Saving liberal democracy from the extremes

Elites must recognise that mismanaged economies have helped to destabilise politics

Martin Wolf

Protesters in Warsaw in July, angry at what they see as an attack on the judiciary © AFP

Nothing to excess”. This motto, also known as “the golden mean”, was displayed in the ancient shrine of Delphi. Such restraint is particularly crucial for the preservation of liberal democracy, which is a fragile synthesis of personal freedom and civic action. Today, the balance between these two elements has to be regained.

Larry Diamond of Stanford University has argued that liberal democracy has four necessary and sufficient elements: free and fair elections; active participation of people, as citizens; protection of the civil and human rights of all citizens; and a rule of law that binds all citizens equally. The salient feature of the system is the restraints it imposes on the government and so on the majority: any victory is temporary.

It is easy to see why this system is so fragile. Today, that truth is, alas, not theoretical. In its 2018 report, Freedom House, a well-regarded federally funded, non-profit US organisation, stated that: “Democracy is in crisis. The values it embodies — particularly the right to choose leaders in free and fair elections, freedom of the press, and the rule of law — are under assault and in retreat globally.” This “democratic recession”, as Prof Diamond has called it, is not restricted to emerging or former communist countries, such as Hungary or Poland. The commitment to norms of liberal democracy, including the right to vote and equal rights for all citizens, is in retreat even in the established democracies, including the US. Why has this happened?

In a recent book, The People vs. Democracy, and an earlier article, Yascha Mounk of Harvard University argues that both “undemocratic liberalism” and “illiberal democracy” threaten liberal democracy. Under the former, democracy is too weak: social bonds and economic security are sacrificed on the altar of individual freedom. Under the latter, liberalism is too weak: power is captured by demagogues ruling in the name of an angry majority or at least a sizeable minority, who are told they are the “real people”. Undemocratic liberalism ends in elite rule. Illiberal democracy ends in autocratic rule.

Mr Mounk’s argument, moreover, is that undemocratic liberalism, notably economic liberalism, largely explains the rise of illiberal democracy: “vast swaths of policy have been cordoned off from democratic contestation”. He points to the role of independent central banks and to the way in which trade is governed by international agreements created by secretive negotiations carried out inside remote institutions. In the US, he also notes, unelected courts have decided many controversial social issues. In such areas as taxation, elected representatives retain formal autonomy. But the global mobility of capital restricts the freedom of politicians, reducing the effective differences between established parties of the centre-left and centre-right.

How far does such undemocratic liberalism explain illiberal democracy? The answer is: it does, up to a point.

It is surely true that the liberal economy has not delivered what was hoped, the financial crisis being a particularly severe shock. One aspect of such liberalism — migration — has, as the British writer David Goodhart argues in his book, The Road to Somewhere, persuaded many “people from somewhere” — those anchored to a place — that they are losing their countries to unwelcome outsiders. Moreover, institutions that represented the bulk of ordinary people — trade unions and left-of-centre parties — have ceased to exist or ceased to do their job. Finally, politics has been taken over by “people from anywhere” — the mobile and the highly educated.

Thomas Piketty suggests that a “Brahmin left” and a “merchant right” now dominate western politics. These groups may differ sharply from each other, but both are attached to liberalism — social, in the case of the Brahmins and economic, in the case of the merchants. The public has noticed.

A big point is that if undemocratic liberalism has gone too far for the comfort of a large portion of the voting public, that liberalism is not just economic: this is not just about neo-liberalism. Moreover, little of it has to do with overmighty international institutions, with the arguable exception of the EU. Indeed, the prosperity high-income countries desire is heavily bound up with international commerce. That, in turn, necessarily involves more than one jurisdiction. A future that does not include international co-operation on cross-border regulation or taxation will not work. This, too, has to be recognised.

A view that the economic dimension of undemocratic liberalism has driven the people towards illiberal democracy is exaggerated. What is true is that poorly managed economic liberalism helped destabilise politics. That helps explain the nationalist backlash in high-income countries.
Yet the kind of illiberal democracy we see in Hungary or Poland, which is rooted in their specific histories, is not an inevitable outcome in established democracies. It will be hard for Donald Trump to become a US version of Hungary’s Viktor Orban.

Yet we cannot just ignore the pressures. It is impossible for democracies to ignore widespread public anger and anxiety. Elites must promote a little less liberalism, show a little more respect for the ties binding citizens to one another and pay more tax. The alternative of letting a large part of the population feel disinherited is too dangerous. Is such a rebalancing conceivable?

That is the big question.

The S&P 500 Will Push The Federal Reserve Too Far

by: Eric Basmajian

- The S&P 500 continues to rise which has been overshadowing some slowing growth trends and aggressive monetary policy.

- Monetary policy is biting more than investors are giving credit.

- Further monetary policy tightening will exacerbate the slowing trends and put the economy in a vulnerable place come 2019.

- The S&P 500 is giving investors and the Federal Reserve a false sense of confidence.

The S&P 500 Will Push The Federal Reserve Too Far
With both criteria of the Federal Reserve's dual mandate sufficiently fulfilled and the S&P 500 continuing to rise, it is hard to argue against additional tightening measures from the Central Bank.
Using history as our guide, the Federal Reserve will forgo further tightening measures when market volatility rises despite having two check marks next to their dual mandate. Over the past ten years, inflation reached a high of 3.8% in 2011 and 2.14% in 2014 along with continual new lows in the unemployment rate, but this data never caused the Federal Reserve to tighten monetary policy. It is not speculation to claim the Federal Reserve is S&P 500 dependent (along with data dependent) as a handful of Federal Reserve board members, as well as Janet Yellen, former Federal Reserve Chairman, have made on the record comments regarding asset price levels.
The Federal Reserve is likely to continue to tighten monetary policy if asset prices remain elevated. A pause to monetary policy actions will come first from market volatility before a data-driven response because, as I will show below, monetary policy is far more aggressive than most realize.
I will make the case below that the Federal Reserve has already tightened monetary policy too far based on the economic data but the continued rise in the S&P 500 will push monetary policy past the point of no return. Monetary policy acts with a significant lag, up to one year after a tightening or easing action, so monetary moves today will be felt in the economy in the latter part of 2019.
Below we will look at the monetary and bank aggregates including the monetary base, M1 & M2, bank asset growth, bank credit growth, and a host of other data points to prove that monetary policy is already starting to bite.

Monetary policy has likely already gone too far. It will take up to one year from the last tightening act for the full effects to impact the banking system and the economy. By the time the S&P 500 responds, such aggressive policy will be hard to reverse when the economy needs it most.
Current Monetary Policy
Before outlining the various data points that demonstrate the degree of monetary tightening, a brief outline of the current policy is appropriate.
In addition to raising the Federal Funds rate, the Federal Reserve is also unwinding their balance sheet in a process commonly known as "Quantitative Tightening"(QT), the sister of Quantitative Easing (QE).
The Federal Reserve has raised the Federal Funds rate seven times, and the market is currently assessing a greater than 80% probability that two more 25 basis point interest rates hikes will occur by the end of 2018.
The Federal Reserve has also increased the pace of QT several times and will reach a peak rate of $50 billion per month in asset sales by Q4.
All Federal Reserve Banks: Total Assets:
Source: Federal Reserve, EPB Macro Research
The balance sheet of the Federal Reserve is down roughly $305 billion from the peak in January of 2015.
Both actions, interest rate increases, and QT are having very severe impacts to monetary and credit aggregates which will flow through to the economy, likely by the second half of 2019. As we move through the impacts in the monetary aggregates as well as the banking system, it is important to understand monetary policy is biting with just a $305 billion reduction in the Federal Reserve balance sheet. Let's take a look at the impact to the monetary aggregates.
Impact To The Monetary Aggregates
The process of monetary change starts with the Monetary Base or "high powered money." The monetary base has been in sharp contraction as the Federal Reserve tightens monetary policy. The monetary base is down roughly $500 billion from the peak at the end of 2014 and is contracting a current rate of 8.3% year over year.
Monetary Base In Millions (LEFT) | Monetary Base Year over Year Change (RIGHT):
Source: Federal Reserve, EPB Macro Research
The monetary base multiplied by the money multiplier or "little m" results in the broad money supply or "M2". The growth rate in M2 + the growth rate in the velocity of money equals nominal GDP growth, so the trending direction in the growth rate of the money supply provides critical information to the future direction of GDP growth.
In order to relate the changes in the money supply to real GDP growth, we must deflate the money supply by the Consumer Price Index to arrive at real M1 and real M2. M1 is a better leading indicator of economic activity than M2 and makes up a majority of M2, so a look at real M1 will be used for a proxy on the trending direction of the money supply. After deflating M1 by the Consumer Price Index, we can start to understand the severity of the contraction in monetary policy.
Real M1 Growth Year over Year (M1 Deflated By CPI):
Source: Federal Reserve, EPB Macro Research
The real rate of M1 growth has plunged in recent months (due to contractionary monetary policy) down to a rate of 1.2% year over year.
I do not want to cloudy the waters and make this into a recession forecast, but I would also be remiss not mention that the rate of real M1 growth turned negative in or preceding the past eight recessions.
With rates of money supply growth that are in freefall, the outlook for future growth is bleak. Monetary policy from the Federal Reserve is clearly biting. If monetary policy is the reason for the declines in the money supply, then further tightening actions will continue this trend and put M1 growth squarely in negative territory.
With money supply growth being half the equation of GDP growth, how can growth continue to be accelerating?
Growth has continued to rise in GDP terms due to a recent bump higher in the velocity of money. The velocity of money has been in a secular decline for structural reasons and will undoubtedly continue to remain low. One-off fiscal stimulus in conjunction with natural disaster spending from 2017 has caused a short-term bump in the velocity of money but without perpetual stimulus in larger magnitudes, the velocity of money will revert to trend, and the growth rate of the economy will then be in a decline that mirrors the collapse in the rate of real M1.
Velocity of Money:
Source: Federal Reserve, EPB Macro Research
It should be abundantly clear through the monetary aggregates that tightening actions from the Federal Reserve are biting in a fairly extreme fashion. These impacts are, for the time being, overshadowed by the transitory gains in the velocity of money from fiscal stimulus and natural disaster spending. If the Federal Reserve tightens policy further, which they are almost certain to do, this will put further pressure on the growth rate of the money supply just as the effects of tax cut stimulus are leaving the economy. After the reversion to trend in the velocity of money, GDP growth will decelerate rather sharply. This is likely to occur in 2019 unless the growth rate in the money supply rises or velocity continues to accelerate, both which are unlikely events.
With the impact to the monetary aggregates fully established, let's look at how these actions have impacted the banking sector.
Impacts To The Banking Sector
The impacts to the banking sector have been much more severe than most analysts give credit and part of that is due to the rise in the S&P 500. The banking sector of the equity market has, however, dramatically underperformed due to the trends below. A revisit to the performance of the equity markets will also follow.

Excess reserves of the banking sector have declined precipitously. This comes as no surprise as excess reserves and the process of debiting and crediting those reserves is the primary tool in which the Federal Reserve controls the monetary base. Many will argue that the nominal amount of excess reserves is still plentiful, which is truthful, but it is the rate of change that matters above the nominal level of reserves, and that can be proven in the growth of various credit aggregates.
Excess Reserves Of Depository Institutions:
Source: Federal Reserve, EPB Macro Research
A meaningful and rapid contraction in excess reserves has reduced the liquidity of the banking system and has caused a rapid decline in the rate of bank asset growth. Cumulative bank asset growth is at the lowest level of this economic cycle.
Cumulative Bank Asset Growth (Year over Year Change):
Source: Federal Reserve, EPB Macro Research
To put this decline in historical context, outside of the great recession, bank asset growth is near the lowest level since the 1970's which serves as evidence for the contractionary impact monetary policy is having on the banking system.
Cumulative Bank Asset Growth (Year over Year Change):
Source: Federal Reserve, EPB Macro Research
Furthermore, there has been a notable reduction in aggregate bank credit growth starting, unsurprisingly, at the time of aggressive monetary tightening from the Federal Reserve. Bank credit growth, that is total bank loans + total bank securities, has been cut in half from 2016 to today.
Bank Credit Growth (Loan + Securities):
Source: Federal Reserve, EPB Macro Research
The economy will not be able to sustain above trend growth rates with bank credit expansion at half the rate of previous years.
It is also worth noting that cumulative bank credit growth is also at a multi-decade low excluding the great recession.
Bank Credit Growth (Loan + Securities):
Source: Federal Reserve, EPB Macro Research
Of the various categories that comprise the $9 trillion bank lending industry including commercial and industrial loans, consumer loans and real estate loans, it is real estate loans that is the largest at $4.3 trillion. Real estate loan growth has fallen off dramatically as the Federal Reserve has contracted monetary policy further providing evidence for the effects of tightening rippling through the economy.
Real Estate Loan Growth:
Source: Federal Reserve, EPB Macro Research
Real estate loan growth has also been cut more than in half since the contractionary policy of the Federal Reserve began.
Higher short-term interest rates, reduced liquidity in the banking system via a reduction in reserves as well as a flattening yield curve have all pressured bank asset growth, bank credit growth and various sectors of bank loan growth.
The yield curve has flattened rather significantly in recent months. Many ignore this indicator unless an inversion occurs but, again, it is the rate of change that matters more than the nominal level of the curve. The yield curve also has not inverted before every recession, only those in the post-war period but the curve has had a significant flattening before every recession.
The marginal changes in the yield curve, steeper or flatter should be monitored for changes in lending conditions as well as the profitability of any institution that borrows short and lends long as the banking sector and shadow banking sector do.
The spread between the 30-year Treasury Yield and the 2-year Treasury yield is nearly at a cycle low of 40 basis points and very flat by any historical standard.
30-2 Spread:
Source: Bloomberg, EPB Macro Research
All of this information regarding the banking sector and the rate of change decline in growth is useful but many will simply point to the S&P 500 for evidence to the contrary.
When looking beneath the surface to pockets of the broad equity market, sectors have taken notice of these events and cyclical changes in the banking system.
Financial stocks and regional bank stocks have dramatically underperformed the broader market proving the validity of these measures on the health of the banking system. If these measures were irrelevant, financial stocks would be joining the broader market to new highs yet that is not the case.

The financial sector, represented by ETF (XLF) and the regional bank sector, represented by ETF (KRE) have been at the bottom of the list regarding equity sector performance, remaining 3%-4% below their January high while the S&P 500 continues to break récords.
XLF & KRE Still Below January 2018 High:
Source: Bloomberg, EPB Macro Research
The relative performance spread between XLF and the S&P 500 also confirms that the banking sector has started to radically underperform as monetary policy gets ever more constrictive and the yield curve gets increasingly flatter.
XLF/(SPY) Relative Performance Spread:
Source: Bloomberg, EPB Macro Research
The impact to monetary measures covered in section one as well as the contractionary impact on the growth rate of various bank and credit aggregates is relatively dramatic given how little tightening has been done from a historical context.
Further tightening from the Federal Reserve will exacerbate the trends described above including pushing the real money stock growth into negative territory, reducing bank asset growth below 1% on a year over year basis and flirting with an inverted yield curve.
If the Federal Reserve, investors and analysts alike continue to watch the S&P 500 for the tell-all sign of the economy without regard to the underlying trends that are developing due to overaggressive monetary policy, the Federal Reserves risks tightening the economy into a recession.

There are several effects that have caused the growth rate to move above trend in the short-term such as tax cuts, natural disaster spending, and the "pull-forward" effect from new tariff policy, which will be covered very briefly in the next section, that are clouding investor judgment regarding the true health of the economy and the impacts of monetary tightening.
At the risk of excessive length, it is worth one more section to take an under the hood look at the last quarterly report of Gross Domestic Product for confirmation of the trends in the pockets of the economy that are typically leading indicators.

Under The Hood Of GDP & Consumer Spending: More Than What Meets The Eye

When looking at more common economic indicators, there are pockets of the economy that lead or set the trend, areas that move in tandem with the trend and finally those sectors that lag the trend.
The sectors that often lead the trend are the big-ticket consumer items such as housing and durable goods consumer spending.
Housing and vehicle sales are the two largest items in the consumer spending basket and the first to take a downturn when the economy slows.
Before diving into those sectors from the GDP report, I want to touch on the 4% growth rate figure that excited many investors.
Exports, specifically soybeans, exploded in Q2 as consumers and businesses tried to lock in old prices before the new tariff policy set in.
The result of this was an over 9% surge in exports on a quarterly basis which accounted for a large portion of the above trend growth rate that we saw in Q2.
Exports Led Q2 GDP Growth:
4% GDP Growth 



Source: BEA, EPB Macro Research
With that out of the way, we can now look at the housing component of GDP growth, called "Fixed Residential Investment" and the subcomponent of consumer spending, "Durable goods."

Fixed residential investment is a volatile segment of GDP and often leads in terms of the rate of change in growth.
Residential fixed investment growth peaked in 2004 and 1998 in the past two economic cycles, far in advance of any declines in headline numbers.
Residential fixed investment grew at 1.2% year over year and -1.6% on a quarterly basis in Q2, quite a different story than the 4.1% growth report that came across the headlines.
Again, this data is not to serve as a call for a recession as that still may be years away but simply to outline that the economy is responding to Federal Reserve tightening and is contracting in the leading segments of the business cycle.
Residential Fixed Investment Year over Year Growth (%):
Source: BEA, EPB Macro Research
There is a plethora of high-frequency housing data such as building permits, housing starts, existing home sales and pending home sales that are in contractionary territory on a year over year basis and confirm this trend but that is for another research note.
Continuing the theme that the big-ticket items lead the economic cycle, we can break down the consumer spending basket into three parts as the Bureau of Economic Analysis does: Services, Non-durables, and Durables.
The only volatile component to these three buckets is the durables basket as this is comprised of autos, home appliances, and heavy duty items. Services and non-durables which are made up of medical equipment, food and clothing are significantly less volatile and are more non-discretionary ítems.
Before showing the chart on the durable goods component of spending, the entire trend of consumer spending, which accounts for 70% of GDP is very telling. While the economy has supposedly been experiencing a "boom", 70% of GDP growth has been flat since 2016.

Total consumer spending growth has not accelerated at all and has been nearly unchanged for the past three years at 2.8% year over year.
Real Personal Consumption Growth:
Source: BEA, EPB Macro Research
It is very clear that the above trend move in GDP growth has been from one-off or transitory factors as the bulk, or 70% of GDP growth, has been relatively unchanged since 2016, despite the rise in stock markets globally.
When we break down this 70% figure into the three baskets and look at durable goods spending, the most volatile and leading of the three segments, we can clearly see the consumer is slowing.
The durable goods basket of real personal consumption is growing at 4.8% year over year, down from 9.3% in November of 2017 and down from 11.7% in January of 2015. There is a very clear and defined trend of slowing in the durable goods basket of personal consumption which corroborates the leading housing data.
Real Personal Consumption Growth: Durable Goods Only:

Source: BEA, EPB Macro Research
When taking a look under the hood at some of the key data points that typically get reported, a stealth slowdown is underway.
Contracting monetary policy further will exacerbate these trends which should already be showing up as slower GDP figures if it were not for one-off events such as massive export growth to beat the tariffs.
The big-ticket items in the consumer basket are empirically slowing, and the trend for the economy is set as lower until evidence disputes this notion.

If the above data continues to move in the same direction as I expect, especially if the Federal Reserve proceeds with more tightening measures, the next place we will start to see the slowdown emerge is in the average workweek (average weekly hours), as well as various employment trends.
A very common sign of a late cycle slowdown is the mismatch between consumer spending and business inventory growth. When consumer spending slows as business inventory accelerates (as it is today) this sets up for sharp GDP declines in the quarters ahead due to the liquidation of that excess inventory.
Monetary policy has already started to bite and has caused key leading areas of the economy to begin to decelerate. Without further monetary action from the Federal Reserve, these trends are likely to continue as there is a lagged effect still to come from previous tightening actions.
If the Federal Reserve decides to get more aggressive with monetary tightening in an attempt to cool asset prices, there is a serious risk that they overtighten and the economy slows sharply in 2019.
Once the effect from tax cuts, natural disaster spending from the 2017 hurricanes and "pull-forward" growth from exports dissipates and the velocity of money returns to trend, the economy will have to face collapsing levels of money supply growth, nearly 1% in real terms.
It appears the Federal Reserve is going to tighten policy too far.
As of Q2 2018, the current year over year growth rate is 2.9%. Given the above trends, this rate will cool significantly as we move into 2019.
The S&P 500 will push the Federal Reserve too far. It likely has already happened.

Iran’s Enemies Strike Back

The government in Tehran made its move. Now, it’s being boxed in.

By George Friedman        

An interesting thing happened last week. A Russian reconnaissance plane was shot down by the Syrian army, so naturally Russia blamed Israel, claiming that Israel used the plane to shield its own fighter aircraft, en route to strike Iranian positions in Syria. Interesting though that charge may be, it’s far less fascinating than Moscow’s other quibble – that the Israelis had failed to give the Russians sufficient warning that they were entering Russia-controlled airspace in Syria. This runs counter to an arrangement whereby Israel, Russia and the U.S. pledged to inform each other about aircraft movement, so congested have the skies there become. In other words, the Russians didn’t object to the fact that Israel entered Syrian airspace – they objected to the fact they weren’t given much of a heads up.
The Russians knew what Israel was up to. The air campaign against Iran in Syria has been going on for some time. And since Iran tends to be unprepared for these attacks, it’s safe to assume the Russians aren’t tipping off the Iranians. The only conclusion that I can come to, being the simple-minded man I am, is that Russia doesn’t seem to mind it when Israel bombs Iran. In the ensuing dispute over who was responsible for shooting down the Russian aircraft, accusations abounded, but the fact that the Israelis bombed the Iranians never emerged as a significant issue.
The tectonic plates of the Middle East have been in motion recently, and this episode is part of that realignment. Russia made a deal with Turkey that seems to have taken a Russia-led assault on Idlib off the table, leaving Bashar Assad, who wanted to take Idlib to secure Syria’s northwestern frontier, out in the cold. Assad may not like it, but he isn’t upset enough to shoot down the plane of one of his biggest benefactors. Even so, Russia’s relations with Syria are a little shaky, as are its relations with Iran, the would-be target of Israeli attacks.
The realignment may not tell us much we didn’t already know in that regard, but it reveals a lot about how far Russia and Israel are willing to cooperate. But it also indicates that Russia very much wants to find some basis for a long-term relationship with Turkey, whose stewardship of the Bosporus is one of Russia’s oldest geopolitical imperatives. The Bosporus makes any Russian naval presence in the Mediterranean shaky. It can pose a challenge to Russia in the Caucasus, an important Russian buffer zone. And when Turkey is allied with the United States, as it more or less is now, Washington has the ability to project air power throughout the region, particularly in the Black Sea.
And so, for Russia, an alliance with Turkey would be a dream come true. Not so for Turkey, which is historically suspicious of Russia, having fought and conspired against it for years. The government in Ankara knows that an alliance with Russia, without a backup plan, would be unwise. We are far from an alliance, but with the Idlib agreement, at least we know outright conflict has been avoided.
Russia is thus cooperating with Israel and courting Turkey. It has proved what it wanted to prove in Syria, that it is still a global power, unafraid of the U.S. and the West. Assad survived. Russia can claim success. Iran was useful in this regard, but when Syria is secure, Iran’s value falls. The Turks have no love for the Iranians, whose expansion in the region was never a matter of great enthusiasm for Turkey or Russia. It was situational, and the situation is changing.
The catalyst for change was Iranian expansion. The government in Tehran took advantage of an opportunity created by the defeat of the Islamic State to assert itself in Iraq, a country that is essential to the security of Iran’s western border. It established a powerful presence in Lebanon long ago and is supporting rebels in Yemen. But it is spreading itself too thin. Iran can project enough power to be politically relevant in all these countries but not enough to hold its position against a determined foreign power.
Enter Saudi Arabia, the United Arab Emirates and Israel. The Saudis share with Israel a sense that Iran is their primary enemy. Neither Israel nor the Saudis want to see Iranian influence spread any further than it already has. It’s little wonder, then, that Saudi and Emirati media have reported that Israel sold Saudi Arabia its Iron Dome missile defense system. (The Saudis and Israelis tend to loathe each other publicly but cooperate with each other secretly.) If true, the sale means their relationship is now out in the open, creating an informal alliance from the Persian Gulf to the Mediterranean Sea. Add to this Egypt, with which Israel has engaged on security issues for some time, and that alliance stretches to the Red Sea.
It’s a peculiar bloc, constituted as it is by Sunni Arabs and Israelis, but already it is taking action. Israel is attacking Iran in Syria, and it is preparing for a fight with Hezbollah in Lebanon in the not-too-distant future. The Turks are in an uneasy alliance with the Sunnis, but they are allied nonetheless. The Russians are essentially giving the go-ahead to airstrikes. The Iranians are being boxed in.
Missing from this narrative, of course, is the United States. It has adopted a strategy I assumed it would, allowing the local balance of power to deal with matters, and being the last recourse, not the first. The U.S. has not abdicated responsibility entirely. It continues to wage economic war against Iran, and it maintains special operations forces in the region to train and support some of these newfound relationships.
The story of a downed Russian plane, then, is really a story about Iran. It made its move, and now its enemies are fighting back. The real battle, whether overt or covert, has not yet begun.

Making the Most of Emerging Economies

Bertrand Badré  

construction copper mine pipes

PARIS – Once again, the world’s emerging economies are facing a bout of uncertainty. Argentina, South Africa, and Turkey are among those generating the most concern, owing to a combination of questionable monetary policies and currency depreciation vis-à-vis the US dollar that threatens to undermine these countries’ ability to service their debts. But not all emerging economies are created equal.

To be sure, as in the past, there is a distinct risk of contagion. The emerging economies that are most vulnerable each must address its own challenges to avoid falling victim. And the approaches countries take to the challenges they face will have knock-on effects of their own.

Given this, investors may find it tempting to pursue a broad risk-off approach to the entire emerging world, especially in the context of rising global trade tensions. But it would be a mistake to ignore the very favorable conditions that exist in some emerging economies. For example, many have made significant progress in managing their debt levels, raising productivity, improving infrastructure, and implementing needed reforms.

All of this has contributed to strengthening these economies’ resilience to external shocks. Indeed, despite enduring uncertainties over the degree to which they have absorbed the lessons of the past, not to mention inconsistencies across countries, many emerging economies have developed much sounder fundamentals over an extended period.

The disparity between perceived and actual risk and the tendency to paint all emerging economies with the same brush is a longstanding problem. But investors should eschew a wholesale retreat from emerging economies in response to high-profile problems in a few. Instead, they should adopt a more nuanced approach, one focused on improving the risk-return profile by investing in selected regions and markets, while working with the right institutions.

In particular, now is not the time to ignore Latin America and the Caribbean, which have a wide range of investment needs – touched upon during the recent G20 meetings in Argentina – and also offer a broad range of growth opportunities. Countries in this region have pursued substantial reforms that have boosted economic growth and laid the foundations for strong financial returns in the longer term.

More broadly, stakeholders should strengthen their commitment to using the “billions to trillions” approach to resolving the world’s most vexing problems. That approach uses a combination of measures related to finance, skills, capacity, and risk allocation to leverage relatively scarce public-sector capital to mobilize more robust private-sector resources.

The multilateral development banks have a critical role to play here, and many have made great strides in responding to market needs. Moreover, the world has agreed, under the auspices of the United Nations, on complementary road maps for addressing global challenges: the Paris Climate Agreement and the Sustainable Development Goals. By establishing the right mechanisms to take advantage of related investment opportunities, we can use billions of public dollars to make trillions of dollars’ worth of progress.

Many of us in the investment community are working to boost the effectiveness of our work by ensuring that the right financial and risk-management instruments are in place to connect the public and private sectors. Already, mechanisms are in place to facilitate capital flows into emerging economies, particularly those in Latin America and the Caribbean, where opportunities for attractive risk-adjusted returns are now available.

In this context, even a very modest allocation by large institutional investors will have a major impact on the pursuit of sustainable outcomes, while also providing attractive, competitive financial returns. This dynamic – a fundamental component of the billions-to-trillions approach – can become embedded, creating the basis for a broader system in which there is no trade-off between making money and doing good.

The current turmoil in some emerging economies must not be allowed to derail past progress. On the contrary, it should spur stakeholders to redouble their collective efforts to establish a broadly beneficial system. This means, first and foremost, taking a nuanced approach to risk assessment that recognizes the attractive long-term growth opportunities that many emerging-market economies offer.

Bertrand Badré, a former managing director of the World Bank, is CEO and Founder of Blue like an Orange Sustainable Capital and Co-Chair of the World Economic Forum’s Global Future Council on International Governance, Public-Private Cooperation, and Sustainable Development. He is the author of Can Finance Save the World?

Are You An Investor Being Set Up For The Slaughter?

by: Avi Gilburt
- I have been very bullish on this market for many years, and am now looking to switch sides.

- Many former bears seem to be urging investors to "buy the dip," and this should be viewed as a strong warning.

- My long-term target is now 2100SPX, as I see the upside as being significantly more limited relative to the downside in the SPX.
For many years, I have been a staunch bull. In fact, many commenters and contributors on Seeking Alpha and MarketWatch were quite vocal as to how they thought I was crazy back in 2016 for expecting the market to go from 1800 to over 2600SPX, and potentially up through 3000. Needless to say, many of them remained bearish throughout that rally.
When many were extremely bearish in early 2016, I was pounding the table about a global melt up. When many were saying before the election that you should “sell everything if Trump gets elected,” we were again pounding the table for a rally over 2600SPX “no matter who gets elected.”
And now that I am taking off my bull suit, and have sent out my bear suit to be cleaned and pressed, these former bears are claiming that they have “learned their lesson” and are now strongly urging investors to buy the dip.
One of the noted indications that a major top is being struck is when formerly bearish analysts and market participants begin to suggest buying the dip. And as I noted earlier this week,
Amazingly, analysts that I have watched be consistently bearish for at least the last three years are now providing us with reasons as to why we should be buying this dip.
Many are pointing to how strong the economy seems, and are quite certain the market has much further to go on the upside because of how strong the economy is currently. Yet, they seem to be forgetting that the market leads the economy, and not the other way around.
Also earlier this week, I discussed a comment posted by a reader. As I said in that piece:

I think it presents the common bullish thinking today quite succinctly:
NFIB reports small business optimism shatters record set 35 years ago. S&P 500 companies are reporting record profit margins and the highest earnings growth in 7 years. The US economy shows no sign of recession and forecast is for continued growth. Forecasting a continued bull market is very reasonable assumption.
Now, juxtapose that with the following quote: markets never collapse when things look bad. In fact, quite the contrary is true. Before contractions begin, macroeconomic flows always look fine. That is why the vast majority of economists always proclaim the economy to be in excellent health just before it swoons. Despite these failures, indeed despite repeating almost precisely those failures, economists have continued to pore over the same macroeconomic fundamentals for clues to the future. If the conventional macroeconomic approach is useless even in retrospect, if it cannot explain or understand an outcome when we know what it is, has it a prayer of doing so when the goal is assessing the future?
This quote was taken from a paper written by Professor Hernan Cortes Douglas, former Luksic Scholar at Harvard University, former Deputy Research Administrator at the World Bank, and former Senior Economist at the IMF. The paper discusses those engaged in “fundamental” analysis for predictive purposes at market turns.
For years, we have had a minimum target of 3011SPX, with an ideal target of 3225SPX. Yet, after we struck the 2940SPX region, I warned that a breakdown below 2880SPX from that point would likely limit the upside we could see in the market. And, that breakdown below 2880SPX certainly opened a trapdoor last week.
However, there is a much larger trapdoor awaiting us at lower levels that will likely not be triggered until 2019. That does not mean the market is a safe place to put your money before 2019. Rather, the breakdown below 2880SPX should make you recognize that, for the first time in several years, the market is finally setting up to strike a major top.
After the rally we experienced Tuesday, the market has retained some potential to still attain that 3011SPX target. But, based upon the structure of the market at this time, I have to be honest in telling you that I do not view trying to play the market for such “potential” as a wise decision when it comes to a risk/reward assessment. While the next two weeks will likely tell us if we can still grind up to the 3011 region as we look towards the end of 2018, it will likely be a volatile type of rally, even if we are able to get to that target region.
Rather than taking needless risk in the overall index, if any investors are looking to play the long side of the market into the end of the year, I would strongly urge you to pick specific stocks that have much better setups to take us higher into the end of the year, rather than playing the index to the long side.
Most specifically, Garrett Patten, one of our lead analysts in our Stockwaves service at, just posted analysis this evening for approximately 50 stocks that seem best positioned to rally higher into the end of the year. I view that as a much safer and higher-probability manner in which you can attempt to play the market on the long side into the end of the year.
But, as far as the SPX is concerned, I am now expecting the SPX to drop down towards the 2600SPX region. Again, I think it is going to take us another week or two to know if the market may still try to stretch to that 3011SPX region before we drop down to the 2600SPX region. And, I do not think it worth the risk to attempt to trade aggressively for that potential in the index. Rather, I would suggest you play individual stocks for any further upside potential in the market into year-end.
But my warning to investors is that once you see us drop down to the 2600SPX region, you will likely have only have one more opportunity (on a rally back to the 2800-2880SPX region) to reduce your long positions before the major trapdoor opens and takes us down to the 2100SPX region in the latter part of 2019.
So, while I do not think that a drop to the 2100SPX region is imminent, I want to at least begin to alert you as to what you should be looking for - so you can know when that trapdoor is setting up to give us that 30% market correction we expect for 2019.