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There’s no place like home for U.S. investors

Staff Writer |
The U.S. economy and financial markets have been pulling away from the rest of the world.

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Of special importance is the lagging performance of emerging market economies, which, not too long ago, had been the primary driver of world economic growth, y John Lonski, Chief Economist, Moody’s Capital Markets Research, reports.

The combination of higher U.S. interest rates and the relatively stronger performance of the U.S. economy has triggered a notable and potentially destabilizing appreciation of the dollar versus a host of emerging market currencies.

Excluding the collapse of Venezuela’s currency, other noteworthy appreciations by the dollar since yearend 2008 include the dollar’s 102% surge against Argentina’s peso, the 74% advance in terms of Turkish lira, the 25% climb versus Brazil’s real, the 24% ascent against South Africa’s rand, the 15% increase versus India’s rupee, the 10% climb in terms of Indonesia’s rupiah, and the 11% increase vis-a-vis Pakistan’s rupee.

Emerging market countries having especially large current account deficits relative to GDP are vulnerable to dollar exchange rate appreciation.

The funding of large current account deficits requires large amounts of foreign-currency debt that is often denominated in U.S. dollars.

As the dollar appreciates vis-a-vis emerging market currencies, it becomes costlier to service dollar-denominated debt in terms of emerging market currencies.

Lower Base Metals Prices Hint of Slower World Growth Moreover, a dollar that costs more in terms of foreign currencies tends to lower the prices of dollardenominated industrial commodities.

Unfortunately, just when emerging-market exporters of commodities need more support from the dollar-denominated commodity exports, the dollar price of such exports tends to fall.

In fact, Moody’s industrial metals price index recently incurred setbacks of 12.4% since year-end 2017 and 9.3% compared to a year earlier.

The industrial metals price index often serves as a useful coincident indicator of global industrial activity.

The calendar-year averages of the 20-years-ended 2017 show a surprisingly strong correlation of 0.83 between world economic growth (as estimated by the IMF) and the annual percent change of Moody’s industrial metals price index.

U.S. Manufacturing Thrives as the Rest of the World Sags Nevertheless, the lively pace of U.S. manufacturing activity offers no hint of the ongoing slide by base metals prices.

The ISM’s index of U.S. manufacturing activity climbed up to 61.3 points in August 2018 for its highest reading since the 61.4 points of May 2004.

For the 12-months-ended August 2018, the ISM’s manufacturing index averaged 59.3 points, which was its liveliest yearlong average since the 59.3 points of the year-ended September 2004.

However, manufacturing strength appears to be limited to the U.S. and helps to explain why the dollar strengthens and industrial metals prices soften.

For example, the global manufacturing PMI as calculated by JPMorgan/Markit last crested in December 2017 at 54.5 points and has since eased to the 52.5 points of August.

Moreover, when the ISM index of U.S. manufacturing activity last rivaled its August 2018 reading in May 2004, the global manufacturing PMI equaled 58.0 points.

The global manufacturing PMI for August declined by 2.0 points since year-end 2017 and by 0.7 points from a year earlier.

Both of those setbacks are consistent with the year-to-date and year-to-year retreats posted by the base metals price index.

By contrast, the ISM index of U.S. manufacturing activity for August was up by 2.0 points compared to both year-end 2017 and August 2017.

To better understand how much livelier the U.S. is relative to the rest of the world, consider how August 2018’s 8.8-point premium of the ISM’s index of U.S. manufacturing activity over the global manufacturing PMI was a record high for a sample that commences in January 1998.

As derived from the Dow Jones Total Stock Market Index (also known as the Wilshire Index), the U.S. equity market’s recent 8.5% advance since the end of 2017 far outperformed the accompanying 7.3% drop by the Dow Jones Global Stock Price Index excluding the U.S. Among the world’s major equity markets, 2018-to-date’s 18.5% plunge by China’s Shanghai Composite stock price index stands out.

The relative weakness of China’s equity prices was in place prior to the start of the ongoing bout of trade frictions.

For example, the average annualized percent changes of the last three years show a 6.0% decline for the Shanghai Composite that lags far behind the comparably measured 13.8% advance by the market value of U.S. common stock.

In terms of month-long averages, the Shanghai Composite stock price index of August 2018 was down by 43% from its peak of June 2015.

The same serial comparison shows a 35% advance by the market value of U.S. common stock.

For purposes of comparison, it was in November 2008 that the market value of U.S. common equity last sank by at least 43% from its prior record high.

The shakiness of emerging markets has prompted a pronounced 95 basis point widening by JPMorgan’s emerging market country bond yield (EMBI Global Index) spread from year-end 2017’s 311 bp to September 5’s 406 bp.

By contrast, a composite high-yield bond spread barely widened by two basis points from 359 bp to 361 bp.

Moreover, after being thinner than the U.S. high-yield bond spread over an extended period, the emerging market country yield spread is now wider than the high-yield spread.

A well-below-average U.S. high yield bond spread of 361 bp remains atypically thin vis-a-vis a recent above-trend long-term Baa industrial company bond yield spread of 191 bp.

The long-term medians for these spreads are 470 bp for the high-yield spread and 174 bp for the long-term Baa industrial spread.

As derived from the historical record, a Baa industrial spread of 191 bp has been associated with a 497 bp median for the high-yield spread.

It was during 2007’s first half that the high-yield bond spread was previously so far under what otherwise might be inferred from the Baa industrial spread.

High-yield investors would have done well to heed the caution expressed by the Baa industrial spread in view of how the average high-yield bond spread ballooned from the 286 bp of 2007’s first half to the 700 bp of 2008’s first half.

A positive outlook for U.S. corporate earnings lends critical support to the corporate bond and equity markets.

Helping to justify a positive outlook for profits has been the recent acceleration of corporate gross value added relative to the business-sector’s unit labor costs.

Corporate GVA equals the value of final goods and services produced by businesses and, thus, excludes the value of materials and non-labor services that enter into the production of final products.

In turn, GVA can be viewed as a proxy for corporate net revenues.

The year-over-year increases for corporate GVA were 5.1% for 2018’s second quarter and 4.5% for the year-ended June 2018, while the comparable increases for unit labor costs were 1.9% and 2.2%, respectively.

The containment of employee compensation can lengthen a business cycle upturn.

Once too many businesses find that labor costs have become unduly burdensome, widespread layoffs can turn a slowdown into a recession.

Perhaps one of the peculiarities of the current business cycle upturn is a possible curbing of growth by the average wage that stems from the retirement of so many relatively highly paid baby boomers.

Given the tendency of wages to rise as the tenure of employment lengthens, a likely increase in the number of new retirees stemming from the now unprecedented increase in the number of Americans aged 65 years and older may be helping to offset the upward pressure put on the average wage by a tight labor market.

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