Asset Management: Asset Manager Insights

The Trump era begins

header-trump-era-begins

We could conceivably write a Pyrspectives without referring to THE election and President-elect Trump and, to be frank, it is tempting to do so as there are so many unknowns that it is difficult to be cogent and value-additive. Nevertheless, we feel compelled to make some stumbling attempt at comment. We never fall into the trap of forecasting the outcome of elections, but if we are being totally honest we did believe it unlikely that we would end up discussing a Trump Presidency.

Trump

The first observation to make is that the stock market clearly likes the prospect of Mr. Trump at the helm. The “Trump-bounce” in the stock indices is very pronounced even on very longterm charts. The market likes the sound of a big-spending President, who has also promised a substantial reduction in the corporate tax rate. The jaw-boning about tariffs and protection seems not to disturb the traders one whit (it disturbs us!).

Janet Yellen, Chair of the Federal Reserve, has met the change of leader head-on by raising the Fed Funds rate by a quarter of one percent whilst forecasting as many as three increases in 2017. The exuberance shown by Wall Street to Trump’s election victory left her with little option but to make a move.

The bond market, on the other hand, has not been appreciative of this turn of events. Yields across all maturities have risen sharply — and not just in the U.S. The U.S. 10-year benchmark treasury yield dipped to a low point of 1.36% on July 8th this year. At the time of writing it has risen to 2.5%. Ouch! (If you’re a holder). If you are a non-holder (and, in particular, a defined-benefit pension fund) you should be cheering. Finally, bond yields may begin to make some sense.

We have read many times that Mr. Trump could be another President Reagan — that is, a President not afraid to turn the fiscal spigots at a rapid rate — spend the money now in the hope that growth eventually bails you out. At the risk of being accused of being out-of-touch curmudgeons (again), we feel it necessary to point out some major differences between January 1981 and today.

Source: Thomson Reuters Datastream

Mr. Reagan inherited a stagnant economy with high inflation and massive interest rates (they go hand-in-hand) but, importantly, very low levels of public and private debt. He was able to spend big and encourage others to do so, safe in the knowledge that the fiscal situation was more or less in control — at least during his two terms. Inflation and interest rates tumbled and the economy perked up (eventually). Mr. Trump, on the other hand, inherits an economy with tiny interest rates, record debt levels, an expensive stock market, modest growth, near-full employment, extremely low inflation and a central bank that has blown its balance sheet four-fold (relative to GDP) since the Reagan years. The money has poured into the system but the economic wheels have gained little traction — with the obvious exception of the stock and bond markets.

The Organization for Economic Co-operation and Development (OECD) has published some insightful work on just how poor the “recovery” from the 2008-9 recession has been, relative to the previous three recession recoveries. The data relates to all OECD member countries but the trend applies equally to the United States. The economic wheels have been skidding all over the world.

Source: OECD Economic Outlook, November 2016 All series scaled to equal 100 at pre-recession peak Average of last 3 recoveries is an unweighted average of developments after Q4-1973, Q1-1980 & Q3-1990
Source: OECD Economic Outlook, November 2016
All series scaled to equal 100 at pre-recession peak
Average of last 3 recoveries is an unweighted average of developments after
Q4-1973, Q1-1980 & Q3-1990

The public debt situation in the U.S. gives the President-elect very little wiggle room. The OECD, in its latest forecast, suggests that nominal GDP may be able to outgrow the expansion in public expenditure mooted by Mr. Trump. Maybe, but the economic lessons from the last decade and a half give us justified cause for scepticism.

Source: Thomson Reuters Datastream
Source: Thomson Reuters Datastream

It seems that every politician, of whatever political persuasion, is tempted to spend money that is not theirs. The rewards of doing so flow to the few. It is a sad but true fact that the gap between the “haves” and the “never will have” continues to widen. We doubt that the policies of the President-elect will do anything to redress this imbalance.

It is not just the headline GDP statistics that have been well below par during this “recovery”. The comment applies equally to employment, real wages, consumption, trade, labour productivity and capital investment. All of these factors are inextricably linked with cause and effect, always difficult to disentangle, but if one stands above the others as indicative of the economic malaise since the crisis it is the global phenomena of weak productivity growth (output per worker). Once again the OECD provides us with a stark illustration of the difference “this time around” relative to the past.

Labor productivity growth following recessions: Aggregate data for OECD economies

The view that we have expressed in past Pyrspectives is that loading an economy with debt is a palliative that works for a while but inevitably reaches a point of diminishing returns and then downright danger. The financial crisis of 2008-9 is an example of the “downright danger” stage. Since then, the ebb and flow of the global economy has been decidedly “odd” — it has been unlike any other post-recession recovery as the OECD has highlighted — and it doesn’t appear that it is about to change.

The household sector in the U.S. and a few other countries has moderated its debt load (relative to income) but governments, central banks and corporations have added vast sums to the pile so that the overall debt statistics are now at record levels (see graph below). Our “fear gauge” therefore remains elevated.

Gross global debt: As at % of GDP (weighted average)

Can Mr. Trump perform miracles? How can we indulge in meaningful speculation about the unforecastable? The President-elect does have some relevant experience — running companies with mountains of debt. He is now about to take leadership of the world’s biggest economic (and military) entity and $20 trillion of public debt. He will probably relish the challenge and still sleep soundly at night, whereas the rest of us are likely to be tossing and turning for four years. It won’t be dull!

 

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