Update: Issue 31
A welcome note from Knightsbridge Wealth
Welcome to this latest edition of our Update. What many observers have called the year of elections is now two-thirds over, with contests having been held in numerous countries from Mexico and South Africa to Pakistan and Indonesia. It would be presumptuous to conclude that global democracy is in rude health but this opportunity for potential volatility has to a large degree passed more smoothly than many may have feared. There is of course one exception – the United States. We look at the progress of the race so far and assess the possible outcomes for global investors.
In the UK, voters welcomed a new government in July. We look at Labour’s short honeymoon and its aspirations for the UK economy and the potential for investors here as it mulls the need for more co-operation with Europe and greater private sector and government partnerships.
Meanwhile, in March, there was an election in Russia. Russia is flourishing after 24 years of rule under Putin, and not withstanding sanctions and pariah status, on the home front, at least, things look better than ever.
In our feature piece, we look at the summer election results in India that delivered Prime Minister Narendra Modi his biggest political setback in his decade of power. In an unexpected blow, his BJP party lost its majority for the first time since 2014. Indians are wondering where the results are from Modi’s much promoted economic success.
Our update on China reflects on the “four Ds” of debt, demand, demographics and decoupling from the rest of the world. Exacerbated by a post pandemic decline in domestic consumer spending, China now finds growth is slowing, money is tight and trade tensions are flaring.
Finally, we turn to Hong Kong which remains a business hub, but one increasingly made up of firms and workers from the mainland. Hong Kong still stands apart from its peers, when it comes to capital markets and investment banking, and its financial workings are more like that of a Western country, but the direction of travel is not without its challenges.
As ever, Update is here to offer insight into the key issues affecting your investment decisions. We strive to paint you a true picture of the issues affecting investments and thank you for your continued support.
China’s Doom Loop
Shanghai still seems much quieter than before the pandemic. Habits have undoubtedly changed since the country’s zero covid policy forced millions to stay at home. The shift reflects changing tastes as well as caution.
In the past, luxury brands, and especially foreign brands, have done well in China, but there has now been a recognisable shift to domestic brands that offer much better value for money. This has been a shock to the system for many brands that bet on China. Burberry, Gucci and Estée Lauder are just some of the luxury names whose profits have suffered because of faltering Chinese demand.
China’s Gen Z have been shifting their purchases towards local brands that reflect national pride.
Chinese brands took advantage of Covid to become much better at brand positioning and marketing and can be as competitive or more competitive than foreign brands now in a lot of categories.
However, this switch also masks a new frugality. Retail sales growth has struggled and is now close to its lowest level since the country emerged from lockdowns. Trading down is still very much a topic at hand, The luxury space is a good example of that. Consumers are tending to either allocate their spending up to the most premium brands or are trading down towards premium athleisure.
But the shift away from Western brands only scratches the surface of the changes taking hold in the world’s second largest economy. Growth is slowing. Money is tight. And trade tensions are flaring.
China grew 4.7% in the second quarter of 2024, slower than the 5.1% predicted by economists as nervous foreign investors pulled a record £12bn out of the country over the same period, in a blow to President Xi Jinping. Some fear the world’s factory is now in overdrive as shrinking profits force producers to ramp up output just to get enough cash to service their debts. China is at potential risk of being sucked into a “doom loop” of falling prices, factory closures and job losses that will leave it facing a Japanese-style lost decade.
China’s problems have long been rooted in four Ds” – debt, demand, demographics and decoupling from the rest of the world. Government data that shows a third of Chinese vehicle manufacturers were unprofitable in May. Cars are getting cheaper quickly: the average electric vehicle produced by Chinese giant BYD now costs 20% less than a year ago. Prices across the economy were shrinking at the end of 2023 and have only just started rising again, climbing 0.5% in July from a year ago.
Most economists would describe a temporary fall in prices as an effective tax cut. However, the drop has been accompanied by weak incomes as household income growth has basically stagnated. Combine that with the property market crash, and the fact that most people’s wealth is tied up in their property, and it’s clear this has not been good for motivating consumption.
International tensions are another worry. Donald Trump has already vowed to escalate its trade war with China if he returns to the White House next year, while Kamala Harris has said that as president she would ensure “America, not China, wins the competition for the 21st century”. Companies that used to export to Europe and America are shifting their focus to domestic sales and export to other developing countries.
Concerns about future trade wars have made lots of Western buyers weary, adding to the problems of softening sales in those traditional markets. Fears about overcapacity are creating more trade tensions, with many countries worried about being flooded with cheap cars in order to meet net zero targets. Some nations have already sought to block this. The US has announced a 100% tariff on Chinese electric vehicles, as well as a 25% tariff on batteries, parts and critical minerals in a bid to keep them out.
This may be the start of a bigger decoupling that will see the US and other western nations pay higher prices for goods going forward as China, which is becoming less reliant on the West for technology to drive development, looks to do more business in Asia, Africa and elsewhere. The US, in particular, has not faced up to the fact that the rest of the world doesn’t have to play by its rules anymore.
But the evidence also suggests that China remains cautious about moving too close to countries such as Russia as it worries about the potential impact of secondary sanctions. While Vladimir Putin’s state visit to China this year was intended to demonstrate their “no limits” friendship, there is evidence that some factories have stopped doing business with Russian intermediaries after Chinese banks began refusing to process payments.
The big question surrounding China going forward is growth. The International Monetary Fund believes the rate of economic expansion is likely to slow to just over 3% by the end of the decade because of weak domestic demand.
For now, growth and its drivers are likely to remain on shaky foundations. The question is not just how fast the economy is growing, but the drivers of that growth. The Chinese economy is almost $18 trillion now. So 3% on top of that in absolute terms is still a lot of growth. But the problems arise when in order to generate this amount of growth, there is a cost in terms of debt, in terms of deeper structural imbalances, and the sacrifices made in terms
of geopolitics.
So the question is not how much China grows in the coming years, but at what cost?
The new trend towards frugality in the world’s second largest economy risks being only a foretaste of what is to come.
Chinese markets are stuck in limbo. Shares lack both the vigour of an emerging market or the stability of a developed one. The benchmark CSI 300 index is down more than 6% this year, leaving it on course for a fourth successive annual loss. Since a 2021 peak, roughly $6.5trn has been wiped out from Chinese and Hong Kong” shares – the value of Japan’s entire stock market.
While much of the world struggles with inflation, China has been battling the opposite problem. On one measure, the GDP deflator (the gap between nominal and real GDP growth), the world’s second-largest economy has already been in deflation for five straight quarters. Falling prices can harm growth, with consumers holding off purchases for hope of cheaper deals ahead.
Rather than UK-style furlough schemes, stimulus in China during Covid focused on infrastructure and building up new industries such as electric vehicles (EVs) and renewable energy. That might prove a wise long-term move, but the resulting ‘excess’ manufacturing capacity cannot currently be absorbed domestically, triggering a surge in exports, which grew 8.7% in the year to August.
The root cause of sluggish domestic demand is a weak property market. The price of existing homes have dropped 30% from a 2021 high. When households feel poorer, they spend less freely. And with corporate profits coming under pressure, Chinese consumers have become more frugal, since they “are worried about the prospects for wage growth and job security.
From an overreliance on construction to a dependence on export markets and a rapidly ageing population, China shares many similarities with the deflation-prone Japanese economy of the 1990s and 2000s. Investors should remember that Japan’s Nikkei 225 took 35 years to regain its 1989 peak after the Japanese bubble burst.
Bloomberg, the respected financial publication, thinks that comparisons with Japan are overstated. China still has more scope for urbanisation and “catch-up” growth than Japan had in 1990, by which point the latter was already a high- income economy. A better parallel might be with South Korea. Following the 1997 Asian financial crisis, Korea seized new opportunities in semiconductors and smartphones. Similarly, China is now emerging as a leader in new green technologies and is already the world’s biggest EV market.
Investors are on a global hunt for bargains, but China, where stocks trade on 11 times earnings, is conspicuous by its absence. Whoever wins the US presidency, more tariffs look likely, jeopardising Beijing’s efforts to export its way out of trouble. Chinese assets are likely ti remain out of favour for some time to come.
Hong Kong’s future
Xi Jinping’s goal for Hong Kong is: “From chaos to order, from stability to prosperity.” This fixation on security and stability is likely to cost Hong Kong in the long term.
Ever since pro-democracy protests swept the city in 2019, China’s rulers have tried to reimpose control. In many ways he has succeeded. Today Hong Kong is less volatile than it was. The Covid-19 pandemic, which saw the city close itself to the world, helped to calm things down. So have two draconian national-security laws, one imposed on the city by the central government in 2020 and another adopted by the local legislature this year. But the measures that have brought order, by striking fear into liberals, risk costing Hong Kong its prosperity by making it a less pleasant and predictable place to live and do business.
In the international firms that fill Hong Kong’s high-rise office blocks, the mood is far from buoyant. When the American Chamber of Commerce in Hong Kong surveyed its members at the end of 2023, it found that 60% of respondents said they would be cautious about expanding their business in the city. Among the challenges cited were tensions between China and America and the slowing Chinese economy, but also overseas perceptions of Hong Kong. Nearly a third of respondents said they had been negatively affected by the older national-security law. Another survey, taken in June and July by the German Chamber of Commerce in Hong Kong, found that many of its members were expecting a worse political climate and more difficulty attracting foreign talent in the year ahead.
It is not all bad news. Most companies still report a positive business environment. In some ways the mood was worse in 2021 and 2022, when covid took a toll on the city. Optimists might note that the number of American companies operating there ticked up slightly last year to 1,273, after declining for four years in a row. But that number is down from a peak of 1,388 in 2012. And although foreign firms are not leaving Hong Kong en masse, many are shrinking their operations and moving their regional headquarters elsewhere.
Hong Kong’s proximity to the mainland had long been its biggest selling point. But now foreign executives and officials talk of it becoming more like the mainland. The city’s independent legal system, robust free press and civic freedoms are all being eroded by the central government. Three of the ten foreign justices on Hong Kong’s highest court have quit this year. In response, Hong Kong’s chief executive, John Lee, said, “The rule of law in Hong Kong is strong and will not change.”
But a string of legal cases targeting liberal Hong Kongers has reinforced the concerns. The most recent involved Chung Pui-kuen and Patrick Lam Shiu-tung, former editors of Stand News. The online outlet (now closed) published articles in support of democracy. On August 29th a judge ruled that during the protests of 2019, Stand News “became a tool to smear and vilify” the authorities. The convictions of Messrs Chung and Lam are a clear signal to the business world “that Hong Kong no longer behaves as a common-law jurisdiction”, said the Inter-Parliamentary Alliance on China, which brings together lawmakers from 33 countries.
On September 6th the American government chimed in, issuing an updated warning to firms about the potential dangers of operating in Hong Kong, mainly from the two security laws. “Businesses should be aware that the risks they face in [mainland China] are now increasingly present in Hong Kong,” it said. Days later America’s House of Representatives passed a bill that could close Hong Kong’s diplomatic offices in the country. Lawmakers have questioned whether Hong Kong deserves representation separate from China’s, given the city’s waning autonomy.
All this has darkened Hong Kong’s appeal relative to other cities in Asia, such as Singapore. At the same time, foreign firms that are hoping to operate in China see fewer benefits to setting up in Hong Kong, as opposed to Shanghai.
Hong Kong remains a business hub, but one increasingly made up of firms and workers from the mainland. In 2022 China overtook America as the country with the most regional headquarters in the city. 20% of the Americans living there moved out between 2021 and 2023. Along with them went droves of Hong Kongers. More than 150,000 of them have moved to Britain under a special immigration programme created by the British government after the first security law was introduced. Several thousand more have received permanent residence in Australia and Canada under similar schemes.
The population of Hong Kong fell from 7.5m in 2019 to 7.3m in 2022. But it rose back to 7.5m last year. The local government has introduced a new visa programme to attract overseas “top talent”. Of the 70,000 visas approved under the scheme so far, 95% went to people from the mainland. Foreign companies seem unimpressed by these new arrivals. Nearly half of the respondents to the American Chamber of Commerce survey said the availability of qualified staff in Hong Kong had decreased in the past year. Another problem is that many mainlanders see Hong Kong as a transition point to the outside world.
Hong Kong still stands apart from its peers, and certainly from the mainland, when it comes to capital markets and investment banking. Though the city has become more Chinese, its financial workings are more like that of a Western country and, as a result, it has access to financial systems in the West. Its currency is pegged to the US Dollar and it remains the dominant offshore dollar funding centre in Asia.
Financial firms are not leaving in large numbers—and probably will not, so long as Hong Kong continues to be the main route to investing in China. But some of these firms have cut jobs in recent years, as the volume of initial public offerings in the city has declined. And bankers worry that the Sino-American rivalry or Chinese influence will disrupt Hong Kong’s position as a global financial centre in the long term.
In the short term, the city’s real economy faces difficulties. Hong Kong’s GDP expanded in the second quarter by 3.3% year on year on the back of strong exports. But retail sales are down, and bankruptcies are up. Hong Kong residents increasingly go to the nearby city of Shenzhen for shopping, reversing an old trend. Hong Kong’s property market is suffering, too, with the value and volume of home sales plummeting in recent months. The city’s tight global financial links have been a double-edged sword: its dollar peg has obliged it to maintain high interest rates despite the weak local economy.
At a town-hall meeting in August hosted by the city’s leaders, including Mr Lee, dozens of residents and industry representatives expressed economic gloom. Mr Lee acknowledged that businesses were facing challenges. He said that the economy will perform better next year, without specifying any future policies. A founding member of Hong Kong’s largest pro-Beijing party complained that the city lacks political leadership. Perhaps well demonstrated by new plans to replace the city’s mascot from a dragon to a panda, following the birth of two cubs in the city.
Whilst this may be designed to promote tourism and cheer up its residents, Hong Kong’s problems are much bigger than that.
The recent Ukranian incursion into Russia represents an enormous embarrassment for Vladimir Putin and his military leadership. Tens of thousands of residents were evacuated after Ukrainian troops stormed across the border. The Russian armed forces, caught off guard, were slow to respond. The Rouble is slumping, as worries mount about the future of the war. Yet on the home front, at least, things look better than ever for Mr Putin. Despite sanctions and pariah status, Russia’s economy is growing strongly. It turns out that accelerating spending, at a time of war, really gets things going.
Russian GDP will rise by over 3% in real terms this year, continuing its fastest growth spurt since the early 2010s. In May and June economic activity “significantly increased”, according to the central bank. Other “real time” measures of activity, including one published by the bank, Goldman Sachs, suggest the economy is accelerating. Unemployment is close to an all-time low. Inflation is too high—in July prices rose by 9.1% year on year, above the central bank’s target of 4%—but with cash incomes growing by 14% year on year, the purchasing power of Russians is rising fast. In contrast with people in almost every other country, Russians are feeling good about the economy.
Consumer confidence, as measured by Russia’s statistical agency, is well above its average since Mr Putin assumed power 24 years ago. We might expect him to be manipulating the numbers. But the Levada Centre, an independent pollster, finds equally startling trends. Only once in the past three decades has sentiment been higher. Russians’ confidence in their own financial situation, according to official data, recently jumped to an all-time high. They are more inclined to make big purchases, such as a car or a sofa, and restaurants are bursting. Last year Russians imported 18% more cognac than they did in 2019, according to one estimate, while spending 80% more on imports of sparkling wine. Sberbank, the country’s largest financial institution, notes that in June overall consumer spending rose by 20% year on year in nominal terms.
The latest data are in sharp contrast to the 2010s. Back then, output and incomes grew slowly or not at all. By 2018, real wages were no higher than in 2012. People were fed up. A round of sanctions, which the West launched in 2014 following Mr Putin’s annexation of Crimea, contributed to the malaise. So did an unusually austere fiscal policy, involving increases in taxation and cuts to spending. The covid-19 pandemic and another barrage of Western sanctions, imposed in 2022 in response to Mr Putin’s full-scale invasion of Ukraine, compounded Russians’ financial woes.
What explains the turnaround? It is tempting to credit Russian exports. Mr Putin has been able to divert hydrocarbons once destined for Europe to other parts of the world. Russian oligarchs, and the companies they run, are doing better than had been feared at the start of the war. In reality, however, Russia’s recent export performance is nothing exceptional. Oil prices are lower than a couple of years ago. In the first quarter of 2024 the total value of Russia’s physical exports was 4% lower in dollar terms than in the same period of 2023—and a third lower than in 2022.
To understand the accelerating economy, look to fiscal policy and monetary policy.
Firstly, fiscal policy. Mr Putin has abandoned austerity as he doubles down on war. He is sensitive to domestic opinion and recognises that he needs to buy public support for his invasion of Ukraine. This year Russia will run a budget deficit of 2% of GDP – large by its standards – which it is funding by drawing on enormous financial reserves, accumulated during the 2010s. In effect, Russia saved yesterday to party today. Total government outlays rose by an average of 15% in both 2022 and 2023, and a slightly smaller rise is budgeted this year. Ministers are devoting much of this extra spending to the war in Ukraine. Data published by the Bank of Finland suggest that military spending will rise by about 60% this year, boosting production of weapons and ammunition, and putting money in people’s pockets.
In July Mr Putin doubled the bonus for those signing up to fight from 195,000 roubles ($2,200) to 400,000 roubles, which regional authorities are supposed to top up. The government is committing vast sums to compensation for the families of those killed in action. And Russia’s splurge goes beyond war-related spending. Mr Putin is lavishing money on welfare payments: in June he raised pensions for some recipients by close to 10%. The government is also spending big on infrastructure, including a highway from Kazan to Yekaterinburg, two cities 450 miles (730km) apart.
The second reason for Russia’s party economy relates to its unusual monetary policy. In order to deal with high inflation, the central bank has raised interest rates from 7.5% to 18%. More increases may be on their way. This has the effect of strengthening the Rouble by attracting foreign investment from friendly countries such as China and India, which in turn cuts the price of imports and thus inflation. It also encourages people to save, trimming consumer spending. In a normal economy, higher rates would hurt indebted households and companies, as their cost of repaying debt rose. Yet the government has almost entirely shielded the real economy through a bewildering array of schemes.
Earlier this year the government made it much easier for consumers to suspend repayments on loans, so long as they could prove that their income had fallen or they were “affected by an emergency”. Banks have offered loan holidays to soldiers in Ukraine. A mortgage scheme kept lending rates fixed at 8%, less than half the current policy rate. An “industrial mortgage” programme has channelled lending to companies at rates as low as 3% a year. Banks’ arms are also twisted so that they do not raise rates too far. When the financial sector loses income as a consequence, the state often steps in to make up the difference.
This has easily observable effects. According to official data, in the first quarter of this year households spent 11% of their disposable income on servicing debt. This is about the same as three years ago. Although the interest rates facing households and firms have risen, they have only done so by only about half as much as the official rates. New borrowing remains healthy. Lending to companies is growing at more than 20% a year. Since Russia invaded Ukraine, unsecured consumer lending has grown about as fast as nominal wages, which is to say very fast indeed.
How long can the party last? Much depends on the war. A continued slump in the Rouble would raise inflation; more military recruitment would worsen labour shortages. At some point, people may get angry about the cost of living. And Mr Putin cannot run budget deficits for ever. At current rates, Russia’s reserves will be gone in five years or so. But the economy has also shown its resilience in recent years. So, for now, the party continues.
Meanwhile, sanctions on Russia are proving in-affective. It looks like Russia is planning for decades of Western sanctions. The evidence suggests that might not be too much of a problem. The economy is growing at an annualised rate of 4% in the second quarter, after a whopping 5.4% the quarter before, despite one of the toughest regimes ever imposed. Trade continues to flourish. How come?
For a clue, look at Kazakhstan. Last year, the Central Asian Republic’s tech industry appeared to pull off a triumph. Since the war in Ukraine began, European firms have been banned from selling most tech products in Russia; they were previously the country’s biggest tech suppliers. But Kazakhstan’s tiny tech industry, some 50 firms with a production capacity of $100m in 2021, seems to have filled the gap. Its exports to Russia rose from $40m in 2021 to $298m in 2023. Of course, all was not as it seemed. Electronic imports from Europe also increased, from €250m ($273m) to €709m. Did Kazakh firms magically expand, or have Russian firms found a roundabout route to their old European suppliers?
Kazakhstan is one of several countries where trade with Russia and Europe has been mysteriously booming since Ukraine’s invasion. Others include Armenia, Azerbaijan, Georgia, Turkey and the other four countries of Central Asia. Exports from the European Union to these countries increased by €46bn in 2023, up 50% from 2021. That was equivalent to three-quarters of the drop in Europe’s exports to Russia from 2021 to 2023.
Along with military aid, sanctions are the West’s main contribution to Ukraine’s war effort, but unlike long-range rockets, they have so far failed to deal much of a blow. Two and a half years in, Russia’s economy is holding up well. It is hard to tell which European firms are simply adjusting well to the new restrictions and which are circumventing sanctions. But, as it happens, the biggest boosts in trade flowing through third countries have been among products that are now heavily restricted. European policymakers are desperate to close the leaks, but that means getting tough on the governments of some of Europe’s most diffucult neighbours.
Three strands lie behind the boom in trade. The first is trade in banned goods, which clearly flouts sanctions. The EU has adopted 14 packages of sanctions, most recently on June 24th. They ban firms making anything that could be used on a battlefield from exporting to Russia. That includes semiconductors and drones, but also ball-bearings and microwave ovens. Even so, more than half of the battlefield equipment that Russia acquired between February and August 2022 contains components made in Europe or America, according to a London think-tan, the Royal United Services Institute.
For example, the most rapid growth in exports from the EU to Kazakhstan and Armenia has been in chemicals, electronics and machinery, all product groups under heavy sanctions. Machinery exports to Kazakhstan from the EU doubled from 2021 to 2022, and then rose another 23% in 2023 to reach €6.4bn. Armenia imported twice the chemicals, five times the IT hardware and four times the electronics from Europe in 2023 as it did in 2021. Then there are the goods that are smuggled across borders, which fall outside the official trade statistics.
Shipments can pass through several middlemen on their way to Russia. Some exporters in Turkey and Central Asia genuinely have no idea where the goods they are shipping came from. But others know very well. Last year America imposed sanctions on a network of European firms organised by Mayak, a Russian conglomerate, to transport forbidden equipment through Uzbekistan and Armenia. In June, it uncovered two different networks of European toolmakers shipping to Russia, one via Turkey for Ostec, a Russian state-owned company, and one via Kyrgyzstan for Newton-itm, a Russian aerospace firm.
The second reason for rising indirect trade is that Russia has barred lorries from entering directly from the European Union since 2022. The EU allows the export of some products to Russia, such as agricultural goods, but they must now take circuitous routes. The EU is not too worried about this: it makes transport more costly, which discourages trade with Russia but allows firms that heavily depend on it to survive. Official figures show that agricultural products flowing from Europe into Kazakhstan doubled from 2021 to 2023.
The third trend is the hardest for Europe to stop. It comes from a manufacturing boom in third countries. Third-country firms import some materials and parts from Europe, which does not necessarily break the rules. Sanctions have yet to touch some exports, such as textiles, raw iron and raw steel.
But even where trade is allowed, getting paid without breaking financial sanctions is a problem. Almost every transaction with a state-owned Russian firm is banned. European banks are barred from interacting with most Russian ones. Major Russian banks are locked out of SWIFT, the network that banks use to communicate with one another. Firms must avoid doing business with 2,200 firms and financiers who are blacklisted by the EU.
Turkey was one of the biggest suppliers of household appliances to Europe before the war started. America believes that Turkish firms are now making drones and microelectronics for Russia. Metals for some munitions may be smelted in Europe, according to a Turkish foreign-ministry official. Kazakhstan’s imports of office machinery from Europe tripled to almost $1bn from 2021 to 2023. That was probably partly due to a surge of new offices and factories. Investment in Kazakhstan rose by 11% in 2023, buoyed by Russian firms.
The economies of Central Asia and the Caucasus seem to be benefiting from the war. Collectively, the economies of the five Central Asian republics grew by 6% in 2023, up from 4% in 2022, while Armenia’s economy expanded by 8%, up from 5% in 2022. A booming logistics sector has appeared and cargo is growing by 20% each year.
This is all bad news for Europe’s policymakers. In December, the EU’s 12th round of restrictions targeted firms in Armenia and Uzbekistan for the first time. Bureaucrats have since threatened more sanctions on third countries and Europeans exporting to them, but have taken action only against a few firms. For each firm added to the blacklist, another is registered elsewhere.
A solution would require enlisting the help of the governments of the Caucasus and Central Asia. That would be difficult. Regional politicians value their closeness to Russia and often profit personally from rule-breaking. Still, the Europeans could offer them incentives. Armenia recently started to shut down firms trading with Russia, after the EU awarded it €270m in aid, loans and contracts.
Alternatively, Europe could use sticks rather than carrots. It could extend export bans to third countries or restrict their banks. That could jeopardise Europe’s remaining sources of gas in Azerbaijan and hurt European firms. The question is whether the European Union thinks that the benefit to Ukraine of a tighter sanctions regime is worth it.
Its current approach suggests it doesn’t.
Modi’s setback
The summer’s general election gave Prime Minister Narendra Modi his biggest political setback in his decade of power. In an unexpected blow, Modi’s BJP party lost its majority for the first time since 2014, winning only 240 out of 543 seats in India’s lower house, down 63 from five years ago. In contrast, the opposition INDIA bloc, led by the Indian National Congress, performed better than expected, winning 234 seats. Modi plans to form a government with smaller parties in his National Democratic Alliance.
Pundits considered Modi’s return to power with a majority as almost an inevitability, with exit polls projecting a BJP landslide. The opposition seemed to have captured widespread frustrations among the masses – particularly in poorer rural areas – at chronic unemployment, low wages and high inflation. In contrast, the BJP’s increasingly polarised messaging seeking to play on Hindu-Muslim divisions seemed to fail to distract from the government’s failure to create quality jobs, particularly for the vast youth population.
It’s not surprising Indians are wondering where the results are from Modi’s much promoted economic success. While India officially grew by 8% in the last fiscal year, private consumption and investment are much lower and national unemployment is 8%, rising to 17% in cities – poor results given India’s natural advantages. Worse, rather than offering voters a vision for escaping this malaise, Modi instead touted various handouts such as food subsidies introduced during the pandemic” Still, while voters have shown that they want him to do better, the question now will be whether Modi takes this election warning to heart, or retreats into even more sectarian and authoritarian methods.
There is a danger that Modi will double down on his more authoritarian tendencies and amplify his polarising rhetoric. Still, the fear that India might inexorably evolve towards a more autocratic form of government has receded given that the BJP failed to win enough seats to ram through constitutional changes and the opposition parties have been given a new lease of life, with debate and dissent reinvigorated. Modi’s dimmed personal brand makes the idea of him ruling for another ten years seem far less likely.
Modi’s confidence that he would be able to negotiate a deal to keep him in power, was well founded. He claimed that his alliance still had a mandate to govern. While the BJP-led coalition has secured enough seats to form a government, leaders of the two small king-maker parties within it may well be an ongoing thorn in Modi’s side.
Indian stocks bouncing back Following the election, concern that a shaky coalition could undermine growth saw Indian markets plunge 6%, wiping $400bn off stocks in a single day. However, Modi has assembled a coalition that is broadly sympathetic to his pro-business agenda, with many of the key ministers from the last term remaining in place. The result? The BSE Sensex index clawed back all its losses within a week and was up by 7% in the first half of the year.
Modi has already achieved much since coming to office in 2014. His government has stabilised a wobbly economy, implemented much-needed tax reforms and powered into the digital economy. But India still faces deep structural challenges in areas such as farming, where mass protests have seen off previous attempts at reform. New Delhi wants to build up India’s manufacturing base, but that requires difficult changes to labour and land laws. As one local business commentator put it, if Modi didn’t manage these reforms in the last ten years, “why would we see them now that the BJP don’t have the majority”?
Complaints about a two-track economy that leaves too many people behind gained more traction than expected at the polls. That could well force Modi to shift some of the attention he has paid to infrastructure and investment toward social programmes to placate angry voters. Nevertheless, growth will continue as already agreed infrastructure projects bed in. Capital expenditure has hit more than a third of GDP. The Indian growth story remains a compelling one.
The Mumbai stock-market’s recent gyrations serve as a reminder that professional investors are horribly bad at assessing political risk. India is the world’s most expensive major equity market on a forward price-to-earnings basis, surpassing even the US. Indian shares deserve some of that premium thanks to rapid growth, quality companies and a geopolitical sweet spot. But local stocks look priced for perfection, leaving them vulnerable to bad news. Indeed, some foreign money managers have been quietly pulling out in recent months, taking the share of foreign ownership of Indian stocks below 18%, the lowest since 2012. Instead, local retail investors are powering the rally.
India’s election result shouldn’t radically derail its impressive growth trajectory. The economy could well double in size over the coming decade. But that doesn’t make Indian stocks especially compelling. A very benign backdrop for India, from improved economic stability and the global hunt for alternatives to China, already looks priced in to shares. Indian stocks have had a good run, but further world-beating returns will be a tall order from here.
India buying a chunk in UK plc In August, it was announced that the French dealmaker Patrick Drahi was selling the 24% stake he has acquired in BT over the last few years to India’s Bharti Global. Run by the billionaire Sunil Bharti Mittal, Bharti Global is one of India’s largest conglomerates, with interests in telecoms, media, space and other sectors, and has started pushing out aggressively into the rest of the world. BT’s shares were up by 33% over the last six months, partly because of the turnaround plan put in place by its new CEO, and partly due to speculation that there may eventually be a full-scale takeover bid for the company.
Bharti might be looking at it purely as an investment, it may be looking for partnerships for its telecoms operations back at home, or it might be considering a full-scale takeover. If it does decide to take full ownership of BT, that will pose a stiff test for the government. Should one of our largest companies, and especially one in such a sensitive area as telecoms, be allowed to be taken out by an Indian conglomerate?
India’s fast-growing economy is generating lots of wealth. Its stock market is close to overtaking China’s when measured by total capitalisation, and there are close ties between the two countries. Tata has been an excellent owner of Jaguar Land Rover and, while its ownership of the steel industry has been more controversial, it is hardly its fault that the government is imposing steep net-zero targets on the industry. Many smaller-scale investments have contributed a lot to the British economy, while many UK companies have built substantial operations in India.
But if an Indian firm is to be allowed to take a major stake, and perhaps full control, of an asset as important as BT, then shouldn’t the UK be asking for something in return? A trade deal, perhaps? A major agreement with India has been under negotiation ever since the UK left the EU, but Ministers have not been able to get it across the line. There have been disagreements over visas for Indian workers and a range of other issues.
But given that a deal with the US does not look likely to happen any time soon, one with India would be by far the biggest prize of the UK’s post-Brexit trade strategy. India has already overtaken the UK as measured by total GDP and it is expected to overtake Germany in 2027 and Japan in 2029 to become the World’s third-largest economy.
Just as significantly, a deal with India would cement the UK’s pivot towards the Pacific which started when it signed up to the CPTPP free-trade zone that stretches across most of Asia and much of South America as well. The Asia-Pacific region is growing rapidly, and it is a lucrative market for the mix of legal, financial and consulting services that the UK has become very good at exporting. With India added too, Britain would have the opportunity to embed itself deeply into the region’s commercial infrastructure. Add it all up, and a trade deal with India could well unlock a wave of investment, exports and jobs, as well as cementing the UK’s place in the Asian trading system.
The Labour government may be keener on restoring relations with the EU, but once it takes a realistic look at the figures it will surely realise that the booming Pacific regions are far more attractive than a stagnant France, Germany and Italy, and anyway there is no reason not to do both at the same time. On announcing the deal, Mittal opened the door to precisely that, arguing that the investment would lead to “elevating and broadening India-UK ties”. Mittal is a close ally of Indian prime minister Narendra Modi, and has been a leading advocate of more trade between the two countries.
A trade deal with India would be a big prize, and perhaps worth losing control of a telecoms company for.
Love Labour’s Lost?
It is just over two months since Keir Starmer was appointed as the UK’s new prime minister, and it’s fair to say that the honeymoon period is undoubtedly over for him and the new Labour government.
According to the latest YouGov poll Starmer’s ratings have fallen to their lowest levels since he became prime minister, with just a third of Britons (35%) now holding a favorable view of the Labour leader, the fewest since June and down from 44% after the election.
Starmer, by his own admission has had to make some tough decisions since he entered number 10, and has hinted that more are on the way, warning that life in the UK is “going to get worse before it gets better”.
The Fiscal Reset – getting back on track The next indication of this is the likelihood of tax rises coming in October’s budget, as a result of what Labour says is a £22bn black hole in public finances.
By preparing everyone for the worst of course, it may turn out to be ‘not so bad’, however there is a significant sentiment that he and his front bench must stop talking down the UK’s prospects, which appear better than
they admit.
Flatlining growth over the last two months, fuelled by a General Election, the Euros and Olympics and now a budget in October, speak volumes of the latent potential when the country does decide to move again.
The prime minister has said it will take years to clean up after the previous Tory governments and that he will have to make some “painful” decisions to put things right.
While he reiterated his promise that the potential tax hikes will not affect “working people”, it is likely to involve an increase on capital gains tax and inheritance tax, leaving some business and property owners already questioning their future in the UK.
Starmer has also faced stern criticism, even among his own supporters, following his decision to cut the winter fuel payment leaving around 780,000 pensioners out in the cold this year.
Europe 2.0
Alongside these decisions that Starmer says are necessary in order to clear up the mess left behind by previous administration, he has also set out his desire to reset relations with Europe, although he has made it clear that this does not mean reversing Brexit or re-entering the single market.
Speaking at the European Political Community summit in July, Starmer said that he wanted to “strengthen our existing relationships and build new ones” and that the UK and EU working together as sovereign partners was a “powerful force for good”.
However many have since questioned his commitment, following his rejection of EU priorities such as the youth mobility scheme, which would essentially grant people aged 18 to 30 free movement for up to four years.
It is thought that the Spanish prime minister, Pedro Sanchez discussed the possibility of a free movement deal for young people with Starmer at the EPC summit during a private meeting, but the government have since said this is not something that is being considered.In the Labour manifesto, Starmer made the promise of a new Border Security Command with hundreds of new specialist investigators and counter terror powers to smash the criminal gangs and strengthen the UKs borders.
He has pushed forward with this initiative recently appointing a new border security commander, former chair of the national police chiefs council, Martin Hewitt, to head up the unit.
The prime minister has also recently met with Italian prime minister Giorgia Meloni to understand more about how Italy has succeeded in cutting illegal immigration by 60% in the last year.
Events, dear boy, events…
While life under Starmer may be making some feel a little uneasy at the moment, some things have started moving in the right direction since he settled into number 10. The riots of the summer were quelled and miscreants processed quickly. Order was restored.
The Bank of England cut interest rates for the first time in over four years on August 1, bringing the base rate down to 5% from 5.25%. This decision was helped by the fact inflation had called back to the central bank’s target of 2% in June.
Their meeting on September 19 saw them hold rates as inflation rose again raising concerns that the BOE may approach with caution and delay any further cuts for the time being – especially in light of the US election outcome.
Chancellor of the Exchequer, Rachel Reeves, says that economic growth in the UK is the Labour government’s “national mission” and featured heavily in the party’s election campaign.
The role for private finance In order to help boost investment in the UK, Labour intend to create a National Wealth Fund worth £7.3billion. The fund will have a target of attracting three pounds of private investment for every one pound of public investment.
The funds will be shared across the steel and automotive industry, the deployment of carbon capture, the manufacturing of green hydrogen and go towards upgrading the UK’s ports and building supply chains across the UK.
Along with this comes the promise to “get Britain building again” with a pledge to build 1.5 million new homes in five years, taking a brownfield first approach by prioritising the development of previously used land wherever possible.
Housebuilding is not the only ambitious project on the new governments agenda, the party has also committed to achieving clean power by 2030, five years sooner than the Tories’ 2035 target.
This will be helped along by the creation of Great British Energy, a new publicly owned company that will be headquartered in Scotland and create jobs and supply chains across the UK.
It is often said, the reason that character is important in politics is that it is that which is relied upon in power when all the best laid plans of politicians are overtaken by events.
The US election is too close to call but will undoubtedly impact plans. Labour, according to sources, is preparing for both eventualities. A protectionist Trump regime which may be more interested in a bi-lateral deal, or a Harris administration which is pro-Europe if not totally pro UK but also closer to the progressive compass of the UK government.
Starmer’s character will be tested over the coming months but he seems determined to ‘do what he believes is right’. Investors’ patience may be tested but there are opportunities in his programme for change.
Whether he gets it right only time will tell.
The US election is just two months away and new presidential candidate Kamala Harris is setting out her economic vision for the country, but what is her stance on the key issues?
It took under two weeks for Harris to replace Joe Biden as the democratic party’s presidential nominee following Bidens disastrous debate with Donald Trump that saw him step down from the re-election campaign.
This last minute elevation of Harris appears to have injected some fresh energy into the race, and has seen her approval rating go up, with many of the polls now suggesting she has nudged the lead on republican nominee, Donald Trump.
In August Harris announced Minnesota Governor, Tim Walz, as her running mate, who has been described as having the “most progressive record” of any of Harris’ potential picks, which is a strong indicator of what a Harris-Walz administration will look like.
So as the pair hit the campaign trail many voters, particularly those in the swing states will be looking to see how the duo will approach challenging policy questions, and how much a Harris’ campaign promises might differ from her predecessor.
While she has yet to set out all of her policies in full, it is unlikely she will sway too far from what democrats expect as she has voiced to continue many of the measures put in place by Biden, such as lowering drug costs, forgiving student loan debt and eliminating so-called junk fees.
As Bidens second-in-command Harris largely stood by his foreign policy positions, but this now an area where she could look to put her own stamp on things.
Up to now Harris has shown a strong commitment for Ukraine and NATO, but observers say she could take a different position when it comes to the Middle East.
When Harris entered the White House she had little foreign policy experience, but quickly learned on the job and has travelled to more than 20 countries attending meetings with over 150 world leaders, stepping in for Biden on occasion.
The vice president has met with President Zelensky a number of times, and more recently met with Israeli Prime Minister Benjamin Netanyahu.
According to reports Harris also helped to negotiate the landmark US-Russia prisoner swap during a meeting with German Chancellor Olaf Scholz at this year’s Munich Security Conference.
Harris has been described as having a more “empathetic” approach to Israel’s war in Gaza than that of Biden, and was one of the administrations first voices to call for a temporary ceasefire in March.
She has described the civilian death toll in Gaza as a “humanitarian catastrophe” and after meeting Netanyahu in July Harris said she would “not be silent” to the suffering.
After previously urging Biden to take a stronger stance against the Israeli Prime Minister, this could be an indication that she is prepared to be more outspokenly critical of Israel than her predecessor.
Americans are not impressed when it comes to Biden’s handling of the economy, after high inflation has left many struggling with the cost of living. Polls say that this is the top issue in the minds of many voters, and one they will be looking to the next president to fix.
Inflation is now under control, but in June the jobs market showed signs of weakening as unemployment rose from 4.1% to 4.3% due to an influx of jobseekers entering the market.
In her recent speeches Harris has said that building
up the middle class will be a “defining” goal of her presidency and she will “fight for a future with affordable housing, affordable health care, affordable child care
and paid leave”.
This stance echoes that of her 2020 presidential campaign when she proposed providing middle class and working class families with a refundable tax credit of up to $6,000 a year, which would allow tax payers to receive the benefit on a monthly basis.
She also advocated for raising the corporate income tax rate to 35% which was higher than the 28% Biden proposed, and affordable housing was also on high on her 2020 agenda saying that every American deserved to have basic security in their own home.
Prior to becoming vice president Harris advocated for more progressive positions than Biden on a number of issues including healthcare, but later took a more moderate stance in line with Biden when she took up the position.
While Harris has yet to set out her polices in full, there have been clues in her recent appearances that suggest how her agenda might shape up.
She has repeatedly spoken about abortion access, something that has been a key issue for Democrats in this race, and also one she has become increasingly outspoken on since the right was overturned in 2022.
At Harris’ first rally since announcing Waltz as her VP, she praised his move as governor to pass abortion access, making Minnesota the first state to do so after the Supreme Court decision.
The vice president has also made clear that climate change is one of the key issues that a Harris administration would address, and her previous presidential campaign saw her propose a climate plan with a $10 trillion price tag, which is almost seven times more than the $1.36 trillion invested by Biden.
The current vice president has faced intense scrutiny from the Republicans when it comes to immigration, who are blaming her for what they call a “border invasion” however Harris has come out fighting with campaign ads and speeches that she says shows her history of tough border enforcement, and an indication that she intends to go hard on the issue.
Harris also supports the bipartisan border funding bill that was nearly passed earlier this year before Trump intervened.
The bill was meant to clamp down on the number of migrants allowed to claim asylum at the US-Mexico border. Speaking about this recently Harris used this opportunity to attack her opponent saying “He talks a big game about border security but he doesn’t walk the walk.”
While a lot of what Harris stands for is in line with Bidens policies and agenda there is some degree of differentiation that could just be enough to re-ignite the interest of some disillusioned democrats, but whether that momentum will be enough to beat Trump in November remains to be seen.
In conversation with many Americans, Trump retains an edge in terms of actual policies that resonate with voters but many, including Republicans, worry about his divisive nature. Investors know that a successful America is usually good for everyone but how that is achieved will be important. Rebuilding through protectionism will arguably be inflationary. A global view will be necessary if growth is to be achieved without collateral damage to other nations.
For now all eyes will be on the campaign trail and we can expect an intense build up to the September 10 debate when Trump and Harris will go head to heard on ABC.
This will be the first big test for Harris who has a mixed record in debates, particularly when she has been asked to explain her position and answer tough questions when put under the spotlight.
Market report
Bonds: Investment Grade preferred
Developed market bonds have delivered strong returns. Growth, particularly in the US has been moderating, raising concerns that the Federal Reserve may have kept policy too restrictive for too long.
July’s unemployment figures in the US ticked up to 4.3% and increased concerns about global growth and the risk of recession. However, labour market statistics have been heavily distorted by post-pandemic effects, rapid migration flows, and more recent weather disruptions.
As a result, markets moved quickly to price aggressive near-term interest rate cuts, driving up the value of Bonds. A US economic soft landing is likely, with interest rates reducing at a gradual pace until a rate of around 3 to 3.5% is reached.
There is limited scope for short-term capital gains. High quality Investment Grade Bonds are preferred for the security they offer and returns in the high single-digit range are forecast over 12 months.
Equities: Recession fears ease
In early July, a large downside surprise in US inflation dragged equity markets down, with smaller companies and value stocks significantly outperforming. Then, disappointing figures in the Purchasing Manager’s Index and non-farm payroll data in the US that was well below consensus reignited growth concerns in August. From peak to trough, the MSCI AC World index dipped more than 8% while volatility, measured by the VIX index, temporarily spiked to almost 40%. The subsequent data points were more constructive (jobless claims, retail sales), helping markets to recoup most of the losses and reach new highs.
It looks like the global economy is heading toward a soft landing. Economies are slowing and labour markets are cooling in an orderly fashion. This has helped ease inflation pressures, including in the US, where the latest inflation figures surprised on the downside. Central banks are now well positioned to cut interest rates. This should not only lead to lower discount factors, but should also help reduce risks of a recession.
The earnings outlook continues to improve, supporting the view that earnings likely bottomed in 2023 and should accelerate in 2024. Tech sectors should lead the growth as they benefit from their cost-cutting measures from 2023, as well as from rapid developments in the Artificial Intelligence space.
Foreign Exchange: Sterling preferred
The US dollar has lost ground, with markets warming up to the prospect of Federal Reserve rate cuts. While the wobble in equity markets initially shielded the Dollar from weakening against highly pro-growth currencies, investor confidence that lower rates will bode well for risk assets has weighed on the Dollar recently.
Whilst rate-cut expectations for the Fed have already shifted significantly, US yields can still come down further. This view hinges on our expectations that US economic growth will slip further in the quarters ahead. As inflation is projected to fall below the 2% central bank target at the beginning of 2025, the pressure on the Fed to normalize rates faster will increase. This should bring forward easing expectations, triggering the prospect of lower real
yields and additional USD weakness.
The Dollar also starts this journey from
an overvalued position.
At the same time, valuations make Sterling and the Swiss Franc particularly attractive, along with the Austrian Dollar and the Euro, to a lesser extent. This reflects the fact that growth expectations outside the US are reduced. It wouldn’t take much to exceed market expectations, especially in Europe where growth has been so muted.
Commodities: Structural case remains
Industrial metal prices have been under pressure, posting a high-single-digit slide since the beginning of July. Price declines have been broad-based, with lead and aluminium falling the most. But prospects for material rate cuts from the Federal Reserve and bottom-up factors still call for higher prices over 6-12 months.
Accelerating growth in China, persistent production challenges, low inventories, and ongoing weather risks remains the key negatives for higher prices over time. Whilst a total return of around 20% for commodities is possible over the next year, although exposure needs to be actively managed.
The price of base metals is likely to be higher at year end. Inventories are at structurally low levels and highly concentrated in China. That lack of supply will be supportive of prices.
Soft commodities remain a different story, apart from cotton, with prices back in the doldrums. Coffee and cocoa remain the stand-out performers of the sector as solid demand and persistent supply-side risks keep markets high. Sugar should see prices stage a modest recovery.
Gold: An attractive diversifier
The case for gold as an attractive diversifier remains strong. Central bank buying, geopolitical tensions, persistently high inflation, and likely lower US interest rates are all supportive of prices. Gold prices could rise to $2,600/oz by the end of this year and $2,700/oz by mid-2025.
Within a balanced portfolio, an allocation of 5% to gold seems appropriate.
Oil: Healthy Growth Rate
Oil is trading at 2024 lows. Oil prices were not immune to the global market sell-off, despite solid fundamentals. Inventories have been consistently falling amid clear indications the oil market has been under supplied. Although demand remains mixed (strong in the US and India, and weak in China), the growth rate is healthy. Meanwhile, OPEC+ is likely to stick to its cautious approach when increasing supply.
US oil production growth seems to also be slowing down. Hence, prices of Brent is likely to move into a $ 85-90 per barrel range over the coming months.
