Electricity bills eat a large part of the economic cake

Stock markets have started the week in the red. The Chinese have had enough of COVID lockdowns and the country is buzzing, though now it seems they are loosening COVID restrictions.

In this post, let’s talk briefly about Black Friday sales and the economic news from the Eurozone. The trumpets of doomsday are sounding on social media, but it’s not really reflected in the sheet music of the economy. The main topic of this post is the recent OECD Economic Review, which contained some interesting observations on the cost of the energy crisis to the economy.

Black Friday

Black Friday, the shopping bacchanal that has unfortunately spread to the Nordics as well, offered an interesting window into the development of consumerism in the United States. So far, the consumer has held their own, with consumption accounting for about 2/3 of the US economy. The American consumer is the ultimate source of demand in the global economy, and I’m not even exaggerating much. According to Adobe and other analysts, Black Friday sales would grow by just over 2% year-on-year, while last year Black Friday sales grew by over 8% and in 2020 by over 30%. Given the high rate of inflation, it’s to be expected that sales volumes fell this year.

This graph shows the annual trend in retail sales, which can be considered a rough measure of private consumption. The latest data is from October. In the US, sales continued to grow at an annual rate of over 8%, but this pace is very exceptional if you look at the average annual growth over the last 20 years. The initial collapse and subsequent recovery during the pandemic are also well reflected in this graph.

The Eurozone economy is holding up

This year's theme has been how the Eurozone is collapsing under the pressure of the energy crisis. This narrative, which President Putin is very eager to hear, is well cultivated in the English-language investment media. The aging, politically contentious and slow-moving Europe isn’t exactly receiving praise in the international arena. But, so far, the economies have fared much better than the worst expectations.

Last week, fresh purchasing managers' index data came out of Europe. Purchasing managers' indices are a convenient way to monitor economic developments on a monthly basis in the current situation. The Eurozone's purchasing managers' indices for services and manufacturing plowed through the low 50s in November, signaling a contraction in activity compared with the previous month. Yet they still improved slightly, so it should be interpreted as a less slight decline compared to previous months decline. The figures were also higher than expected.



In several posts, I've raved about the attractiveness of European stocks, even if you have to worry a bit about the earnings forecasts. If the economic downturn remains mild or doesn’t materialize, earnings forecasts will be on a more secure footing. Due to the recent stock market rally, stocks are no longer mega cheap, but the forward-looking P/E ratio is still below its 20-year average at 12. Perhaps looking at a longer-term average at the index level is justified because the collective growth rate and profitability of companies doesn’t change so much over time. (If you're looking at individual companies, be careful if someone justifies the cheapness of a stock with historical multiples.)



When looking at the price to book ratio, we are already closer to the 20-year average of 1.8. These haven't been bad places to buy either, but there are fewer of the delicious opportunities of recent months on offer.

Electricity bills eat a large part of the economic cake

Last week the Organization for Economic Co-operation and Development (OECD) published its latest economic review with some interesting highlights on the global economic outlook. Let's go through some of these.

Many readers will have noticed how electricity bills have gone up recently. In fact, we are living in an energy crisis. This graph shows an estimate of how much of the economy is spent on energy consumption. Practically the same amount as in the energy crisis of the 1970s. Before the pandemic, energy consumption was around 10% of GDP, while now it has jumped to 18%. I always like to remind people that one person's expense is another one’s income, so the energy sector has certainly enjoyed a real golden age after years of adversity. At the same time, of course, the rise in energy prices limits consumption possibilities for other commodities. That new sauna stove from Harvia or the new flat screen TV from Amazon will have to wait for better times for now.

Here is the same message with a slightly different graph, detailing more precisely which types of energy the money is burning into. Practically everything from electricity to coal is becoming more expensive. In general, such shocks have led to an economic downturn. In particular, European economic growth is expected to take 1.5% hit this year and one and a 1% one next year from the energy crisis.

The energy crisis, exacerbated by the war in Ukraine, is the main reason for the sharp slowdown in the global economy. The OECD isn’t predicting a global recession per se, but growth will slow sharply despite government intervention amid the energy crisis.

Inflation is a genie that has escaped the lamp, which central banks are trying to lure back by raising interest rates. Monetary tightening is eating into the economy from the other direction. This graph shows economic growth projections for the world. The global economy as a whole will slow to a couple of per cent next year, according to the OECD's educated guess. Especially, Europe and the United States are slowing down. Nor is China growing fast, stuck in its COVID policy like a commuter in traffic during the rush hour. Interestingly, Indonesia and India in particular are seeing more robust growth in Asia, according to the OECD.



In many countries, inflation has become very broad-based, although it’s now showing signs of abating. This graph shows the percentage of products in the price basket that increase in price by more than 6% per year and what the situation looked like a year ago. In the US, for example, more than half of goods and services are subject to inflation of more than 6%, in Finland almost half.



The OECD expects inflation to come down rather slowly. Globally, inflation would be 9.4% this year, 6.5% next year and 5.1% in OECD countries in 2024. Inflation would be 3.4% in Europe and 2.6% in the US in 2024. The inflation problem, and hence monetary tightening, isn’t going away anytime soon, although there are promising signs that it is starting to recede.

Inflation is indeed hitting purchasing power. This graph shows the development of real wages in different countries. In the US, real wages have fallen by a couple of percent in the third quarter. Even if the salary remains nominally the same, it buys less bread to take home than a year ago. In Finland, real wages will fall by 3%, as in many other countries. Thus, the consumer is really struggling with a falling standard of living.

Of course, the economic slowdown, the energy crisis and rising interest rates are no cause for celebration. Given the sensitivity of the global economy to high debt levels, the OECD stresses that there are downside risks. For example, households with variable interest rates on their mortgages are quickly hit by rising rates. In Finland, almost 100% of new loans are of this type. In Sweden, where the housing bubble is about to burst, 70%. Fortunately, in the world's economic powerhouse, the United States, almost none of the new loans are at variable rates.

 
High debt levels are often associated with Europe and the US, but there are other places where people tend to build wealth on top of debt. This is the total indebtedness ratio for many emerging economies, i.e., the ratio of private to public debt to the size of the economy. In China, the ratio is an unimaginable 300%. In Malaysia, 200%. In Thailand, more than 200%. Brazil: 150%. To make matters worse, emerging countries have less developed financial systems and often borrow in dollars, making them very vulnerable to disruptions. This is good to keep in mind when investing in emerging economies through funds.

This is interesting point as well. Because many Central Banks tightening monetary policy at the same time, it’s impact is less than powerful than usual via exchange rate channel. As a result, stronger domestic policy interest rate rises in all countries are needed to bring down inflation.



Finland's economic growth is not very important for our stock market as such, because many of our companies are international and our main market is Europe. However, we have a handful of domestic-driven companies on Nasdaq Helsinki, from Kesko to NoHo Partners, so let's take a quick look at Finland's forecasts. Here, the OECD expects the economy to be in a mild recession next year. Real wages will take a hit until inflation falls back below 3% in a couple of years.

 
What is perhaps embarrassing for Finland is that unemployment would rise again to 8% while public debt continues to rise. NB: public debt in principle isn’t bad, for example, if used wisely for investment in education, but I'm not sure if that's where the government is spending it. The household saving rate also remains negative. This is reflected in Finland's current account, which is returning to negative after a break of a couple of years. In layman's terms, Finland spends more than it earns. That can go on for a long time, but not indefinitely.

Thank you for reading the post! Read analysis but remember to take forecasts with a grain of salt and save money for better buying opportunities.