Last week Janet hiked. Yawn. This was much telegraphed and not much of shock. In fact, the aggregate change in the forward indicator on rate raises (the dot plot) barely moved and it still appears that we’ll see two more hikes this year with three to follow in 2018. The market cheered and rallied on the back of mildly “dovish” commentary. Wall Street likely sees higher rates but not as fast as the Fed predicts. The US economy is still expanding at a moderate pace.
Maybe an underappreciated risk for the market right now is inflation. Current readings of inflation suggests that inflation is beginning to emerge, albeit slowly. The core consumer price index is running slightly above 2 per cent. Whether the tight labour market in the US leads to even more inflation from rising wages remains to be seen, but we could see this trickle in faster than most expect. That is the thing with inflation, once it gets momentum it can accelerate in a hurry.
Real short-term rates will actually remain negative for about two years (assuming stable inflation) which is very attractive for equity investors. The market is giving investors very limited opportunity to get real returns without taking some risk.
Elevated valuation multiples could pose a problem. Depending on the actual outcome of Trump’s policies in the US, earnings growth may not offer much support to some stocks extended valuations unless pro-growth policies are enacted swiftly — I don’t see this as being the case due to the complexity of the US legislative process.
Speaking of Trump, we continue to get a bull market in rhetoric with a bear market in details. Recent budget suggestions seem to ironically hurt some of his base of support with withdrawals from some training programmes and a tilt towards providing less social welfare support in the future.
The future trajectory for the US economy will be somewhat predicated on the shift from a heavy reliance on monetary policy to one of pro-growth fiscal stimulus. Right now that transition seems murky, recent immigration amendments and healthcare reform only seem to be highlighting the dissension in Congress and the polarised state of government. Even with a full run of Republican majorities across all levels of government, internal party cohesion is not guaranteed (especially with some Tea Party proponents) and the US judicial system won’t play ball with policies that may border on constitutional violations.
Trump is learning the hard way that getting stuff done in Washington is not like running a real estate empire. It’s worth noting, however, that all political commentary is not necessarily the answer to the markets. Policy decisions operate with lags and there is much more to consider with regards to stock market performance over longer stretches than political manifestations in developed markets. Warren Buffett said it best in his recent CNBC interview: “If you mix your politics with your investment decisions, you’re making a big mistake.”
Europe is probably less of a risk then feared. The Liberal party in the Dutch election won (even with a low per cent of a vote). France’s elections are on the radar now but I don’t think they will end badly. Those are probably brave words given the shocking surprises seen in political outcomes recently, but the French love the euro. Polling has been wrong but I think recency bias seems to be playing into the slight fear we are seeing in regards to France.
The real risk for European integration probably lies with the Italian election which may be sometime in 2018. Foreign stock markets are cheaper on some metrics and have even outperformed the US year-to-date despite the focus on proposed market friendly US policies.
One final word on trade policies and protectionism. As much as Trump and Co jawbone and needle US companies that don’t seem to put America first, I am not so convinced that a watershed change is afoot. Much of the job losses in manufacturing are not likely to return to US shores. Their obsolescence is more technological in nature. US manufacturing has been expanding for years and its productivity is massive. From the Made in America Movement itself: “The output of the US manufacturing industry is higher than ever before, even though employment has hardly recovered since 2010” and “Manufacturers have increased productivity by over 2.5x since 1987.”
Less people are simply required to do a lot more. The sector will likely grow but it is fighting a fundamentally difficult situation where robotics and automation are increasingly effective. There is a risk that the world now moves further into the realm of trade wars and protectionism under the guise of “saving the domestic worker”. If this becomes a global and co-ordinated response, trade will suffer and we are almost assuredly all going to be worse off. Jim Clifton wrote it best in his book The Coming Jobs War: “Of the seven billion people on Earth, there are five billion adults aged 15 and older. Of these five billion, three billion tell Gallup they work or want to work. Most of these people need a full-time formal job. The problem is that there are currently only 1.2 billion full-time, formal jobs in the world. This is a potentially devastating global shortfall of about 1.8 billion good jobs. It means that global unemployment for those seeking a formal good job with a paycheque and 30+ hours of steady work approaches a staggering 50 per cent, with another 10 per cent wanting part-time work.”
This may ultimately be the defining issue of the next few years and the source of populous future dissent and conflict.
“15 Facts Showing US Manufacturing is Growing”
Clifton, Jim. The Coming Jobs War (Kindle Locations 45-49). Gallup Press. Kindle Edition.
72 per cent of French people against ditching euro — survey
Here is the full transcript of billionaire investor Warren Buffett’s interview with CNBC
Nathan Kowalski CPA, CA, CFA, CIM is the Chief Financial Officer of Anchor Investment Management Ltd. and the views expressed are his own.
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