Ikea open for the growing middle-class in India

Ikea open for the growing middle-class in India

We can now add Ikea to the throes of companies that are targeting the growing middle-class in India. We’ve acknowledged for some time that market in India is one of the drivers behind our Rise of the New Middle Class investing theme, and the latest data from the International Monetary Fund finds India to be the world’s fastest-growing major economy in 2018. With a household furniture market that is expected to be worth $2.7 billion by 2022, odds are other companies like Walmart and Amazon will be attacking this market as they look to expand their presence in India.

Ikea has finally opened its first store in India on Thursday, targeting the country’s growing middle-class in an environment that Chief Executive Jesper Brodin has described as “more committed to progress.”

India presents businesses with one of the world’s largest consumer markets. Its 1.3 billion citizens means that it is the world’s second most populous country after China. But, gross domestic product (GDP) per capita remains less than a quarter that of its fellow Asian giant.

Nonetheless, India is expected by the International Monetary Fund (IMF) to be the world’s fastest-growing major economy in 2018. The country’s household furniture market is expected to be worth $2.7 billion by 2022, according to The Economist Intelligence Unit.

Indian consumers are unused to traveling to stores to buy self-assemble furniture, Reuters reported. Instead, furniture is usually delivered to customers fully built. To solve this problem, Ikea has set up a 150-strong in-house team to help customers put products together.

According to one analyst, Ikea’s latest venture into India is likely to be a success — and this is not just down to the country’s economic fundamentals. “With high real estate prices forcing more and more Indians to live in small apartments, Ikea’s minimalist and multi-purpose furniture will be expected to register strong demand,” Barsali Bhattacharyya, deputy lead companies analyst at The Economist Intelligence Unit, told CNBC via email Thursday.

Chicken and vegetarian variations of Ikea’s famous meatballs are sold in the Hyderabad store to account for India’s prevailing religious beliefs.

Source: Ikea opens first India store in Hyderabad

China isn't the only country slowing

China isn't the only country slowing

Slow-TurtleChina isn’t the only country slowing, as we are sure you’ve all been hearing, the global economy is slowing to a level that ought to make everyone pay attention. Earlier this month the International Monetary Fund (IMF) cut forecasts for 2015 yet again, projecting 3.1% versus its prediction in July for 3.3% and its April prediction for 3.5%.  This means that this year, despite the unprecedented level of monetary stimulus injected all over the world by government desperate to get things moving… the world economy will grow at its slowest pace since the global financial crisis.

Last week, Citibank cut its global growth forecast for 2016 for the fifth consecutive month, predicting 2.8% versus the previous forecast of 2.9%. Keep in mind that Citibank’s chief economist William Buiter has stated previously that global growth below 3% coupled with a significant output gap effectively represents a global recession. Now that’s just one person’s opinion, but it conveys the importance of these numbers.

If we take a brief tour around the globe, we’ll see that the Eurozone in 2014 finally posted positive growth of 0.9%, after having contracted in 2012 and 2013. The first quarter’s growth rate came in at 0.5% with the second quarter slowing slightly to 0.4%, giving the economy about 1.2% growth year-over-year.

In mid-November, we’ll get the first estimate for the third quarter, which so far is likely to be at around the same pace as the second. On Friday, we got some good news when the Eurozone Markit Composite PMI (Purchasing Manager’s Index) came in at 54 (above 50 is expansionary). The data for services came in nicely at 54.2 with manufacturing unchanged from the prior month at 52. So there is some growth in the region, though from a historical perspective it is still relatively weak. So let’s dig into the details.

If we dig a bit deeper, we see that the Eurozone’s largest economy, Germany, is suffering from the slowing in China and Russia, two major export partners with its 2nd quarter GDP coming in at 0.4%. Consumer confidence has been falling since the first quarter, but it still maintains an enviable unemployment rate of less than 5%, with a youth unemployment rate of 7%, which bodes well for the nation’s productivity in the future.

France, the Eurozone’s second largest economy, on the other hand experienced no growth in the second quarter, versus expectations for a 0.2% increase with an unemployment rate of just under 11% and a youth unemployment rate of nearly 25%.

Italy, the Eurozone’s third biggest economy experienced just 0.2% growth versus 0.3% expected. Unemployment has remained stubbornly high at nearly 12% with youth unemployment over 40%, which is a devastating number for the future of the country.  However, Prime Minister Matteo Renzi has made a lot of progress in reforming the government, so despite those rather dour numbers, consumer confidence is higher today than it has been over the past 12 years! Directions are important – we can’t just look at the numbers in isolation.

So things aren’t great in Europe, but they aren’t horrible either… however, significant growth seems perpetually illusive with rising concerns that the slowing in China and the emerging markets could be a tipping point for the area, which is likely why the head of the European Central Bank, Mario Draghi, hinted last Thursday that the ECB (Europe’s version of the Fed) is willing and ready to inject more quantitative easing into Europe’s economy. More QE, the now omnipresent heroin of the stock market was promised and equity indices all over soared!

So what about China? How bad it is there? Truth is, no one really knows. The country is based on an ideology that requires opacity at all levels of government, so accurate data or even an honest attempt at accurate data is something we are unlikely to ever get from official sources.

Those sources recently reported that China’s growth in Q2 was 6.9%, close enough to the official target of 7.0%, but being below, it provides a wee bit of cover for some stimulus. And wouldn’t you just know it! The People’s Bank of China, essentially their Fed, just lowered lending rates…a coincidence we’re sure!

Taking a step back, China has cut their 1-year interest rate 6 times since November of 2014, lowering the rate from 5.6% to 4.35%… but we’re sure everyone there is quite calm! The Required Deposit Reserve Ratio for Major Banks has been lowered 4 times since February, from 19.50% to 17.50%. This ratio determines how much leverage banks can have, which translates into loans. The lower the ratio, the greater the leverage which means more loans… more of nothing to see here folks? We don’t think so.

Here are a few more interesting data points:

  • China’s export trade has fallen -8.8% year to date.
  • China import trade is down 17.6% year to date.
  • Railway freight volume is down 17.34% year over year.
  • China hot rolled steel price index is down 35.5% year to date
  • Fixed asset investment is up 10.3% sounds great? (averaged +23% 2009-2014)
  • Retail sales are up 10.9%, the slowest growth in 11 years
  • China Containerized Freight Index, which reflects the contractual and spot market rates to ship containers from China to 14 destinations around the world, has just hit its lowest level in history, now 30% below where it was in February and 25% below where it was at its inception 17 years ago.

You get the point. It is slowing and we suspect it is slowing a lot more than the official GDP numbers would indicate.

Why should those of us outside China care? Because China has been a major supporter of global growth since the financial crisis. When all hell broke loose in 2007 & 2008, China put its infrastructure spending into high gear. That meant that those economies that supply commodities had a backup buyer for their exports when everyone else was crashing, which put a vital floor under the global economy.

But China couldn’t keep it up indefinitely, and we are seeing the consequences of that nation’s shift from a primarily export driven, massive infrastructure-building economy to a more domestic demand-driven economy with a lot less infrastructure spending.

China has been Germany’s fourth-largest export partner, with Russia not that far behind. Falling oil prices and sanctions have crippled Russia’s economy, so it also isn’t buying much from Germany. If Germany sells less, it’ll buy less from other nations… and keep in mind that all those Eurozone countries are just barely eking out positive growth, so small changes will have an impact.

Onto those emerging economies, many of which were benefiting from China’s infrastructure spend as they are primarily commodity exporters. If we look at what has happened to commodity prices over the past twelve months, you can get an appreciation for just how painful this has been for many of these countries. Keep in mind that 45% of global GDP comes from commodity export nations – commodity prices crater and these nations can buy less stuff from other nations – more headwinds to growth.

In fact, 2015 will be the fifth consecutive year that average growth in emerging economies has declined. This is a serious drag on the advanced economies, which on the other end of the spectrum, will likely post their best growth since 2010 – albeit growth that isn’t all that spectacular.

Japan… well it’s still stuck between barely growing and contracting, regardless of how much the Bank of Japan tries to kick start the economy. Japan’s industrial output unexpectedly fell in September, raising concerns that the nation may be slipping back into another recession. Production declined 0.5% in August following a 0.8% decline in July versus economists’ expectations for a 1% gain. Inventories rose 0.4% in August over July, and expanded in five of eight months this year, which is a hindrance to future growth as with rising stockpiles of unsold goods, companies are less likely to expand output in the future.

As for Latin America, Argentina is still a mess and Brazil is in a recession, with many of the other countries doing alright. Chile is expected to be around 2.5% for 2015. Colombia 2.8%… like we said, ok, not great.

In the US, things aren’t awful, but not exactly robust, which is why I had been predicting for months that the Fed would not hike rates in September.

  • For example, the Industrial production index came in with another decline of -0.4% in September versus expectations of -0.2%, which makes it the 5th decline out of 8 reported figures in 2015.
  • Capacity utilization, which measures to what degree the economy is taking advantage of its ability to make stuff, was expected to drop from 78% to 77.8%. Instead, it fell further to 77.6%, for the 7th decline out of 8 readings in 2015. This means the U.S. continues to use less and less of its capacity to make stuff – hardly shocking given the wide misses in manufacturing data reported by regional Federal Reserve banks for August.
  • September retail sales came in below expectations, rising a seasonally adjusted 0.1% from August versus expectations for 0.2%. The good news is the increase came from a 1.8% month-over-month increase in auto sales. Overall retail sales, when we exclude autos and gasoline, have not grown since January.
  • U.S. producer prices in September posted their biggest decline in eight months, at a drop of -0.5%, as energy costs fell for the third month in a row. This means that the Producer Price Index is now down 1.1% year-over-year as of the end of September.
  • U.S. total business sales also declined in September, down -0.58% month-over-month and down -3.09% year-over-year as of August.

Going forward, I still remain very skeptical that the Fed will raise rates. The fact that China is continuing to loosen its monetary policy and comments out of the ECB concerning it likely embarking on further easing only add to our skepticism as the moves by China and the ECB will already put upward pressure on the dollar, harming U.S. exports. A rate hike would only exacerbate the dollar strengthening against other currencies.

Fed tightening has been a trigger in nine of the last eleven recessions, so you can see yet another reason for the Fed to be cautious.

The tough thing now is that with a Fed that can’t seem to make up its mind, investors are left wondering what to do, so they end up selling the good and the bad when they get nervous. This will make for increased volatility, but that also means more opportunities for those that keep focused on the goal and don’t get distracted by shorter-term market dramatics.

Shove It! A Greek Tragedy?

Shove It! A Greek Tragedy?

The headlines are once again dominated by the living Greek economic tragedy, vacillating between dire predictions of a Greek collapse and ensuing global financial calamity to ebullient, (and frankly rather ludicrous) stock market jumps of joy on hopes of a pseudo happily-ever-after. Conventional wisdom has been to lambast the Greeks with the usual damning triumvirate of a nation whose citizens are either lazy, stupid or evil… or all three. The nation is currently in a technical default, having failed to make payments already due on loans to the International Monetary Fund (IMF), but has claimed that it will make a single lump sum payment later in the month for all monies due in June. The size of the Greek debt relative to GDP is second only to Japan, which given its ability to control its own currency is a very different animal.

Debt2GDP

 

To put the level of Greek debt in context, at a total of $352.7 billion, it is about half of the $700 billion that was approved by Congress for the Troubled Asset Relief Program in 2008.   So in the context of global debt, it isn’t that big of a deal, what is a big deal however is the precedent the situation will set for the Eurozone, the second largest economy in the world. I can’t imagine just how much coffee and antacids have been consumed this week in Luxembourg, as all sides find themselves stuck between a rock and a hard place, with no clear common ground.

As for that excruciating austerity we keep hearing about, meaning the cuts governments were wailing about having been forced to endure. Errrr, hmmmmm, not so sure where that is coming from when we look at data from the IMF on the next chart….

EuroDebtByYear

Spending cuts? Where? All three countries have increased their debt to GDP ratios since the crisis began. So here’s the real scoop.

 

Greece has a massive government full of rules and regulations on darn near everything that makes it very difficult to start or run a business and a tax code that makes War and Peace look like a summer beach read. Now all these rules, regulations and taxes were put in place for ostensibly good reasons, like most bureaucratic shenanigans, “We need to protect hotel employees, cab drivers, restaurants, nurses, fishing boats, gardeners etc. etc. etc.” The problem is that when you add up all this “protection” for existing businesses, employees, consumers, tradespeople… it becomes increasingly tough to run a business.

 

To make up for just how tough it is, the government has made it a practice to promise people lots of safety in the form of pension systems, welfare aid, etc. The math here isn’t too tough to figure out. If on the one hand you make it really hard on people to get things done and on the other hand you provide ample support for a decent living for those who aren’t working for whatever reason, well you’ll have less people working their tails off, which means less money available to tax and spread around to those who aren’t working. But that’s ok, because hey, we are part of the Eurozone and can get debt cheap, so we’ll just borrow whatever we can’t get through taxation and spend that. No worries.

 

That worked for a while… until the market started looking at the math a bit more in depth and realized that Greece had reached the point where it really cannot sustain its debt any longer.

Greece is like the family with a single income earner holding down two jobs that pay slightly over minimum wage who needs to support a spouse, some kids, manage a $525,000 adjustable rate mortgage whose rate keeps rising, has two cars in the driveway in desperate need of rather costly repairs, a cousin who just moved in and has some serious health problems and found out today that the roof has a major leak. Now the bank keeps calling and telling you that you need to work harder and cut back on the spouse’s spending habit as your mortgage rate continues to rise and you are already late on a few months’ worth of payments and your credit cards are maxed out. Your boss is telling you that your skills are seriously lacking and your cousin says she can’t possibly live in that room you gave her unless she gets to redecorate it on your dime. At some point, you throw your hands up in the air and tell everyone to shove it!

 

Earlier this week, according to a report by the Financial Times, Greek prime minister Alexis Tsipras argued that,

 

“The pensions of the elderly are often the last refuge for entire families that have only one or no member working in a country with 25 per cent unemployment in the general population, and 50 per cent among young people.” That’s Greek for shove it.

 

How does a politician manage this type of pressure from back home? Ms. Merkel and Mario Draghi just aren’t that scary or persuasive!

 

So that’s where we are. The majority of Greeks have decided to go the “shove it” route and sent Yanis Varoufakis to deliver the message, in a rather debonair manner we might add, (that’s Yanis on the left in the picture below.) This has left Germany’s Angela Merkel, the European Central Bank’s Mario Draghi and France’s François Hollande in a tizzy as they try to figure out how to work with a Greek envoy that appears to be quite confident their game theory skills will eventually get them whatever they want. Italy’s Renzi, by the way, is mostly back home dealing with his nation’s struggling economy and the seemingly eternal roll of sitting between the U.S. and Russia – poor man has enough on his plate!

Greeks

 

So here we stand with Greece still wanting to be part of the Eurozone club, having never, even upon admission to the club, been able to satisfy the requirements for membership. To be fair, many nations who were let into the Eurozone club never have been able to meet them either.

 

Bottom Line: What does a Grexit mean for the rest of the world? First, it likely means a stronger dollar relative to the euro, at least in the near-term, as there will be a flurry of uncertainty given that (1) the Maastricht Treaty didn’t provide any way for a nation to exit the Eurozone and (2) there will be fears that other member nations may try to find wiggle room around their heavy sovereign debt loads, which will give some cause for concern about the future of the Eurozone. Eventually, all that flurry will likely pass as frankly a Eurozone without Greece is stronger than one with it. Holders of Greek debt will be hit hard, which means a lot of European banks, (primary holders of all that debt) are getting even more complicated. However, the Eurozone economy is still struggling, thus the ECB will continue on with its euro-style quantitative easing, which means that over the longer run, the U.S. dollar is likely to continue it bull run.

Inflation is a tricky game

Inflation is a tricky game

On February 19th, the Bureau of Labor Statistics (BLS) recently reported that inflation, as measured by CPI, remains low in the United States at a non-seasonally adjusted 12 month rate of 2.6%.  On February 12th, 2010 Olivier Blanchard, the IMF’s chief economist, called for central banks to raise their inflation targets, perhaps to 4% from the current standard around 2%.  I find it interesting that this recommendation comes as nations across the globe are facing the momentous challenge of controlling the potential time bomb of their “quantitative easing,” a polite term for printing money, while Germany and the EU debate how to bail out Greece.  Remember that debtors love inflation!

The most widely used measure of inflation in the United States is the Consumer Price Index (CPI), published by the BLS.  According to the BLS,

(1)     The index affects the income of almost 80 million people as a result of statutory action

  • 47.8 million Social Security beneficiaries
  • About 4.1 million military and Federal Civil Service retirees and survivors
  • About 22.4 million food stamp recipients.

(2)     Since 1985, the CPI has been used to adjust the Federal income tax structure to prevent inflation-induced increases in taxes.

The BLS calculates CPI using a weighted basket of goods and services, with occasional substitutions to account for changing preferences, using hedonic regression.  There is much debate over the accuracy of the CPI, but it is clear, given the stakeholders mentioned above that there is a potential conflict of interest for the federal government in reporting accurate data.

(1)     The higher the CPI, the more the federal government’s expenses increase, such as Social Security benefits.

(2)     By keeping CPI below the actual rate of inflation, federal tax receipts rise as tax payers are pushed into higher tax brackets through inflation induced wage increases rather than a true increase in purchasing power.  This is illustrated in the example below.

25%  Bracket Reported CPI Wages Actual Inflation
Year 1 30,000 3% 28,000 8%
Year 2 30,900 3% 30,240 8%
Year 3 31,827 3% 32,659 8%
Year 4 32,782 3% 35,272 8%
Year 5 33,765 3% 38,094 8%

Here we have an individual making $28,000 in Year 1.  His/her wage increases along with the true rate of inflation.  Tax brackets are adjusted according to CPI to prevent an individual or family from being taxed at a higher rate due to inflation rather than as increase real wage rates.  Here we can see that if CPI is reported to be 3%, the bottom of the 25% tax bracket increases by only 3% a year while wages increase at 8% a year.  By Year 3 the individual is squarely in the 25% tax bracket although real wage rates/purchasing power has not increased.  So now they are paying higher taxes, although inflation-adjusted income has remained flat.  This means the federal government can increase tax receipts by creating inflation above the reported CPI.  I’m not aware of any government in history that would be able to resist that temptation!

There’s both opportunity and motive for bias and manipulation.  Be skeptical.  The chart below shows the percentage change in CPI as reported by the BLS starting in 1959 vs. the seasonally adjusted M2 as reported by the Federal Reserve.  M2 is currency, traveler’s checks, demand deposits, and other check-able deposits, Money Market Mutual Funds, savings, and small time deposits.  M3 is considered the best estimate of the money supply and includes time deposits over $100,000, institutional money market funds, short-term repurchase and other larger liquid assets in addition to M2, however the Federal Reserve stopped reporting on M3 in March 2006, thus I have used M2 as an approximation.

CPI has not kept up with the increase in the money supply, thus I would argue that CPI has been understating inflation since around March of 1982.  You might recall that the 10 year Treasury Bond hit a high of 15.32% in September of 1981 under Volcker as he sought to combat a brutal inflationary environment with a sharp spike in interest rates.  At this time as well, unemployment had reached a 26 year high of over 10%.

The BLS states that, “As the most widely used measure of inflation, the CPI is an indicator of the effectiveness of government policy.”  Again, the government is incentivized to show lower CPI.  Be skeptical when there are conflicts of interest.