Outlook 2015

A small increase in World trade in 2015 | World trade grew at around 1.2% during 2014. This is still a forecast but is based on the actual data from the International Monetary Fund for the first three quarters of 2014 and the Delta Economics forecast for Q4 2014. The Delta Economics forecast aligns with the CPB Netherlands Bureau Trade Monitor for the first three quarters of 2014 but is divergent from the IMF and WTO’s trade forecast for 2014 by some margin (Figure 1).

Delta Economics is predicting that World trade will grow in value terms slightly during 2015 from 1.2% to just below 2% by the end of 2015. Because this is a forecast in constant values, it represents likely increases in World trade volumes during the course of the year.

Care should be taken in interpreting this growth, however. While it is the first forecast of slightly faster growth that we have made since 2011, it is still too slow to suggest that there is any major resurgence of trade as a driver of economic growth or, indeed, a return to the multiples of trade growth versus GDP that was evident in the immediate aftermath of the financial crisis.

 

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Figure 1  | Delta Economics, WTO forecasts versus actual trade growth, 2011-14
Source | Delta Economics, WTO and CPB Netherlands Bureau 2011-14

 

The growth in 2015 will be led by two regions, Asia and North America (Figure 2). Asia’s growth, to a large extent will be driven by:

  • China’s recovery from slow trade growth (at just 4%) in 2014 to above 7% in 2015, although this is still a long way below post-crisis peaks
  • Re-distribution of trade around the region away from China, we expect particularly rapid trade growth in Indonesia and Malaysia at over 10% and 7% respectively in 2015

North America’s growth is driven by exports which, following a sustained period of re-shoring, are forecast to grow by nearly 4.5% in 2015.

However, every other region’s trade is forecast to decline or grow at a slower rate in 2015 with Europe’s trade set to shrink in current prices by 3.5%. Much of this is due to declining intra-European trade: trade within the Eurozone is forecast to drop by 3.7% this year reflecting weak demand conditions within the Eurozone.

 

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Figure 2  | World and regional trade growth (% constant prices), 2014 and 2015 compared
Source | DeltaMetrics 2014

 

Disinflation, oil prices and the risks of contagion | MENA’s trade is forecast to drop to 1.9% in 2015 from an already disappointing 3.6% growth in 2014. At the beginning of 2014 the Delta Economics forecast was for above 4% growth. On paper at least, oil producing nations are net losers in export terms as the oil price drops while oil importers are net winners in that it reduces costs for producers and exporters.

A zero-sum game in trade terms as the oil price drops is over-simplistic, however. Trade and oil are 94% correlated. This means that trade can effectively be a mechanism through which disinflation is spread through the global economic system. Emerging markets are the largest oil producers and, as they lose export revenues, their aggregate demand falls back meaning that they demand less by way of imports from other countries. Lower oil prices reduce producer costs, but if there is little demand either within or outside of a region then export prices will also have to drop.

Against this backdrop the forecast for World trade becomes important as a predictor of when we might see oil prices increasing again (Figure 3).

The monthly predictions of trade growth suggest that there will not be any major pick-up in the oil price until the end of Q1 2015. Even then, any increase will be erratic and relatively small based on how we are predicting global trade will grow.

 

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Figure 3  | Monthly value of World trade vs. NYSE Arca oil spot, Last Price Monthly, June 2001-Nov 2011
Source | DeltaMetrics 2014, Bloomberg

 

Geopolitics, geoeconomics and “febrile stability” | 2014 was dominated by geo-political and geo-economic risks from the outset: starting with the Emerging Markets in January, Russia and Ukraine in late February, the Iraq crisis in June 2014 and subsequent crises in August to the end of tapering, with China and Japan’s economic slowdowns at the end of the year. Until the major fall in oil prices at the end of 2014, markets appeared to be pricing these in. Equity markets continue their bull run with the role of central banks increasingly seeming to be to provide reassurance to markets that nothing precipitous is likely to happen to interest rates in the immediate future.

This creates what Delta Economics terms, “febrile stability”: markets are behaving as if there are no underlying geo-political or geo-economic concerns, yet watching for one incident that will trigger a major sell-off.

The case of Germany’s car trade with China and Russia illustrates the interplay between geo-politics and geo-economics and its dampening effect on trade (Figure 4). The DAX is 86% correlated with Germany’s trade overall, 73% correlated with its car trade to China and 84% correlated with its car trade to Russia. Figure 4 shows:

  • German car exports to China are forecast to grow during 2015 but it will not be until the end of Q2 that exports really pick up again, this suggests that China’s demand for luxury goods, while growing, is not growing at the pace that might be expected
  • German car exports to Russia are forecast to slow during 2015 and have dropped substantially since the beginning of the Russia-Ukraine crisis, this is partly a reflection of Russia’s weakening economy but in the first instance was the result of punitive reciprocal trade restrictions

The tipping point in 2015 is likely to be an increase in interest rates in the USA. If this is early in 2015 while oil prices are still falling, this will further strengthen the US Dollar, reducing further the export revenues for emerging economies in particular and placing at risk of default any sovereign debt or bonds denominated in US Dollars. As Russia, Argentina and Venezuela are close to default this could be the catalyst that sparks a global correction.

 

 

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Figure 4  | Monthly value of German car exports to Russia and China, USDm vs. DAX, Last Price Monthly (June 2001-Dec 2015)
Source | DeltaMetrics 2014, Bloomberg

Global equity markets long overdue a correction | Delta Economics modelling continues to suggest that equity markets are long overdue a correction. The correlation between World trade and the S&P 500 has weakened from 68% in January to 62% now and this reflects its long bull run that has extended to the end of 2014. It has become increasingly detached from real macroeconomic indicators and increasingly determined by central bank monetary policy and short-term sentiment indicators.

Delta Economics considers the bull run to be unsustainable given the pressures of disinflationary contagion and geo-political and geo-economic risk that spread through the global trade system. Economies do not operate in isolation in the same way as they did pre-crisis and a hike in interest rates in one country, particularly the USA, will impact others through trade and debt dependencies. Against this fragile backdrop, it is likely that a major correction in asset prices will take place during 2015.

 

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Figure 5  | Monthly value of World trade (USDbn) vs. S&P 500, Last Price Monthly, June 2001-Dec 2015
Source | DeltaMetrics 2014, Bloomberg

Outlook 2015: a small increase in World trade in 2015  |  Trade View Author  |  Rebecca Harding  |  CEO

Bull in a China Shop?

China’s status as the world’s largest economy is no reason for hubris  |  China’s status as the world’s largest trading nation and, during 2014, as the world’s largest economy should be treated with caution by markets. It is still an emerging economy, faces manifest problems in terms of structural reform and has a difficult year ahead of it in terms of trade and economic growth. Observers would do well to treat the news about its size with the ambivalence it deserves: over-reaction, which is admittedly absent at present, could add further challenges to China as it seeks to impose major structural reforms without causing a sovereign debt crisis. It is no longer growing, either in trade or GDP terms at the rate that it was pre-crisis. This is a fact, and one that should concern markets more than the size of the Chinese economy, which does little more than beg the question, “so what?”

In October 2011, Delta Economics predicted that China would become the world’s largest goods trader by 2014. In January 2014, China officially became the world’s largest goods trader (1) in the world accounting for over 13% of world trade according to our estimations. Last week the World Bank (2) announced that China would also become the world’s biggest economy, in 2014, a fact which surprised many economists who had forecast that this would not happen until 2019; it also frustrated the Chinese government. There is some scepticism about the materiality of the numbers themselves because of the way in which they are calculated but, as Martin Wolf (3) points out, it is a reasonable, even an unsurprising conclusion and does not mean that China is the world’s most powerful economy.

The Delta Economics view is that China should indeed be regarded as an emerging economy. This means that analysts should be looking for evidence that its economic fundamentals are catching up with those of the developed world to justify investment decisions.

First, there is no better place to start than in a closer examination of the structure of its trade. China is not catching up quickly with either Germany or the United States in terms of the goods it imports and exports and, indeed its trade is becoming more concentrated in its top ten exported and imported products rather than less. In import terms, this means that it is still importing predominantly commodities and intermediate manufactured goods while in export terms, its exports are heavily concentrated in computers and intermediate machinery. As Figures 1a and 1b show, the fact that the “rest” component of the top 30 sectors has fallen so sharply, suggests that the reliance on these sectors in export and import terms has increased.

 

Bull in a China Shop  |  Figure 01a

 Figure 1a  |  Share of China’s top 10 export products as a percentage of its top 30 export products, 2014

Source  |  DeltaMetrics 2014

Bull in a China Shop  |  Figure 01b

 Figure 1b  |  Share of China’s top 10 import products as a percentage of its top 30 import products, 2014

Source  |  DeltaMetrics 2014

Figure 2 compares the structure of China’s trade with Brazil, India, Russia, Germany and the US in 2001 and 2014 using the Finger-Kreinin Index, which measures the similarity of the structure of exports between countries. Effectively it is a measure of how a country is catching up/competing with another in terms of its exports. The closer the value is to zero, the less similar the structure of exports is – in other words, the country comparator as few export sectors in common.

 

Bull in a China Shop  |  Figure 02

 

Figure 2  |  Finger-Kreinin Index for China’s export similarities with selected countries

Source  |  DeltaMetrics 2014

What the figure quite clearly shows is how different China’s structure of exports is to other countries, whether developed or emerging. It is more like a developed world economy that Brazil, India or Russia since electronic goods and intermediate goods dominate its exports as compared to the dominance of commodities in the other countries. Only India shows any sign of a major shift towards export similarity, but as the value is still low, at 0.13, the change does not suggest that India is competing directly with China.

Of more interest is the fact that neither Germany nor the US are similar in terms of their exports either. China has become more like the US over time, although it is still very different and Germany became mildly more similar immediately pre-crisis with slightly higher values (0.12) which is arguably because of a shift in German manufacturing out to China at that time which has since performer5 coupon code reversed. Similarly the biggest shift in the similarity of US export structure to Chinese was in the same period and has not yet reversed.

But the fact remains that neither selected emerging economies or the two other, largest, trading nations, are at all like China.

Second, while Barclays Capital, argues that China’s trade is not growing fast enough to keep investors happy, the effects of Hong Kong are dampening prospects for growth. Strip the effects of Hong Kong out, and export growth last year was 6.8%. This is very close to the Delta Economics similar estimate of Chinese export growth of 6.9% in 2013 suggesting that the Hong Kong factor is an important one to consider.

It is necessary to exercise caution when looking at the relationship between Hong Kong and China in trade terms. Because Hong Kong is a semi-autonomous region, it counts as part of China for some import and some export purposes. Thus, re-imports into China (which are the proportion of imports from, say, Hong Kong or China Macao that originate in China) grew from 4.5% of the share of top 30 importers into China to nearly 10% now.

 

Bull in a China Shop  |  Figure 03

 

Figure 3  |  Chinese exports to key port nations, USDm, June 2001 – January2016

Source  |  DeltaMetrics 2014

The figure shows Chinese exports to key port hub nations. Clearly it exports more to Hong Kong than it does to other port nations but this figure suggests two things: first, the volatility of China’s trade with Hong Kong has increased since 2009 and follows a regular pattern and second, that trade with Singapore and the Netherlands grew faster year-on-year in the first quarter of 2014 that exports to Hong Kong.

Third, the volatility in particular suggests that Chinese trade inflows and outflows themselves do not necessarily reflect the trade fundamentals, which have remained very similar since 2001. And yet, the Hang Seng index and Chinese exports are extremely highly correlated, with a value of 0.81 suggesting that this volatility may even be helping investors to predict where that market might go in the future, as illustrated in Figure 4.

 

Bull in a China Shop | Figure 04

Figure 4  |  Chinese exports versus Hang Seng, Last Price Monthly, June 2001 – March 2014

Source  |  DeltaMetrics 2014 and Bloomberg

It is this last point that is the most important. The correlation between markets and Chinese trade is strong, but much stronger for emerging markets than it is for developed world markets, even regional ones like the ASX 200 or the Nikkei (Figure 5) and, as shown in Figure 6, the relationship between the S&P 500 and Chinese exports is negative from the end of Q1 2013.

Bull in a China Shop | Figure 05

Figure 5  |  Correlation of Chinese exports with key regional markets and the S&P 500

Source  |  Delta Economics own analysis

Bull in a China Shop | Figure 06

Figure 6  |  Chinese exports (USDm, June 2001 – Dec 2014) vs S&P 500, Last Price Monthly, June 2001 – March 2014

Source  |  DeltaMetrics 2014 and Bloomberg

All of this illustrates the importance of China’s exports to emerging equity markets. These watch China’s economic indicators and react accordingly, perhaps because the emerging countries in the Asia-Pacific region are so dependent on China’s economic health. Interestingly there is a relatively weak correlation with the ASX 200 and one that turned negative in early 2010.

There are lessons for investors in both emerging markets and developed markets in this. For emerging markets the case is clear: China’s businesses are key to the growth of their own markets (whether in the real economy or money markets) and this drives capital inflows and outflows. Delta Economics has downgraded its forecast for Chinese trade in 2014 from 6.1% growth at the end of last year to 5.3% now suggesting a tough year for these markets.

For the developed world, the apparent bullishness is still not pricing in the risks in emerging markets. These risks are manifesting themselves through trade in the first instance but have the capacity to spill over into debt markets as well as disinflationary pressures and the potential for defaults become more evident. It might well be that these bulls could do themselves a lot of damage if they don’t look more closely at the Chinese shop.

 

(1) Anderlini, Jamil and Hornby, Lucy (January 10th 2014) | ‘China overtakes US as world’s largest goods trader‘ Financial Times

(2) Giles, Chris (April 30th 2014) | ‘China poised to pass US as world’s leading economic power this year‘ Financial Times

(3) Wolf, Martin (May 2nd 2014) | ‘China: On top of the world‘ Financial Times

Webcast 008 | Marching forward?

Delta Economics is still forecasting relatively flat trade in 2014, but Rebecca Harding argues that the economic fundamentals in Europe and the US are likely to improve as these economies start to regain some of their pre-crisis growth. She argues that Emerging Market currencies will continue their slide against the US dollar in March, but that equities look set to continue the rally that began in February.

 

Webcast 008 Author  |  Rebecca Harding  |  CEO