The four horsemen of 2019

On a short visit to Australia from his home base in Denmark this month, Saxo Capital Markets Chief Economist and CIO Steen Jakobsen was keen to give his views on where global markets are heading in 2019.

Always outspoken, Jakobsen likened the headwinds facing markets and investors to four economic horsemen – the key components that drive most economies. He points to negative global credit growth, the rising cost of funds, higher energy prices and the challenges around globalisation.

Among other things, he says the trade tensions between the US and China that are spurring heightened volatility on markets are a results of economic plans that are totally incompatible.

Jakobsen also has a dire warning for Australians that the shockwaves from our housing downturn are yet to be felt across the wider economy.

Listen to the podcast, or read the full transcript below.

Tony Kaye: Hi, I’m Tony Kaye, the editor of InvestSMART, and today I’m talking with Steen Jakobsen, who’s the Chief Economist and Chief Investment Officer for Saxo Capital Markets. Hi, Steen. How are you?

Steen Jakobsen: Hi, Tony. Thanks for having me.

Tony Kaye: Pleasure. Steen. Why are you here in Australia? I know you’re doing a semi-whirlwind visit out from Denmark. Really, what’s going on at the moment with markets? They’re certainly quite volatile. We’ve seen a lot of action over the past couple of weeks.

Steen Jakobsen: So, I think what we’re really seeing in the markets right now is the end game of a very, very, very tight monetary policy. When I talk about tight, I’m not talking about the RBA at 1.5 per cent or the Federal Reserve, where they are, but really the monetary condition. I think the analogy, of course, in the case if we compare to Australia, you have the fact that the Royal Commission is sitting, the banks are self-regulating, they’re reducing the flow of mortgages, you see the auction periods being extended, you see all of these factors. Why do they happen? They happen because of the four horsemen, as I like to call them.

They are four key indicators that goes into any economy, any global economy, but certainly also Australia. It is the quantity of money, so how big is the credit cake? And make no mistake, Tony, everything in terms of growth that you’ve seen in Australia and globally since the great financial crisis has been driven by one thing only, and that is the size of the balance sheet, the size of the total debt that we have in the world. The bad news is that this cake is getting much, much smaller. We have moved from 10 to 12 per cent growth in credit to negative growth in the world right now. Led by China, the biggest, of course, component of exports for Australia. So, what we see is a serious headwind from the size of the cakes. So that’s number one of the horsemen.

Number two is the price of the cake or in other words, the price of money. As you know Federal Reserve has been on a mission at taking 10-year interest rate in the US out by 80 basis points. So that’s also, of course, becoming more expensive. Number three has been during the year, energy. Energy is now flat for the year. But as you know most of 2018 we spent with energy prices up 25 to 50 per cent in dollar terms, and for some, emerging market currencies up almost 100 per cent. And energy is a consumption tax. Because of course you as you pay more for your petrol or for your heating in your home you’re actually taking something from your disposal income.

And finally, the thing everyone wants to talk about, the globalisation/productivity. Globalisation, or rather, these days of course, the anti-globalisation driven by the America First Agenda in the US and the China 2025. Two incompatible plans that can never co-exist. And of course that is creating tension in the market and also instability. And then you connect all the geopolitical risk with the Middle East, with Italy, with France now, and certainly a lot of the Latin American countries. And you have a cocktail that has been severely negative in terms of the ability of continuing to pretend and extend, as I like to say.

Tony Kaye: I was going to suggest a fourth or a fifth horseman could be Donald Trump. In terms of all the instability that’s being caused in and around America. So that comes back to the fourth horseman. Is all of this likely to continue into 2019 and beyond? Is there an end point to all this volatility?

Steen Jakobsen: I think the best we can hope for in terms of end point would be that Trump doesn’t get re-elected, but it’s pretty clear that a cabinet that sits with Trump lays ties with the US trade representative. His trade advisor, [Peter] Navarro. Wilbur Ross, the Commerce Secretary. All of these guys are in the very hawkish camp of beating down on China and seeing the rise of China as both an economic but certainly also a geopolitical risk for the US. So hence you have this confrontational view in between meetings. What’s funny about Mr Trump in my opinion is that he always ... behind the Twitter account, he’s a harsh and provocative guy, but every time he’s going into a face to face meeting with all these guys he becomes a pussy, right? Because like you saw him with North Korea, you’ve seen it again with Xi Jinping. And why is it that he’s confrontational as he sits behind a Twitter, but not in person? I think because he has no ability to follow through in this.

So maybe the hope here is that ultimately it falls by the wayside, not because of Trump’s victory. But simply because the policy doesn’t work. But having said that, again, as I said in the introduction China 2025 and America First are incompatible. They are both plans to create independence, self reliance, independent of the other party in the world. So what we see is the rise of a bipolar world, and never in economic history has two powers shared the number one spot. But what we have right now is that militarily, strategically growth wise that China is the biggest country in the world. But in terms of the capital market, there is no one even close to being second to the US in terms of the depth of the market.

And remember your excess savings, the Australian excess savings, the Danish excess savings has to go somewhere because our economies are too small in themselves to take all this excess savings. So we need deeper capital markets. So in my vision, we see a bipolar world where we share the power between China and the US for the next 10 to 20 years. And that in itself is destabilising because as you know, for better or worse we are better off if there’s only one power in the world that is trying to lead.

Tony Kaye: What happens with the US and China is really pivotal to what goes on in the global markets and as you said there’s no quick resolution to what’s going on. It’s going to continue for quite some time.

Steen Jakobsen: Yeah, there is a truce right now because Trump is concerned about the stock market, and Xi Jinping is slightly concerned about the upcoming party conference that comes up in March. So there is sort of for both of them a need and a demand for them to sort of retract and take a break from this. But as I said a few times, already, these two plans aren’t incompatible. This is not going to stop, it’s going to get worse. And it’s probably going to get worse into 2020 because it’s the re-election year of President Trump and the one thing that resonates, not only with his voters, but one of the few ways he resonates with the Democrats is actually being anti-China.

Tony Kaye: Let’s steer the conversation, if I can, towards investing. What should investors do in this type of climate, I mean there’s no way to hide really, is there?

Steen Jakobsen: There is, and there’s already been in creating fundamental value. You see the ASX trading at a multi-year low, you see the good old dividends stocks being hammered down and in the ASX as well including the banks now. But I think the refuge from this is to have a preservation of capital attitude to your portfolio. You have to realise you had the best of times in the last 15 years. Both in Australia and globally. Driven by low interest rate and of course in this country but the housing market being as explosive as it has been on the upside. But having said that, the housing market in my opinion is the biggest risk for the Australian investors. And the injury impact of the housing market in Australia is massive. Think about all the people contracted to work with the housing sector from the actual builders to the surveyors to the auctioneers to all these people that are involved. So, the leverage is of a magnitude I’ve not seen in any other country.

So, for me and for your listeners, I think the real advice here is to be in preservation of capital mode. But I also think that something like Australian bonds. The Australian interest rate is going absolutely nowhere. You can see already now at a very, very low unemployment rate and benign inflation RBA is already concerned. You see that the banks are over-extending the self-regulation that they do to themselves because of the incoming expected increase in tightness of regulation coming on the back of the Royal Commission, but now also from the competition board this morning. So, I think you’re going to have a continuation of these four horsemen, and they’re going to be negative. What can then on the other hand be positive, is that I think in terms of the Federal Reserve, I think the December hike if it goes ahead and that’s what it looks like it will be, that’ll be one bridge too far in terms of the interest hike.

And secondly, I think China is coming online again, end of Q1. I think I made the mistake and I think generally people made the mistake in 2018 to look at China and see, and not observing the fact that everyone on the ground in China was waiting for a signal from the party in China whether to continue the reform in opening up that’s been in place since 1979 with Deng Xiaoping. So, when I was on the ground in China three weeks ago no one was willing to take any risks because they were still waiting for the smoke signal to come from Beijing in terms of what’s going on. This morning they have decided to have a party conference on the 11th to 13th of December opening up and reforms is the celebration theme of that conference.

In other words, China is continue for the next 30 years into its 100 years anniversary on a reform and opening up with the Chinese characteristic reform. I think that’ll have a massive impact in terms of the year business and the bureaucrat in China ramping up the fiscal and monetary stimulus and probably we will see a tax cut for personal income coming up as well. So, I’m pretty positive that when the four horsemen has played out during January and February, we’ll see some kicking from the Chinese first and then secondly from of course from the Fed. So not everything is negative. But in all this environment fixed incomes should outperform, commodities should outperform, certainly something like gold would do extremely well in this environment.

Tony Kaye: Alright, we’ll leave it there for now. Thanks very much Steen.

Steen Jakobsen: Thank you for having me.

Tony Kaye: Pleasure.