them huge advantages on foreign trade. It scores 100 on trade balance metric and leads the second-place Ireland by 55.54 points. Inflation stability and improved unemployment also support Germany in developing further under the Eurozone system.

France is the worst performer among major Eurozone countries. Unemployment score is the only other score above 50, while the scores in all other metrics are depressed, which show the country suffered from low real GDP growth, increasing government debt, deteriorating industrial production, and decreasing the foreign trade balance. No wonder populism is booming in France. Eurozone system does not seem like a good fit for France. Even though Macron won the presidential election, Le pen’s National Front could grow further in the future if the fundamentals in France don’t change.

Italy scores 42.9 and is one place above France in the rank. As a well-developed country before joining Eurozone, there was not as much potential to improve on retail sales and the unemployment rate. Real GDP growth is the second worst among Eurozone countries with a score of 1.68, and even trade balances got worse. Further, industrial production has completely collapsed under the euro — it has been absolutely butchered – since, after entering the single currency market, Italian firms can no longer offset their high production cost by depreciating their currency. This has been deteriorating their trading competitiveness dramatically and has led to the slowdown of a historically great economy. Facing corruption, fiscal and banking sector issues, and a refugee crisis, it is time for Italy to change. The Anti-Euro Five Star movement is leading the poll at 32%, whereas the center-left Democratic Party is at 26% [3]. It is very likely that the Five Star movement will win the election next year and exit the single currency market soon thereafter.

The creation of Eurozone has its own benefits and flaws. It is crucial to question whether Eurozone is a good deal for all the Eurozone countries. Based on the Economic Scorecard model, the answer is simply ‘No’. Just as Nobel laureate Milton Friedman (1997) wrote: “Europe’s common market exemplifies a situation that is unfavorable to a common currency. It is composed of separate nations, whose residents speak different languages, have different customs and have far greater loyalty and attachment to their own country than to the common market or to the idea of ‘Europe’ [4].” With more exposure of the innate problems of the Eurozone system, the European right-wing is gaining popularity. Structural changes to reshape the Eurozone are unavoidable.

After Brexit, who’s next? My answer is Italy.

Citations:

[1] http://www.economist.com/blogs/freeexchange/2011/07/greece-and-euro

[2] http://fortune.com/2014/10/22/why-germany-is-the-eurozones-biggest-free-rider/

[3] https://www.ft.com/content/ff14351c-3572-11e7-99bd-13beb0903fa3

[4] https://www.project-syndicate.org/commentary/the-euro–monetary-unity-to-political-disunity

Do you remember when Canada got rid of the penny? There was months of advertising, plenty of time for planning, and thus it was relatively easy to exchange pennies for other forms of money. But many people didn’t bother exchanging, as Canada’s economy is not exactly dependent on the penny, and most people in Canada don’t use cash for transactions regularly anyway [1].

Now imagine if 78% of transactions in the country were done in cash. And then one day, without warning, the government got rid of the most used bank note in the country – say the $20 bill. Imagine the chaos that would ensue. That is what happened in India.

On November 8, 2016, Prime Minister Narendra Modi announced he would be getting rid of the old 500 and 1000 rupee bank notes, and issuing new 500 and 2000 rupee bank notes. The deadline for the exchange was December 30, 2016. In addition, people could only exchange a certain amount of money per week. Finally, large exchanges – over $3600 – were subject to a tax.

The reason for PM Modi’s decision was to tackle crime and corruption in the country. It is easy to see why cash transaction would be so helpful for different kinds of criminals. It is extremely hard to track. This leads to huge amounts of tax evasion and an easier time for underground criminals.

In a month and a half, roughly USD 183 billion dollars were exchanged. The process, was unsurprisingly rough. Since the decision was such a surprise to everyone, people had to line up for hours. As well as that, there was an initial shortage of new banknotes, and people living in small villages had a hard time even getting to banks. Many Indians didn’t even have a bank account. This was an unmitigated logistical mess – especially early in the transition.

Because Modi decided to get rid of about 86% of all currency in circulation, there was a tremendous shortage of cash – in a country that runs on cash!. This is causing a slowdown in the Indian economy. Investment, real estate, and the automobile industry are all down. And perhaps most devastatingly, farming is down, too [2].

The slowdown hurts the poorest Indians the most. Those living on the edge of poverty, now have to reduce consumption. This might be okay in a developed country, like Canada, where incurring a slowdown may help to solve such a problem. But for those on the poverty line, a reduction in consumption means eating less food [3].

The question remains, what about the corruption that was going to be combated? Well, the evidence on that question has yet to come in. There is, of course, the fundamental question, what is stopping criminals from switching over to the new cash system – especially when more cash becomes available? It is true that more tax than usual was paid over the last two months, but beyond that, this policy won’t shift India into using plastics overnight. Overall, expert opinion seems to say that crime will not be too affected by this new policy.

The dream of Modi, to turn India into a cashless society and to combat crime and corruption, is worth striving for – considering the level of tax evasion. But an aggressive policy like this targeted toward an India that is simply not ready to become cashless is a misguided move that will continue to have harsh economic consequences.

[1] http://www.bankofcanada.ca/wp-content/uploads/2015/05/boc-review-spring15-fung.pdf
[2] http://www.npr.org/2017/01/03/507983996/indian-farmers-hit-hard-by-governments-currency-restrictions
[3] https://www.nytimes.com/2017/01/02/world/asia/modi-cash-ban-india.html
[4] http://blogs.wsj.com/briefly/2016/12/30/50-days-of-indias-war-on-cash-the-numbers/
[5] https://www.bloombergquint.com/business/2016/12/30/50-days-after-demonetisation-real-estate-deals-remain-few-and-far-between
[6] http://www.livemint.com/Industry/SIK34NIedgYQjLwFHmy6BI/Demonetisation-takes-a-toll-on-automobile-sales-in-December.html
[7] http://www.livemint.com/Politics/5vmA6lF40HFY3P381uzkTJ/Demonetisation-takes-toll-on-investment-manufacturing.html

Since 1945, the world has seen an era of American leadership. Now, with the populist mindset swaying in favor of protectionist policies and the 2008 Financial Crisis still reverberating in the pockets of the public, a new stage has been set with the receding role of the US in international leadership. Reminiscent of, though not entirely resembling, the American isolationist period of the 1930s, this power vacuum will grow and peak in 2018, when the full impact of the Congressional budget comes into play. The fair question: which actors will fill this vacuum, and with what currency?

Percent change of budget, based on the Trump Administration’s preliminary 2018 proposal // The Washington Post [1]

Comparison of Aramco’s potential offer to previous offerings // Bloomberg [5]

OPEC Performance after the production cuts // Bloomberg [5]

With the ambitious objective to create a sovereign wealth fund that will anchor Saudi state revenue by 2030, there’s no doubt this IPO will have a monumental impact on the cash flows of the East. A survey conducted by investment bank EFG Hermes at an investment conference in Dubai, polling 510 international fund managers, shows that 63% predict Aramco’s market capitalization to be over $1 trillion, while 36% predict under $1 trillion [9]. Such a valuation falls in the middle, though leans upward, between Saudi Arabia’s prediction and Wood Mackenzie Ltd.’s harsher rough valuation of $400 billion. 

Comparison of the valuation of publicly traded companies, highlighting Aramco’s potential // Bloomberg [10]

References

[1] https://www.washingtonpost.com/graphics/politics/trump-presidential-budget-2018-proposal/?utm_term=.7483d7263da8
[2] https://www.ft.com/content/99353918-ed8c-11e6-930f-061b01e23655
[3] https://www.forbes.com/sites/ellenrwald/2017/02/25/the-worlds-biggest-ipo-is-coming-what-you-should-know-about-aramco/#29110053535f
[4] http://knowledge.wharton.upenn.edu/article/boutique-firm-landed-big-role-aramco-ipo/
[5] https://www.bloomberg.com/news/articles/2017-02-26/this-is-all-the-ways-a-saudi-aramco-ipo-could-impact-markets
[6] https://www.bloomberg.com/news/articles/2017-03-06/aramco-ipo-prep-on-powerful-saudi-prince-s-long-2017-to-do-list
[7] http://www.reuters.com/article/us-saudiaramco-ipo-restructuring-idUSKBN15W1ZB
[8] https://www.bloomberg.com/news/articles/2016-10-06/saudi-aramco-ipo-will-offer-stake-in-all-of-company-s-operations
[9] http://uk.businessinsider.com/investors-expect-saudi-aramco-ipo-to-value-at-one-trillion-2017-3
[10] https://www.bloomberg.com/news/articles/2017-02-23/saudi-arabia-2-trillion-aramco-vision-runs-into-market-reality
[11] http://www.marketwatch.com/story/saudi-arabia-favors-new-york-for-aramco-ipo-2017-02-21