It’s been three years since the world panicked over an alleged “fiscal cliff.” Yet, in a rare intersection of opinion during the U.S. presidential election campaign, both Donald Trump and Hillary Clinton were united on fiscal expansion, with a focus on upgrading America’s aging infrastructure. They had plenty of ammo for the argument, and it remains to be seen how President-elect Donald Trump will follow through.
The Debt-to-GDP ratio has stabilized since 2011, and the budget deficit has declined dramatically. Gross government investment as a percentage of GDP is at a 70-year low. What’s more, lobby groups such as the American Society of Civil Engineers claim that us GDP growth could be diminished by $4 trillion between 2016 and 2025, due to lost sales and rising costs associated with bad infrastructure.
Pitching into the debate are the likes of Larry Summers and even Fed Vice Chair Stanley Fischer with arguments that fiscal largesse is the solution to concerns over “secular stagnation” (a phrase originally coined by Alvin Hansen in 1938 following the Great Depression).
In Canada, the Liberal government was elected on a platform that placed austerity and balanced budgets on the back burner.
More globally, fiscal stimulus is also making a comeback. For the first time in five years, more developed economies plan to loosen than tighten fiscal policy (16 countries for the former, while only nine for the latter). We expect this to be a multi-year trend.
Turning to other “megatrends” in the world of investing, consider three others that our Investment Committee is closely tracking:
Trump’s message to the world: You’re fired!
Who knew Trump would make it so far? And what implications will a Trump presidency have on global markets? We see four big ones.
* First, and most clearly, Trump’s policies will significantly reduce taxes and increase spending on military and infrastructure. Early estimates predict $10 trillion in higher debt and deficits. Over the short term, this would boost corporate profits (given the current period of low corporate investment along with a current account deficit).
* Second, and offsetting the first, would be a likely damage to business confidence (surely the quickest way to short circuit growth). Here any number of Trump’s policies (take your pick: abrogation of trade treaties; censorship; a tariff war with China; etc.) could create a confusing business environment and slow a still-fragile us economy.
* Thirdly, especially compared with the more predictable Hillary Clinton, market volatility would soar as markets adjust to new political realities (and erratic policy).
* Finally, and perhaps most importantly, Mr. Trump’s nationalism is highly risky. Trump not only advocates America retreating behind a wall, he also threatens to shelve trade agreements like the Trans-Pacific Partnership. In a globalized world defined by a move toward closer interconnectedness, the “biggest loser” would undoubtedly be the U.S.
Consider China’s longer running ambitions to establish Beijing at the center of a new Asian imperial domain. A Trump presidency would allow China to send this message to every Asian country: Do you want to be with us or with the United States, who is openly against you? No doubt, President Xi Jinping is celebrating Trump’s win in November.
Running for the Brexit? Not quite
The U.K. has voted to leave the European Union. Undoubtedly, it is having a negative impact on business and investor confidence. What’s more, it is increasing fears of the entire bloc’s disintegration – emboldening anti-EU parties like Spain’s Podemos and Italy’s Five Star Movement and creating an upsurge in populist groups promoting nationalism and protectionism. That’s a clear negative for risk markets.
However, Brexit will very likely prove to be yet another post-crisis macro fear with limited fallout. Why? First, markets had already been pricing in damage to investor sentiment. The post-Brexit bounce has simply relieved an oversold market. Second, the U.K. will likely be a member of the EU for a few more years at least (even “Leave” leaders have cited 2020 as a likely exit). Referendums are merely a recommendation to politicians (who often drag out the process to determine particulars of the actionable result). Thirdly, Brexit has forced central bankers into action – further underwriting higher asset prices.
Emerging market investing: So hip it hurts (again)
After a long and punishing period of underperformance, emerging markets (EM) are hot again. Global fund managers are scrambling to close their deep underweights, and emerging market ETF inflows are surging. One can almost hear echoes of the prolific Gord Downie’s lyrics: “Come in, come in…from thin and wicked prairie winds, come in/It’s warm and it’s safe here.” The rich irony, of course, is that many countries in the so-called emerging universe now appear more secure than their developed world counterparts, offering a “heartening” refuge from the perilous world of quantitative easing, negative rates, and their associated freakish offspring – overvalued stock and bond markets. Tragically hip indeed.
Looking back, was the EM underperformance of last year justified? Not likely.
First, revulsion toward China was unduly influenced. The consensus spun a narrative that policy has finally pivoted to pursuing a weak renminbi, providing evidence of an imminent hard-landing scenario. While growth is slowing and should not be trivialized, the more important story is China’s solid progress on the road to rebalancing — namely, a shift away from manufacturing and construction activity toward consumers and services. This is exactly what well-intentioned Western economists urged EMs to do: rebalance economies away from cheap exports to more self-sustaining middle class consumption.
While Beijing can be criticized for a poorly communicated agenda, their longer-running ambitions shouldn’t be understated – internationalize the currency, modernize the financial system, address excesses in debt markets, and transform state-owned enterprises – all couched in a nationalistic revival of the “China dream.”
Second, forecasts of a widespread EM crisis were also off the mark. Here, the commentary focused on slowing growth and high debt, with extravagant comparisons to the 1997-98 Asian crisis. Yes, exports are slowing. But this is concentrated in the commodity exporters (declining by almost 40% in July, year-on-year). And, the outlook is actually improving for a number of countries. It’s important to recognize that EMs already had a large slowdown between 2010 and 2012. Since then, currencies have weakened (boosting competitiveness), commodity prices have fallen (raising consumption), and policy has turned stimulative (lowering the cost of capital). These benefits always show up with a lag. Why should this time be different?
Looking ahead, despite recent events like Brexit, our Investment Committee’s outlook has not changed significantly. In fact, it has confirmed our longer running thesis: We continue to live in an era of new realities. The best approach for investors is wide global diversification with exposures tilted to longer-running megatrends. We remain committed to that investment discipline, striving to ensure that our clients meet their financial objectives.
Courtesy Fundata Canada Inc. © 2016. Tyler Mordy, CFA, is President and CIO of Forstrong Global Asset Management Inc. Securities mentioned are not guaranteed and carry risk of loss. This article is not intended as personalized investment advice.
