Summary

The "synchronized global recovery" narrative is falling apart after a remarkable multi-quarter run for the global economy.

Yes, European and Chinese economic growth is slowing.

In the interview below, economist, portfolio manager and author Daniel Lacalle discusses his global growth outlook with Hedgeye CEO Keith McCullough.

Investors have been riding a wave of easy money.
The “synchronized global recovery” was the tide that lifted all boats.
It’s over.

That’s one of the key takeaways from this Real Conversation between renowned economist, portfolio manager and author Daniel Lacalle and Hedgeye CEO Keith McCullough.

The video below features a key excerpt from their conversation where Lacalle describes what he sees as "the biggest risk in markets right now." Also, below is a brief transcript from the broader video.

CLICK HERE to watch the entire 36-minute interview.

Keith McCullough: I’d like to welcome my friend, economist and author Daniel Lacalle. Daniel, I’ll let you kick it off here with a question that’s on everyone’s mind: What’s next for Europe and what do you make of the recent Italian elections?

Daniel Lacalle: Thanks Keith. The Italian elections brought back what actually never left and what a lot of investors forgot, that’s political risk. Political risk continues to be a drag on European growth. The Italian elections have shown yet again – as a country that’s had more than 50 governments in the last 60 years – how challenging the political environment is.

For me it comes back to debt. And the big factor that most economists ignore is overcapacity. Europe has excess capacity. That is not a problem in the US. Slack in the US economy is very, very low. And obviously the level of debt and the level of public spending in Europe makes a big difference on growth.

Aging of the population, overcapacity and debt are three factors that will massively impact the European Union relative to the United States.

KM: And isn’t it true that these secular issues really matter when the economic cycle is slowing.

DL: Of course, credit growth disguises all these factors. Public expenditure shadows many of these problems. We have seen it in Japan. We have seen it in Europe, but ultimately longer-term trends catch up with reality.

Let’s compare the U.S. and France. Both countries have a very large proportion of small and medium enterprises. The big differences is the small and medium enterprises in the U.S. are much more dynamic, much stronger, and noticeably bigger. In Europe, the tax rich, productive sectors continue to subsidize the unproductive sectors and that always leads to lower growth, lower earnings potential and lower improvement of the economy.

KM: But Daniel, everyone says they’re long European stocks because they’re cheap relative to the US.

DL: The problem with the European stock market is that everybody, every year says that it’s cheap. Of course it is. Look at the earnings growth. It doesn’t even compute. So far, if you look at Bloomberg consensus estimates for earnings growth on the Euro Stoxx 500, they have come down by -32%. So the first thing you have to believe, if you think European stocks go up because they are “cheap,” is that the multiples expand for no reason.

KM: Is that the problem macro investors face? So the earnings growth expectations go down by -32% -- the E in P/E – and the stocks get more expensive. Isn’t this the trap? Cheap can keep getting cheaper if the prevailing growth conditions continue to slow. Is that the problem, that investors are trying to use their value strategies in stock picking at the macro level?

DL: Yes. Most macro analysts place too much attention on monetary policy and government spending and too little on the fundamental drivers of the economy, which are profits and private consumption, you know the profit driven economy. And therefore they’re bound to be disappointed. So they overweight these stimulus efforts and the results are worse and worse.

Keith, the average EPS growth of stocks in the Euro Stoxx 500 in the last 5 years has been 0%.

KM: Let’s take some questions. What do you think is the biggest risk in macro?

For me the biggest risk is that the dollar is the new VIX. In other words, if the dollar were to go up meaningfully here I think that would catch a lot of investors offsides.

What do you think the biggest risk is in global macro right now?

DL: I think that the biggest risk is that what we have right now is a big bet on synchronized growth. But synchronized growth is being driven by synchronized debt. So debt is the key factor here.

The moment that we have an uptick in the perception of risk in fixed income, Emerging Markets or in growth economies you can see that reverse rather quickly. It could be driven by a slowdown in China or a combination of factors.

This is what people tend to forget. The unwinding of that trade can happen rather quickly. We saw it in ’95-’97 and we saw it in 2007-2008. When it unwinds, it unwinds fast. That’s why we have to consistently look at the drivers that either cement or negate what’s driving the trade and prepare accordingly.

CLICK HERE to watch the entire 36-minute interview.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.