The amount businesses are prepared to invest in their own infrastructure and growth is a very good indicator of the state of the wider economy. In times of recession, companies tend to protect their balance sheets and spend as little as they can. In the good times the opposite happens, and that’s the scenario we’re witnessing in two of the world’s largest economies – the US and China.
When the US Senate passed President Trump’s ‘Tax Cuts and Jobs Act’ in December last year, they knew they were taking a gamble as the cuts were forecast to increase the Federal deficit by hundreds of billions of dollars. But if the strategy worked, it would encourage companies to invest in growth and infrastructure, as well as encouraging businesses that would otherwise have invested overseas to invest in the US instead. More spending would create jobs and increase wage growth, giving rise to higher interest rates and inflation, which would ultimately reduce the size of the deficit. That was the plan, and it seems to be working.
The Richmond Manufacturing Survey measures expected manufacturing capital expenditure (capex) in the US. That measure is now at its highest level in decades. Although actual capex has fallen in the last two years, that trend is reversing, and investment spending is accelerating. And it’s not just thanks to tax cuts. Capex growth is also fuelled by the energy sector. Oil companies are having to invest heavily as pipelines start to run dry, and this is supportive of the US economy.
This expansionary environment is not exclusive to the US. Despite the ongoing trade negotiations between the two countries, China continues to grow at a healthy rate. This is fuelled by its continued urbanisation, and a growing demand for products and services as the population benefits from increases in wealth across society.
Such positive news coming from two globally significant economies is good news for investors. When the US and China are doing well, other economies will benefit, which makes us optimistic about the future. As always though, this optimism is exercised with caution – especially as the unwinding of quantitative easing programmes gains momentum.
“While the growth story in the immediate-term is a positive one, we will be watching closely as the world comes to terms with higher interest rates and inflation because of that growth.
We look to invest in companies that will be able to navigate this new environment and remain dominant in their sectors as a result.” - Philip Smeaton, Chief Investment Officer
Investment view: Will ‘Quitaly’ be the sequel to Brexit?
Italy dominated the news in late May when the new government took charge and shook the status quo, threatening the already tenuous fiscal outlook for the country. This caused some panic in global markets as – yet again - the future of the Euro was questioned. But could (and should?) Italy realistically turn its back on the Euro? Here we discuss the outlook for Italy as it finds itself backed into an economic corner.
Italy has struggled to thrive under the Euro
There have always been structural problems in Italy, giving rise to low productivity and political instability. But before Italy joined the Euro, they were able to bail themselves out of economic trouble by printing more Lira and devaluing their currency. This enabled them to compete on price, if nothing else. But as a member of the Euro, they can no longer do this. As a result, more stable and productive European countries are attracting investment and can compete more effectively on the global stage.
Italy’s economic growth has lagged Germany for 12 years
As you can see from the graph, economic growth in Italy has consistently lagged Germany’s since 2007, and the gap widens every year. While Germany has been able to reduce its debt levels, Italy has continued to borrow money, but has no economic growth to show for it, and therefore no way of reducing the debt. Indeed, productivity is further in decline, and the economy is under a huge amount of pressure.
For Greece to survive in the Euro it endured a halving of its GDP – the worst (non-war) economic performance ever from a developed country. And growth continues to remain subdued. For Italy to survive, it also needs to embrace some painful structural reforms to address its productivity. But this is going to be extremely difficult given that they’ve failed, so far, to turn their borrowing into decent economic growth.
Leaving the Euro is unlikely to be an option
While leaving the Euro could arguably help Italy in the longer-term, there’s very little chance of that happening. Given the complexity of this move, the political and public will behind the Euro, and the shock to global markets that a ‘Quitaly’ would create, Italy is going to have to find another way to turn its fortunes around.
This article is for information purposes and should not be treated as a forecast, research or advice to buy or sell any particular investment or to adopt any investment strategy. Any views expressed above are based on information received from a variety of sources which we believe to be reliable, but are not guaranteed as to accuracy or completeness by Sanlam Private Wealth. Any expressions of opinion are subject to change without notice. Reproduction of this commentary is not allowed in whole or in part without prior written agreement from ‘Sanlam Private Wealth. Past performance is not a reliable indicator of future results. Investing involves risk. The value of investments, and the income from them, may fall as well as rise.