One does have to be careful of what is going on with capital flows. The countries in South America are dependent on export growth primarily tied to commodities. While Argentina may be coming out the other side of its ability to access the capital markets, it is not clear that other countries can make it through this period without some degree of financial stress. But, the Americas represent an unusual somewhat isolated set of investment opportunities across the equity, fixed income, and fixed asset markets, both public and private.

EUROPE: ECONOMICALLY BETTER, BUT POLITICALLY WORSE
This is the same title we used last year. The addition of the immigration issues to a general reaction against the austerity that has been put in place leads to reduced economic and political coordination among the European countries. Talk of closing borders will likely produce greater immigration issues in the near term and certainly conflicts among the countries. There is a macro bet one can make based on continued QE of some form from the ECB combined with a relatively weak currency and relatively lower valuations. This seems like a crowded bet. However, we are beginning to see more dispersion by country and by company against a heightened backdrop of geopolitical risk and engagement. Again, this is another place where active management can produce decent returns, but the volatility and variability within the public markets will make the timing of investments more difficult. I think we need more time to sort out these markets.

CHINA: CHINA USES ALL FISCAL, MONETARY AND STRUCTURAL TOOLS AT ITS DISPOSAL TO CONTINUE THE TRANSITION TO A SERVICE ECONOMY WHILE PUTTING A SAFETY NET UNDER ITS INDUSTRIAL SECTOR
The country takes steps to slow down the capital outflows that have been occurring in anticipation of a continued weakening currency. While the currency weakens modestly relative to the dollar, the one-way trade ultimately becomes problematic. The currency stabilizes and capital outflows shift their mix to an even bigger share of global FDI.

China has been the all-time consumer (and in some cases, producer) of the four biggest metal markets in the world: iron ore ($225B), copper ($130B), aluminum ($90B), and nickel ($40B). If you add these numbers, these markets at these prices represent less than $500 billion in a global economy of over $79 trillion. Yes, these resources are at the core of industrial and infrastructure activity, but there is a global shift from industry to services taking place, similar to China’s. China produces close to 50% of all iron ore and aluminum and has been the consumer of 50% or more of all four of these metals. As the Great Recession occurred, China stepped up its internal investments to offset what was happening in the rest of the world and became the driver of demand and price increases. Prices peaked in 2011; supply increased, and demand growth began falling as well as prices. But, China’s commodity consumption is still growing at 3%–4%, but with consumption down elsewhere, demand hasn’t quite caught up with supply.

China’s focus will continue to be maintaining political and economic stability as it transitions from an industrial export-driven economy to a consumption/services economy. Let’s assume that the Chinese leadership actually does know (as well as any country leaders can) what is happening economically in China, even if the rest of the world doesn’t. They are trying to accomplish this while introducing some elements of reform, e.g. fighting corruption, that may actually produce slower growth than might have occurred otherwise. This will not be a smooth transition, but the transition is occurring. We have to watch what is happening in China, but I would posit that our attention should be focused on Europe, and to some extent, the Middle East. A pickup in growth, which will likely show up in commodity prices and numbers from the services sector, may be the next signal from China, which may not come until much later in the year. In the meantime, services, technology and the Silk Road Initiative will offer some interesting Chinese investment opportunities. In addition, China continues its push to create its own intellectual property. The patent battle between the major economies may become the real story over the rest of the decade.

INDIA: HAVING TAKEN IMPORTANT GEOPOLITICAL STEPS, NARENDRA MODI TURNS HIS ATTENTION INTERNALLY WITH MODEST SUCCESS
While India turns out to be the fastest growing large economy in the world, it happens in spite of attempts by minority parties and the states to put roadblocks in the path of reform. India embraces its role in China’s Silk Road Initiative, which results in both its own infrastructure spending as well as FDI by China. India continues to add to its technological portfolio with patent filings and a specific focus on the medical area. In addition, with 600mm citizens still off the electrical grid, India looks to distributed alternative energy with help from both China and the US. This is the one place where the US can actually have a positive interaction with India. While the stock market looks relatively rich, the growth pattern and an expectation of continued reform attracts private and corporate capital.

RUSSIA: LOW OIL PRICES, OIL FLOWS, SANCTIONS, AND THE COST OF FORAYS OUTSIDE OF RUSSIA RAISE THE STAKES FOR THE LEADERSHIP AND CHANGE RELATIONSHIPS
Lifting the US oil export ban changes the West’s relationship with Russia as crude can flow from the US to Europe reducing its dependence on other sources, specifically Russia. A total revisit of sanctions, Syria, Iran and the Ukraine takes place before the end of the Obama administration. The question on timing may be a determination by Putin of whether it is best to work with the current US administration or take his chances on the next one. At these prices while Europe would be an oil buyer it is not clear who would be the incremental seller. While lower oil prices continue to have a major financial impact on Russia and affect negotiations on the topics listed above, the US sees an opening to change the relationship with Russia and Putin sees the same.

While the dialogue and negotiations are not smooth, a different path is set for the new administration. As I said in last year’s “Expectations”, Russia has an educated population and the ingredients for being an important economic player on the world stage. The current path will not get them there and will add to geopolitical volatility as long as it continues. It can still lead to regime  change. Technologically, Russia continues to advance and remains one of the top ten patent filers even while the rest of Asia, led by China, South Korea and Japan, puts distance between itself and the western world.

THE REST OF THE WORLD (AND OIL)
We could spend time discussing the rest of the emerging markets and the turmoil in the Middle East. In all instances the most significant elements to watch are the capital flows as many of these countries see reduced demand at lower prices for what they offer while their fiscal budgets are more rigid. The capital to support the expenditures has to come from somewhere. Borrowing is problematic. The capital accounts primarily represented by their sovereign wealth funds have to be the source. Much of that capital is invested in developed country public securities as well as less liquid investments in the same areas. Depending on how long low growth and low prices remain, we could begin seeing a measurable impact of this selling on markets. And the excess capital will move toward the more liquid markets with lower currency risk. We have seen what the lack of liquidity can do to values within the US markets when relatively small amounts are in play. This may offer real opportunities for the buyers with capital, but the dollar amounts may at some point overwhelm the markets. We will be watching this as an element of risk away from the fundamentals of individual investments.

The oil situation, while representing a dramatic shift in beneficiaries, at these levels becomes more problematic. While the users of energy benefit, we are getting closer to country risk and expanding the list of energy related companies that will ultimately suffer. This ties in to the capital flow discussion above. These levels add an element of risk to the overall global capital markets. There may be unintended consequences.