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Hello and welcome to our latest video #MacroMemo. There's plenty to share with you this go round on the economic front.

We'll start actually by acknowledging that some of the headwinds we've been talking about for the economy have recently faded. Certainly not all. We still think a recession is more likely than not. So I don't want to shock you into thinking our view is changed radically, but actually some of the some of the drags that we've talked about for a few months have faded. So we'll talk about that.

Economic data, it’s still pretty poor. We're still seeing evidence of a deceleration. That's really the counterpoint to some of the headwinds going away. The developed world has been maybe weaker than people think (ex-U.S.). So we'll look at that, just get a sense for that as well.

We're also going to spend a moment on something that might seem obvious to you: I'm going to say China is not Japan. And so clearly we all know that. But there are some efforts right now to say that the Chinese economic experience and the housing bust and so on looks like Japan of the early nineties, which would be an ominous thing to the extent that Japan then just didn't really grow for several decades.

We don't think China is quite the carbon copy of Japan, so we don't think we need to worry too, too much about that.

We'll talk about inflation falling. We'll talk about the heavy fiscal burden that a number of countries carry. And we'll also talk about who drives global growth in terms of what countries are going to be responsible for the bulk of economic growth over the next five years.

So I think some interesting things. Let's jump right in.

Short-term headwinds fade: As I said off the top, we've been talking for several months about a number of admittedly fairly small, but nevertheless, headwinds that have presented themselves. And I should report that some of those headwinds have faded.

• We had seen bond yields rising a lot. Bond yields have partially retreated. More on that in a moment.
• We had warned there could be a government shutdown in the U.S. There still could be, but there hasn't been yet, and the risk is diminished to some extent.
• We talked about the auto strike in North America and the damage that could do, and it has done some damage, but it's ultimately over. So we've moved past that as well.

So there are little bits of good news. Circling back around and starting with that higher yield story, bond yields rose enormously, of course, over several years, but also quite palpably over the last several months. Just in the last few weeks, we've seen a material reversal since late October, really right through to late-ish November.

As I record these words, we've seen a 58 basis point drop in the U.S. 10-year yield from 5% down to the realm of 4.4%. And so that's a big drop.

Some of that is because inflation came in better than expected, which I'll get to later. Some is because the Fed has been a bit less hawkish. Some is on soft landing expectations, the thinking that maybe the economy can settle at a reasonable point and doesn't need to be killed by higher interest rates.

But the bottom line is yields have come down. And just as we noted in recent weeks and months, that higher yields hurt growth, it would be quite inconsistent and unfair not to observe that as yields have partially retreated – again, we are talking partially here, yields are still very high in an absolute sense –but as those yields have come down, that helps or hurts growth a little bit less. So we can celebrate that.

On the government shutdown side, we just haven't had one in the U.S. There was a very high risk on October 1st, but the government managed to pass a continuing resolution and keep the government funded through to late November.

In late November, we saw another continuing resolution pass and so that now funds things for some items through to January 19th, for some to February 2nd. But it kicks that can down the road several more months.

Again, the fact that we've managed to avoid two shutdowns argues that the risk of a shutdown actually happening later has probably gone down.

More generally, and related to that, I think some credit actually needs to be given to American politicians, who don't get a lot of credit. They did strike a bipartisan deal back in late May to avert a debt ceiling disaster. They passed that continuing resolution on October 1st. They did it again on November 17th. And so we are getting a bit of bipartisan support when it's needed.

The latest vote, by the way, had bipartisan support, not universal, but bipartisan support both in the House of Representatives and in the Senate. And so we'll take that. There is going to be plenty of time for doom and gloom predictions over the next year in the lead-up to the American presidential election. That's less than a year away.

So let's flag that constructive behavior when it happens, and it has happened. We would say the risk of a shutdown next year has diminished.

The auto strike was also resolved, but we won’t go into great detail there. It's been well covered. It happened, in fact, a few weeks ago, though since we last did one of these videos. There is a large wage increase, rather, coming with it and some other concessions to workers.

But again, the point is that the key headwind flagged a few months ago has been worked through and we've now moved beyond it, and we are going to see some rebound in the auto sector. And so it's nice that those headwinds have weakened.

I would stop short of upgrading the forecast materially for the next reason.

Economic data worsens: So the next reason is really just that as much as a few headwinds have faded, we still have higher interest rates, which have increased quite a lot over the last few years.

That is still more than enough to induce a period of significant economic weakness. And when we look at the actual economic data, we do see signs of softness. And so we've been watching purchasing manager indices decelerating and giving very weak readings for a while. Global trade is now in serious freefall. And so not just nominal, but inflation-adjusted trade is also falling.

So it's not just a commodity price trick. This is the number of things people are buying and trading going down. We haven't seen periods of decline like this outside of a recession over the last 30 years. And, you know, it's tempting to excuse this and say, well, maybe people are shifting back from buying goods to services. And so trade in goods just looks bad as a result of that.

But no, actually, people aren't shifting all that much from goods to services right now. This seems to be genuine weakness. Again, historically, you've gotten a recession, every time we've seen this extent of decline in global trade.

One other thing on the labor market side, with a U.S. emphasis: we've been watching very carefully, we've said for a while we see bits and pieces of evidence of softness. Job openings declining in general and the rate of hiring positive but slowing, and unemployment's low but starting to edge higher, and those sorts of things.

One thing that contradicted that, that refused to cooperate with the weakening narrative until now was initial jobless claims, which you get every week, so it's a very fresh and important indicator. We are now maybe starting to get that. We've seen four straight weeks in which initial jobless claims are rising. They are materially higher than they were four weeks before.

We had a few false readings from this in the past. It was rising a year ago and then it was falling for a while. But let's watch that very closely. This could be telling us something and it could be signaling that genuine labor market weakness is beginning.

Okay on from there.

Developed world growth weakens (ex U.S.): A lot of our focus is on the U.S. It makes sense. It's a big market, it's a big economy, it's the bellwether economy. But it's worth acknowledging the U.S. economy has very significantly outperformed the rest of the developed world. And so as we debate recession, no recession and these sorts of things, I think it's worth highlighting that the developed world ex-U.S. is already quite weak and has already been quite weak for a while. These economies have been stumbling for the better part of a year.

Just to give you a very light sense of this, the Canadian GDP (gross domestic product) has fallen in two of the last three quarters. It's tracking a slight negative for the next quarter. UK GDP was negative in the latest quarter. It's barely grown over the last year, 2.6% growth year over year, which is which is almost nothing. The eurozone economy has stagnated or shrunk in three of the last four quarters.

I'm not claiming this is a recession. Recessions usually have a sharp decline and a sharp rise in unemployment and things like that, that we haven't seen. So I'm not claiming that a recession snuck along that we just never noticed. But this has been a period of materially underwhelming economic growth and economies are therefore already well behind a normal growth trajectory.

There is some pain and suffering already being felt ex-U.S. from higher rates. In terms of why the U.S. has held together better, well, some is lower rate sensitivity which isn't changing. Some was there was a lot of fiscal stimulus that stuck its way out in 2023, which is becoming less generous going forward. Some was households enthusiastically spending a lot of their accumulated savings, which we're now seeing them run out of, and so tailwind may start to fade.

The U.S. could start to look more like these other countries as well.

China’s tepid recovery continues: As I mentioned at the top, China's not Japan. I'll start by just saying the Chinese economy right now, we think it's rebounding a little bit. They've announced some more fiscal stimulus for the next two years. So we actually feel cautiously optimistic on China in the short run.

Really, the focus here isn't that there are some parallels to Japan circa 1990 – just before Japan or as Japan was starting to blow up.

• There’s an asset bubble in both places, mostly in the housing market.
• A housing bust in both countries at the appropriate time.
• Both countries had accumulated debt.
• Both countries had/have bad demographics.
• Both countries, you know, Japan encountered deflation. China is struggling with low inflation right now.
• Japan had frictions with the U.S. in the early nineties. China has similar frictions today.

So there are some similarities. And so I guess I would make this comment: we think in a narrow sense there are clearly some similarities. We are forecasting slower growth going forward for China. But it's not a perfect parallel.

We don't think China will suffer anything like what Japan suffered over the last few decades. A number of reasons why, just to highlight maybe three of the bigger ones:

1. One is China does not have as large an asset bubble as Japan did. So at its worst, Japan's property market was worth 560% of GDP in Japan. In China, that's 260% right now. So it's less than half as big a housing market in terms of size.
2. China still has access to fairly easy growth ahead of it. Japan almost caught up to the U.S. in terms of prosperity in the early nineties. It would have made it harder for them to grow fast going forward regardless of housing bubbles. China is still just 28% of U.S. GDP per capita. There's more room for easy growth going forward.
3. China also has a fair bit of room for urbanization as a as a tailwind. It's just a less urban country. We expect them to loosen the spigots, I suppose, and allow more urbanization. That should boost productivity, keep the economy growing.

So China's slowing, we absolutely think. But the parallels are not quite to the point of predicting a multi-decade malaise as experienced by Japan.

Okay. A couple other quick ones from me.

Inflation cooperates: So just briefly, inflation numbers really are cooperating nicely. In October, you recall August, September didn't look very good. Oil was rising. Some things weren't going right. We've been saying for a while we thought October would get back on track. It looks like it has.

• U.S. inflation, as an example, back to 3.2% year over year. That's a big drop from the prior month.
• Oil prices have reversed. Nowcasts are showing further improvement ahead.
• Money supply is shrinking.
• Housing inflation should turn lower with a lag. And that's been one of the most stubborn components.
• The breadth of inflation has narrowed a lot.

To be sure, there's more work needed. We're not at normal rates yet. We're in the 3 to 4% range. Two percent would be nice. We remain slight optimists on inflation. We think there's going to be further progress coming down the pipe if we get a recession. Of course, that actually helps the process of getting to normal inflation.

U.S. fiscal burden may create drag: And so just a flag here. I mean the U.S. is running a big deficit. Moody's just downgraded the U.S. outlook from stable to negative. That could presage a drop from a triple AA to A+ rating, which the other two rating agencies have already effectively delivered in recent years.

The U.S. deficit is still quite big. It's now shrinking. We are forecasting a fiscal drag next year and so that does present a headwind to the U.S. economy.

But I guess the broader story is one in which the U.S. and a number of other countries are running very large deficits right now. They are going to need some fiscal austerity at some point. It's not clear that the focus is on that right now as people debate recession or not. But looking beyond that, I think over the next five years or so, we're going to see a lot of focus on fiscal excesses and we're going to see some countries have to engage in some fiscal austerity to get there.

To give you a sense of how costly it's becoming to service government debt as rates rise, the cost of servicing that debt was just 1.2% of GDP in the U.S. a number of years ago. It's 2.5% today, so it's doubled. But that's still very normal looking. It's forecast by the Congressional Budget Office to go from 2.5% of GDP to nearly 7% by 2050.

So that's going to be eating a lot of the economy and the government's budget in a fairly non-productive way. And so, again, the incentives are there to deal with this and it's going to become just very slowly a bigger burden.

Okay. I'm going to finish with one last thing:

Who drives global growth? This is based on forecasts from the IMF (International Monetary Fund). Really, the question is which countries are going to be responsible for the biggest share of the global economy’s growth over the next five years? So not who is the biggest economy, but who's contributing the most to growth?

Functionally, you've got to be a pretty big economy that's growing fairly fast, if that makes sense. And to be clear, if you're a big economy not growing at all, you're not contributing at all to global growth, just to set the parameters.

The U.S. is still the largest economy in the world but set to be the third largest driver of growth over the next five years, generating about 10% of the total.

China is set to remain the number one driver of growth. So its economy is no bigger than the U.S., but it's just growing faster, if that makes sense. It may generate about a quarter of global growth, which is huge.

I would note though that China has been generating over the last decade or so about a third of global growth. So this is China contributing less, but still actually the dominant player in terms of economic growth.

Fascinatingly in second place is set to be India. So India has long been an investment darling, and it now has the biggest population. It's been growing fast for a while, but its economy was too small to move the needle. It's gotten big enough now that it's moving the needle. It may generate about 16% of global growth over the next five years, more than the U.S. So it matters quite a bit.

The remaining countries are less important, but those big three are a lot bigger than the rest. But there's a few other things that you can say that are sort of interesting.

• One would be in fourth place is Indonesia. And so Indonesia, a big population, fairly fast growth, that does the trick I suppose. Indonesia's way back from the big three. Indonesia is way ahead though of number five through 195 or so. So Indonesia is differentiating itself as well.

You've got all sorts of countries that you'd expect to be in the top 20, like Vietnam and Bangladesh and Brazil and Mexico, countries like that. Some surprises, though, too:

• Turkey is set to be the fifth biggest driver of global growth.
• Egypt is set to be the ninth biggest driver. I wouldn't have guessed that if I hadn't seen the numbers.

Finally, just recognizing that the growth is very emerging market heavy. And so more than 80% of global growth over the next five years is expected to come from emerging market countries, less than 20% from developed countries.

It certainly argues for having some exposure to emerging markets in investment portfolios – if you want any kind of exposure to where 4/5 of the global economy’s growth will come from.

Okay, I'll stop there. Thanks so much for your time. I hope you found this interesting and I wish you very well with your investing.