Additional Disclaimer: The following thoughts are musings and not advice.

Our current view of the global economy is that Trump’s policies may provide some turbocharging to an economy that is already in a growth phase, but that the short term stimulus is in fact a temporal wealth transfer and that growth slows due to higher rates and tighter financial conditions from 2018 onwards. The US equity market has therefore built in significant hope and optimism and while it may head higher, is a risky bet. The corporate credit markets are similarly pricing in such optimism but technical factors, namely the demand for yield and the supply of corporate paper will be sufficient to support the credit markets and push them into ever tighter territory.Europe is clearly in a growth phase which will lift corporate prospects, however, political concerns will cap upside in equities and credit. With Dutch, French, German and possibly Italian elections on the horizon, and with Brexit hanging over the region, it is hard to see valuations improving. Europe is a buyer’s market, but investors may be forced to be patient.

More immediate and tactical opportunities present themselves in the commodity markets.

Energy:

The demand and supply dynamics of oil imply a significantly stronger oil price. More than all the fundamentals and demand and supply is the Aramco IPO, which requires a stable oil price between 50 to 65 to price decently, is the main driver of oil and the Saudi’s will defend this range come hell or high water. For the delta driven trade, the Exploration and Production sector has the most potential. Within this, tight oil is attractive, it is relatively small and will not drive pricing but is efficient enough to worry OPEC. XOP is a natural candidate for expressing such a trade.

There are other trades one might attempt, such as a Long Brent Short WTI trade, betting on relative demand and supply imbalances between the US and Europe/Middle East.

An indirect play which also expresses a Trump energy policy element to it is a simple long position in MLPS LN, the tax efficient UCITS MLP ETF tracking the Morningstar MLP Index. MLPs are yielding over 7% in a rising energy price environment.

Industrial metals:

China’s reflationary policies and efforts to put a floor under its growth metrics played no small part in the recovery in commodity markets. There are, however, reasons to believe that the recovery has more to go and is built on a firmer base. The last assault in the global trade war which involved reorganizing manufacturing to face a domestic audience is complete and has resulted in global manufacturing coming out of recession. Industrial commodities should, by implication, also exit recession, and has. The new structure of manufacturing will grow and prosper in its current state until it exhausts domestic demand. Until then, however, commodities will follow suit. XME is a natural candidate for expressing this trade.

If we had to make more conventional country bets: Japan and India.

The demonetization in India is misunderstood. Ostensibly to root out the black economy, demonetization was an immediate reduction in money supply which basically disabled the majority of the cash economy for a period of time. However, money supply will in all likelihood rise significantly. The demonetization is basically an exercise which transfers cash from physical form (and thus subject to no multiplier) to electronic form (subject to the multiplier inherent in the fractional reserve system.) Note the RBI’s initial shock absorbing 100% reserve ratio requirement immediately after demonetization which has now been rolled back. The impact on the Indian economy and assets will be significantly reflationary. The RBI will likely halt any rate cuts until the liquidity injection is absorbed.

Economic growth in Japan has been sub-par for a long time. Abenomics is getting long in the tooth and the BoJ has deployed an array of unconventional policies from QQE to NIRP to buying ETFs and now near total control over the yield curve, to stave off deflation and recession. It is difficult to see Japan achieve escape velocity, however, the current environment presents some interesting opportunities.

With growth coming from such a low base and expectations so dire, the potential upside in growth and small cap growth companies could be substantial.

The yield curve control policies of the BoJ present the banks with a profitable trade, involving buying long dated JGBs, allowing them to roll down the steep long end (intentionally steep by BoJ policy), before selling them to the JGB (which cannot buy directly at auction as it is deemed monetization.) This trade is very profitable for banks and insurers.

The multiple fronts on which the BoJ operates is exhausting its options and it is unlikely that the BoJ can accelerate its activities on any front any further, thus no further easing. Coupled with a hawkish US Fed, this implies a weaker JPY which is generally positive for Japanese equities and especially positive for exporters or multi nationals.

And finally a word about Singapore…

It is tempting to be too bearish about the prospects for Singapore. The world is in a cold trade war which threatens to go hot, and trade is some 400% of Singapore’s GDP, interest rates are rising and the MAS policy of targeting the exchange rate imports rate hikes from the US, China, Singapore’s 2^nd largest trading partner is reining in monetary policy to manage the surge in credit from 2016, and energy prices while having recovered from deeply distressed levels, hover in a tight range insufficient for saving Singapore’s oil and gas, and shipping sectors.

Energy prices are rebounding and are likely to rise further. The impact on the energy and the related maritime sectors (collectively some 12% of the economy) will be significant. In the next 12 months, growth is likely to exceed expectations.

In the longer term, Singapore’s fortunes will be dependent on its ability to reinvent itself in the face of a more insular world.

PS: European Convergence Trade.

The impending French elections are hardly having any effect on European equities. In the bond markets, however, political risk is being priced in. One trade which might pay off, and to be sure this is clearly a bet, a wager, a gamble, is to buy the French 10 year bond and short teh 10 year bund. The spread is currenlty 0.7 and could well head below 0.5 if Le Pen does not win the election, and she is not expected to. Why are the bonds pricing up like this? A Le Pen victory is a very low probability event indeed, but if it did happen, she has promised a referendum on euro membership, and this would create a very uncertain environment in the Eurozone. No one knows how a member would extricate itself from the single currency, yet the question is become more and more topical, to the extent that the Dutch have commissioned a study into how to effect an exit and what the consequences might be. For some countries exit might be difficult but for others, particularly those with big TARGET2 deficits, exit might well be intractable.

Economic growth expectations have risen in the past few months on the back of

• a real improvement in economic data,
• a recovery in commodity prices,
• strong equity and credit markets,
• expectations of fiscal stimulus under the new Trump Administration.

In China, growth in 2016 was bolstered by the reorganization of manufacturing, which is really a global phenomenon, but even more so by fiscal and monetary stimulus on a significant scale.

One should, however, consider what is sustainable and what is not, and what is short term expedient and what is long term structurally sound.

China’s economy is fast approaching a size and wealth which makes over 6% annual growth difficult to sustain. Efforts to maintain that level of growth can lead to imbalances and instability. The gains from globalization and integration are largely over and future growth will be dependent on the demographics, resources and know how of the Chinese economy. Further gains can be had by the liberalization of the economy and financial markets, but even these will eventually reach their limits and further growth will require innovation and improvements in know how.

Chinese economic, and indeed social policy, have always prioritized stability and continuity. It is this quest for stability that led Chinese policy to become highly expansionary in 2015/2016 to address the slowing economy and stock market declines in 2015. China’s command economy affords it more tools than the conventional or even unconventional tools that Western developed countries have at their disposal. Instead of wide ranging quantitative easing, the PBOC engaged in targeted credit provision in a series of open market operations as well as targeted operations, effectively repo lending to specific sectors and institutions, on a large scale. China’s desire to maintain a target level of growth led it to lean on the central crutch of infrastructure and construction. This has fueled a commodity recovery and a housing boom in China.

In early 2017, however, recognizing the scale and speed of credit creation in the economy, Chinese authorities are reining in credit, raising its cost and rationing its availability. It remains to be seen if they will be able to contain the risk without slowing the economy too severely.

China’s experience is instructive as it illustrates the difficulty facing central banks trying to operate an economy at a rate of growth higher than that implied by its endowments of labour, resources, capital and technology. Is it sustainable or does growth slow below prior natural rates once stimulus is withdrawn?

For now, current data suggests that China has stabilized growth at a reasonably high rate, has reorganized its manufacturing sector to the new de-globalized reality and is in risk management mode. As markets are more sensitive to rates of change than levels, asset markets are likely to take an optimistic view.

The risks to the prognosis are that the cold trade war turns hot under the Trump administration, that a political crisis in Europe precipitates contagion, that there is a growth slump from policy mistakes, or that there are geopolitical disruptions closer to home such as in the South China Sea.

Even excepting such exogenous events, the gains in manufacturing will not fully compensate from the reduction in world trade, and there are no signs that trade relations globally are warming and it is likely that the current trajectory of the PBOC’s policies, even as touted as risk management, will be a brake on growth.

More immediately, the impact on asset markets is likely to be adverse given their sensitivity to policy and financial conditions over fundamentals.

India’s recent economic slowdown is to a certain extent self inflicted. In November 2016 a mass demonetization of large denomination currency notes led to 85% of notes in circulation being taken out of circulation. The immediate impact on an economy with a large proportion of informal participation has been significant. The aim of the demonetization was ostensibly to root out the black economy. The recent implementation of GST as part of a wide ranging tax reform program is certainly made more effective by bringing the informal economy under the regulated banking system.

While the immediate impact of the demonetization has been serious for certain industries which traditionally have relied on cash for transactions, the coincident rise in point of sale card usage is indicative of an overlooked dimension.

As money is transferred out of the physical realm to the fractional reserve system, the money supply is almost surely to surge. The RBI initially hiked the reserve ratio to 100% before later relaxing it. Some of the cash deposited will leak out of the system again once the new 500 INR and 2000 INR notes are circulated, but for many, the forced experience with banking will translate into future comfort with banking infrastructure.

It is likely that the increase in money supply will be significant and could be inflationary. The RBI will have to be vigilant and will likely have to raise rates or reserve ratios to manage the increased money base.

India is the most interesting economy in Asia not least because its potential is great, and slow to be realized because of political and policy frictions. It is an economy struggling in the right direction contrasted with some other economies that rush in the wrong direction.

The US stock and credit markets are making an unequivocal statement about the policies of the Trump administration. Valuations are getting richer and credit spreads are getting thinner and asset prices are grinding higher on lower volatility almost daily.

Trump’s fiscal and trade policy are aimed at addressing what the President has identified as areas of weakness and potential improvement in the US economy. While the problems are properly identified, solutions are not easy to find and the ones proposed may not be as effective or without side effects as advertised.

A fiscal stimulus plan worth 4 trillion USD over 10 years (some 2.3% of GDP) is significant, however, House Republicans will be interested in how this will be financed, and the potential inflationary aspects of the plan could encourage the Fed to raise rates more aggressively, precipitating a slowdown.

The tax cuts will be highly regressive and distribute income towards high earners and asset owners reducing the velocity of circulation and lowering multiplier effects. Savings rates will likely rise.

Interest rates are already rising driven by an expected deterioration in federal debt to GDP, the current account, the budget deficit and higher inflation expectations. Financial conditions have therefore tightened, despite the tightening of credit spreads. SMEs and lower quality issuers tend to lend at floating rates which are feeling the immediate impact of higher rates.

The Trump administration’s policies are likely to lift US growth 2017 and 2018 but the longer term impact is likely to be reversed or diluted. Debt financed fiscal policy is not immune to the fact that borrowing is a temporal transfer of wealth from one time period to the next. It is only to be undertaken if the investment in the current period generates sufficient returns to more than compensate for the future repayment. The infrastructure investment policy likely meets this test but the regressive tax code likely does not.

US growth is therefore likely to be front loaded while the costs are back loaded. Companies’ earnings guidance and analysts’ estimates have tracked the exuberant sentiment and been upgraded this year for 2017 and 2018, and perhaps rightly so. In the meantime, current period corporate performance has slowed with fewer beats and more misses. Much hope and expectation is built into the US equity and credit markets.

What happens to an economy if everyone suddenly got rich without expending much effort or ingenuity? What if the people toiled for decades with some success but then an overriding factor made them rich which had little to do with their efforts? What if the magnitude of this wealth increase, which was uncorrelated, was disproportionately large, accounting for a greater proportion of the increase in wealth than employment and enterprise?

Would not people regard their work and enterprise as inefficient wealth accumulators? Would not people seek to increase their exposure to the single most efficient factor responsible for wealth creation? This would seem to be the logical thing to do.

In land scarce Singapore, real estate, in particular residential real estate, has been that factor. The index of HDB (government subsidized housing) resale prices has risen at an annual rate of 6.6% per annum since 1990. Private residential prices have risen by 4.6% p.a. in the same period. Landed private residential prices have risen by 5.3% p.a. Given that inflation has mostly been hovered at around 2%, these growth rates in real estate prices have been impressive.

The experience of most house owners has been enhanced by leverage since houses are rarely ever bought without a mortgage, and with LTV’s as low as 20% or even lower in some cases, (pre cooling measures), returns would have been levered 5X. Couple this with over 30 years of falling interest rates and the returns and attractiveness of real estate as an investment is easy to understand.

Why have property prices risen steadily over the history of Singapore? A competent government, strong and steady economic growth, a rising population and falling interest rates are some of the main factors. But what happens when growth slows and interest rates stop falling?

Are people sufficiently flexible and able to meet the new challenges? Are they sufficiently motivated and equipped to seek new avenues of growth and wealth creation? Have they had sufficient practice or has the rising property market provided such benign conditions that they have lost their motivation, their so-called hunger to succeed?

Is Singapore suffering from Dutch disease? In economics, the Dutch disease is the apparent causal relationship between the increase in the economic development of a specific sector (in this example residential real estate investment) and a decline in other sectors (like the manufacturing sector or service sectors).

The side effects of a real estate curse are different from those of the resource curse. Whereas natural resource curses tend to result in armed conflict and the undermining of democracy and freedom, the real estate curse has less extreme but no less pernicious effects.

By devaluing effort and enterprise, the real estate curse causes apathy and defeatism, frustration and a sense of injustice, since effort and enterprise do not equate to wealth. Certainly it threatens to dilute the virtues of meritocracy.

And what about interest rates. Current mortgages in Singapore cost about 1.4-1.5% per annum for the first 3 years, rising by a step up to a spread over floating rates from year 4 onwards. At these rates of interest, debt service is highly negatively convex and can rise very quickly if interest rates rise even slightly. If interest rates were higher, say 5%, a rise to 6% has a small impact on monthly payments, but if interest rates are low, at 1.5%, a move to 2.5% would have a significant impact on monthly payments. An overly leveraged populace adds a layer of complexity to monetary policy.

An investor is faced with two sets of information. The first regards the commercial performance of companies thus earnings and cash flow, returns on equity etc, and the second is price information, which tells them what other investors are making of this information.

What would the world look like, what would financial markets look like, if investors were denied the second set of information? That is, they would know all they could know about the commercial and operational performance of companies but when it came to stock prices, bond prices, credit spreads, FX, interest rates and commodity prices, the investor has no memory and only sees current prices. Under these conditions, what would financial markets look like?

The reason for contemplating these investment conditions is that historical price information tends to encourage herd mentality which can lead to bubbles. Deprived of historical price information, would investors still display herd mentality and create an environment of extreme valuation?

The deprivation of historical price data addresses only part of the problem. Without historical time series data, the investor is disabled from the emotional mechanisms which encourage chasing an asset. They do not see the price of an asset rising while they feel they have under-invested in it, they do not see other investors profiting from a situation which they are missing out on, and they are less inclined to form opinions about the short term future valuations of the asset based purely on price action (since earnings and cash flow are relatively stationary processes.) They are less likely to delay purchases, seeking technical corrections.

However, the investors’ own profit and loss history cannot be obscured and so the investor will still have a price related metric which could enable market timing and momentum driven behaviour. This somewhat dilutes the objective of encouraging an investor to inform their decisions based purely on current prices. Despite this dilution, the investor is protected from the influence of other investors’ behaviour transmitted through historical prices. The investor cannot be protected from the influence of their own historical decisions transmitted through their P/L.

There is an opportunity for Europe to lead as a template for a better balance between individual and collective interests.

Tax union.

• Creation of an EU tax authority which will set the Unified Tax Code.
• Member countries will have representation in the EU tax authority which will set a Tax Benchmark.
• Member countries which have tax rates below the benchmark will be required to collect a proportion of the gap and pay this to the EU tax authority. The proportion is set at 10% in the first year and rises by 10% each year with 100% of the gap collected and paid to the EU tax authority in year 10.
• Member countries which have tax rates above the benchmark will pay 10% of the gap, which they have already collected, to the EU tax authority. The proportion is set at 10% in the first year and rises by 10% each year with 100% of the gap collected and paid to the EU tax authority in year 10.
• The Unified Tax Code will apply to personal and corporate taxes, as well as to inheritance, capital gains, asset (property or land) and other taxes.
• The Unified Tax Code will apply to VAT.

Tax devolution.

• The tax union applies only to federal taxes. Local taxes will be devolved to local tax authorities.
• The EU tax authority will determine how taxes in countries which do not distinguish between local and federal taxes is allocated.
• The convergence rules apply only to federal taxes.

General principles on Tax.

• Corporation taxes should be encouraged to converge as soon as possible to avoid tax arbitrage.
• Personal income taxes should be made more progressive with the introduction of new tax bands to cater to ultra-high incomes.
• Since tax rates will be made converge, double taxation treaties within the union and the concept of global taxation are academic. However, since the tax code is regional and not global, ex-union tax liability will have to be legislated for.

Sovereign wealth fund.

The European Union would establish a sovereign wealth fund. Unification of assets cannot be immediate so the concept of sub-funds or cells should be implemented initially.

The establishment of a sovereign wealth fund is part of a bigger effort to better define the balance sheet, the assets and liabilities of a country. It also allows countries to tranche their liabilities so that they can optimize their funding and provide investors with different investment opportunities in different claims.

All state assets should be contributed to the sovereign wealth fund so that they appear with full transparency on the fund’s balance sheet.

Each member has a sub fund, and each sub fund has its own assets and liabilities. Each sub fund will have its own credit rating and will generally face its own funding conditions.

The Union’s sub fund will house the common assets of the Union.

There is legal separation between sub funds so that the assets and liabilities of the sub funds are not commingled.

Budget union.

The state should only provide those goods and services which the market is unable or unwilling to do so. The federal budget should be parsimonious.

Budget union is not an explicit objective. Member states still collect their own local and federal taxes. Only gap payments are collected by the EU tax authority which funds the sovereign wealth fund. However, since the Unified Tax Code encourages tax convergence, any guidance towards a balanced budget or at least tendencies or limits towards budget balance will encourage budget convergence.

Budget limits.

Budget guidance will be given, perhaps, re stating the Maastricht conditions. Budget discipline will be imposed through the creation of the sovereign wealth fund since a profligate member will find its unsecured funding costs rising. If it turns to secured lending, it is no longer able to ignore claims on its assets since its sovereign wealth fund, the repository of its assets, will be subject to EU insolvency law, such law to be refined as necessary to be relevant to a sovereign wealth fund. A delinquent borrower may find its national monuments, utilities and other assets foreclosed upon.

Social security.

Social security should be harmonized. One element shall be a compulsory defined contribution pension scheme which will be funded by contributions from income as well as an employer contribution. Another element will be a social insurance scheme funded by tax.

The pension assets will be under substantial control by the workers so that no one need fund their sovereign or indeed any other member country if they do not feel so inclined. Assets will be held in custody and not on the balance sheet of the scheme. This is to prevent any de facto expropriations.

The social insurance scheme will be funded by taxation and is a general commingled pool.

To avoid benefits arbitrage, pay in rates and pay out rates will be harmonized.

Labour and individual mobility.

Labour mobility is a good thing but has to be managed. Immigrants need to be able to find jobs and fund themselves. They need to be accretive to the welfare of the host country both financially and socially. Immigration should be encouraged to fill jobs where there is a shortage of labour.

To discourage benefits arbitrage, benefits should be harmonized between member countries. Immigrants should draw on the home benefits system for before they can draw on the benefits system of the host country. In year 1, an immigrant shall be entitled to a quarter of the host country’s benefits and three quarters of their home country’s benefits, the host country entitlement rising and the home country entitlement falling by a quarter each year so that full transition takes 4 years.

Certain questions should be addressed regarding immigration:

• Are there sufficient suitable jobs? What is the impact on incumbents’ employment prospects? What is the impact on prospective employers?
• Is the immigrant accretive to the economy and society?
• Are there sufficient resources?
• Is there enough space?
• Are the cultures compatible and will the immigrant integrate into existing society
• Is the immigrant a refugee and what special conditions apply?

Settling in the EU:

Strict entry requirements apply. The above issues should be addressed in assessing eligibility.

Movement within the EU:

EU member country citizens should be accorded freedom to move and settle anywhere within the EU, however, movement should no longer be unmonitored. All movements across member countries’ borders whether by citizens or tourists should be monitored and recorded. Citizens or tourists should not normally be refused passage across borders.