Year of big risks
Stock markets have made a cautious start to the new year, which is not unusual after the ferocious rally at the end of 2023. A breather is required.
In this post, let's talk about the themes of the year that has just begun and the upcoming elections in 2024. The US presidential election is a proper nail biter for investors. Equally exciting is China's reaction to the Taiwanese presidential election. We will also take a brief look at the state of the US labor market, which is sending worrying signals of a deteriorating economic situation.
2024 will be a major election year
2024 will be characterized by much the same themes as last year. The US economy is roaring, Europe is clinging on to recession and China is trying to start its economic engine in a very similar manner to me trying to get a rental car going in last weekend's freezing temperatures. (Spoiler alert: I wasn’t successful). Listed companies, especially domestically, are focused on protecting their profitability.
Inflation is expected to fall and interest rates to slow down as a result.
People have a bad habit of expecting the future to be what has happened in the recent past.
The obvious difference from last year is the huge number of elections in different democracies. Finland's gray presidential election is just a drop in the ocean. And I am not referring to the presidential elections in Algeria or Chad, but primarily to the presidential election in the US, the world's economic powerhouse. It’s going to be a wild ride for investors. In addition, an important election is right around the corner in the thorn in China’s flesh, Taiwan. The Parliament of India, dubbed the world's largest democracy, will be re-elected. Geopolitics is now on everyone’s lips because of the wars in Ukraine and the Middle East.
The US presidential election is - of course - the highlight at the end of the year. The world's main stock index, the S&P 500, has risen about 83% in election years, but that's what the index tends to do when on average stocks have risen in two out of three years over the past few decades. Part of the reason for the strong stock market may be the sitting president's administration's motivation to stimulate and accelerate the economy, as voters' choice will determine how much bread is put on the table. And Joe Biden has really excelled at stimulative fiscal policy like there’s now tomorrow.
Unfortunately, the small sample size does not tell us much about the future.
Ryan Detrick also had an interesting, anecdotal observation based on morsels of data that the S&P500 has never once fallen in a year when the president is elected if the previous midterm election year was in the red. Of course, the strongest winning candidate of the elderly front-runners at the moment, Donald Trump, is a slightly different president when it comes to respecting and preserving US democratic institutions, which could have a number of far-reaching consequences for the world's most important economy. However, those are beyond the scope of this video. In short, Trump represents a kind of disjuncture and populism in pushing for US isolation and primacy, while the unpopular Biden represents institutional continuity in domestic politics and on the international stage.
Coming back to Taiwan, there is a growing anxiousness in investment circles about a possible Chinese invasion of Taiwan in the wake of the war in Ukraine and the Middle East. Taiwan's presidential elections and the underlining of its independence may provoke some kind of backlash from China, as is part of the overly sensitive nature of great powers.
In the long run, war is not an excluded option. Bloomberg had some rough economists' sketches of the kind of deep dive the global economy would take if China tried to annex Taiwan by force. If China were to besiege Taiwan from the sea and the US and its allies responded with economic sanctions, the world economy would fall by 5%. If the US were to get involved in the conflict locally, the impact would be as high as 10%.
Well, the exact percentages are not relevant, but the gist is that it would be a massive mess. Taiwan is the world's most important semiconductor production region. The global economy fell by 5% in the COVID pandemic and the financial crisis, so by these estimates the Taiwan war would be the worst economic crisis in a hundred years and no one can predict the ultimate consequences.
The good news is that it's clear to everyone that such an adventure would be expensive, which reduces the desire to undertake it. Secondly, as the war in Ukraine reminded us, the preparations for such an operation would take months - if not years - and this would give the world time to react and adapt. Several countries are already investing in their own semiconductor industries in a sweat. Investors are also on their toes about Taiwan. Warren Buffett, the world's most famous investor, famously sold his Taiwan Semiconductor shares a year ago, vaguely citing geopolitical risks after holding the stock for just a short time.
Even if a conflict seems unlikely, the consequences would be so great that it is at least worth bearing in mind.
Further signs of weakness in the US labor market
A strong US labor market has been the cornerstone of a sustainable and robust economy. People have jobs and therefore money to spend. One person's consumption is another one's income, and demand from American households is pulling the sledge of the entire global economy.
The latest employment data published last week made a superficial case for a still strong labor market, with more than 200,000 jobs created in December. But below the surface, things have taken a turn for the worse. The number of jobs is measured using two different survey methods based on a large sample of households or enterprises. According to the household survey, the number of employed persons fell by more than 700,000 in December. However, the results of this survey normally fluctuate more on a monthly basis. In addition to this drop, the employment rate fell, people say it is harder to look for work and more people are taking part-time jobs to make ends meet. The number of hours worked also decreased. Bloomberg economists say that workplace data is usually a better measure, but at turning points, household surveys also work well.
Another alarming indicator of the risk of recession is the number of temporary or seasonal workers, which is sensitive to the economic cycle. It has been on a steeper decline for more than a year now. As the graph shows, such a slide has often heralded a recession.
I could also end by dryly pointing out that in the stock market, when unemployment is low, buying stocks may not always have been the best idea, although of course structural reasons for the current still low unemployment rate can be found, e.g., in demographic change and labor shortages.
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