By Dan Steinbock
There is a deep chasm between America’s historical rebuff of G20 efforts, which seek to re-ignite trade, and markets, which remain at record heights. This rift is untenable.
Historically, Baden-Baden’s spas are famous for their healing waters, which have healed ancient Romans’ arthritic aches, Prussian queens’ rheumatism and European aristocrats’ paralyses. Nevertheless, the G20 Summit is fresh evidence that even Baden-Baden cannot do miracles.
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As US Treasury Secretary Mnuchin rebuffed the push by the masters of the global finance to renounce protectionism, concerns are mounting that the Trump administration will execute its “America First” policy, even at the risk of unleashing waves of retaliation worldwide.
As world trade is frozen but markets remain close to record-heights, contraction is looming in the horizon.
(Bad) History in Baden-Baden
History was made in Baden-Baden, but not the kind of history that the world economy needs. For the first time since the global crisis year of 2008, the world’s leading finance ministers, dropped the commitment to free trade. It amounts to the most consequential shift of the international trading community since World War II.
Following pushback from Treasury Secretary Steve Mnuchin, the G20 Summit backtracked from a joint position that would have explicitly renewed the long-standing pledge to free trade.
The timing could not have been worse. Before the global crisis, world investment soared to almost $2 trillion. Today – almost a decade later – it remains below that level. The state of world trade is even worse. World export volumes reached a plateau already two years ago. World trade has stopped growing.
In turn, the third leg of globalization, global migration, is plunging or stagnating, while refugee crises escalate. In the past year, more than 65 million people – more than ever since 1945 – were displaced from their homes by conflict and persecution.
To foster global recovery, finance ministers should have hammered a compromise in Baden-Baden. Instead, the White House tied their hands, which reinforced concerns about new US protectionism and increased trade friction in the coming months.
But if that’s the case, why are markets smiling?
At the peak of globalization in May 2008, the Baltic Dry Index (BDI) – a barometer of international commodity trade – soared to a record high of 11,793 points. Today, even before trade friction, the Index remains 90 percent lower than a decade ago.
That’s not the case with US equity markets, however. Since March 2009, the broad Dow Jones Industrial Average (DJIA) has more than tripled to soaring to more than 20,900. The blue-chip S&P 500 Index (SPX) has kept its gain at close to 2,380. And the tech sector’s Nasdaq Composite Index (COMP) exceeds 5,900.
According to the cyclically-adjusted price-earnings ratio (CAPE), the average now exceeds 29, which is about the same as amid the Wall Street crash in 1929 that heralded the Great Depression.
Historically, the CAPE average has been higher only once – in December 1999 – when the technology bubble finally burst and markets crashed. Of course, history does not always repeat itself in the markets, but it does rhyme. If the century-long CAPE median is about 16 and the current figure is 50 percent higher, markets appear to be substantially overvalued.
What makes the huge discrepancy between fundamentals and markets extraordinary is that valuations have ignored the negatives of the Trump administration’s measures, while touting the positive consequences of Trump’s executive decisions and signs of accelerated deregulation, privatization and liberalization. Also, as the Fed will continue to tighten, it will conflict with the administration’s infrastructure plan but also subdue growth prospects.
In the long term, markets penalize investors for such discrepancies. After all, the leading movers of those markets feature America’s largest companies from financials (American Express, Goldman Sachs, Visa) to industry giants (Caterpillar, Disney, McDonald’s) and tech leaders (Apple, Cisco, Microsoft).
Indeed, these are corporate titans, which earn an increasing share of their revenues in foreign markets – especially in those country markets that the White House is about to challenge.
Dr Steinbock is the founder of Difference Group and has served as research director at the India, China and America Institute (USA) and visiting fellow at the Shanghai Institutes for International Studies (China) and the EU Center (Singapore). For more, see http://www.differencegroup.net/
The original commentary was published by Shanghai Daily on March 22, 2017