Fiscal stimulus still needed to sustain growth momentum in US
EQUITIES have had a stellar run this year, underpinned by growth and loose monetary policy.
Can this momentum be sustained in view of the coming reduction in central bank liquidity, geopolitical tensions, currency moves and stretched valuations.
“All data are coming in very strong at the moment and we’re really seeing this synchronised recovery take hold,” says Keith Wade, chief economist and strategist for Schroders.
“This ties in with a synchronised recovery in trade. It’s good for Asia and generally good for emerging markets,”
Aymeric Forest, head of global income, multi-asset investments for Schroders says: “Equities have benefited from the global synchronised upswing and have come out of a period of earnings recession. We are also seeing a synchronisation of earnings growth.”
“We are in stretched valuation territory but not extremely,” he says, adding that earnings growth has been strong. “At the moment, we would see any correction as a buying opportunity.”
Forest argues that a V-shaped recovery following an earnings recession is normal. He anticipates earnings growth of 8%-12% supporting gains next year, but a smaller expansion in price-toearnings ratios.
Now if America’s debt is a concern, the argument below should put the issue to bed.
Many still have the misconception that the US doesn’t have the most pristine of balance sheet. That’s because the proper context is nescessary.
In September, US federal government debt crossed US$20 trillion, garnering headlines.
Fisher MarketMinder says this refers to gross debt.
“Net debt, which excludes money the government owes itself, is a more benign US$14.6 trillion. (Net debt includes the Fed’s holdings, as it is technically a private institution.)
“Treasury’s interest payments relative to tax receipts are now around 7.3%, less than half 1980s and 1990s levels. Not that the US was in danger of defaulting then, just that concerns are even more misplaced now,” it says.
US assets today are returning about 10.8%, and this excludes impossible-to-value assets like its national parks.
When comparing that to the US’ borrowing costs, the appropriate level of debt is the amount where marginal borrowing costs equal marginal return on assets. The average interest rate for all US debt is 2.3%, a fifth of America’s return on assets.
Thus if anything, the US is under-indebted.
Yet Fisher MarketMinder says widespread conventional wisdom believes America is being crushed under unsustainable debt loads when it’s rarely been easier to pay for that debt. This is because the assets backing it tower over the nation’s liabilities and generate much more income than it costs to service.
Fisher sums this up very eloquently. “Stocks move on the difference between sentiment and reality, and the current wide gulf between the two suggests positive surprises for markets well into the future as debt problems fail to materialise.”
Fiscal stimulus
On a longer-term view though, some fiscal stimulus is likely to be required to sustain economic momentum.
“We see the US economy as more of a 2% economy in terms of trend,” says Wade. “There’s a shift away from consumer towards capex. That will carry the economy forward, but there would need to be some stimulus to get it back to 3%.”
Forest sees further stimulus as crucial, for equities as much as the economy, predicating his positive 12 month outlook on expectations of fiscal loosening. He thinks the market is too preoccupied with the US and that fiscal stimulus across the globe is key.
“As valuations are becoming less appealing, the focus will be on growth,” says Forest. “It’s the idea of keeping this cycle going, which has been long in relation to history. To break hurdles going forward will be more and more challenging.”
“The focus and need for stimulus is global, not only in the US. For next year we expect balance sheets to expand, but at a much slower pace than this year and with potentially a negative rate of growth from 2019,” he says.
Forest acknowledges there is a lot riding on the next 12 months in terms of shaping the longerterm path for equities. With ultra-accommodative policy coming to an end, what companies and governments do on the ground will be increasingly important.
“In a year’s time we will have a bit more feedback on what has been achieved on the fiscal side and will see where we are in terms of capex and maintaining earnings growth,” says Forest.
Currency risks
With the selloff in the US dollar, the appreciation of the euro and the recent rush for the safety of the yen, currency is again a key risk for investors.
“Going into 2018 this is going to be critical, if we see a stabilisation or a short-term correction of the euro or yen it will help to boost earnings expectations,” says Forest. “Currency will be critical for regional equity allocation.”
Indeed, according to Forest, current levels suggest the euro and dollar moves may have largely played out, with US$1.20 an accurate reflection of the euro’s longterm fair value.
“To go beyond that you need a drastic change in monetary policy or clear divergence in economic growth in the US and Europe, which is unlikely.”
Another facet to currency moves has been their influence on central banks. “The Bank of England (BoE) is under pressure because of the weak sterling and the ECB wants to start its exit strategy but has seen tightening as a result of euro strength,” says Forest.
Wade adds: “The BoE has been unhappy about the effect of the weak pound on the economy. It has boosted inflation, but it hasn’t boosted trade at all, net exports are still dragging on the economy.” He expects the BoE to look through fundamentals and hike rates in November.
Political headwinds
A possible headwind to the economy comes in the form of geopolitical tensions, between the US and North Korea especially, and regional political unrest.
The more immediate implication of US-North Korea tensions, Wade suggests, would be more protectionist measures between the US and China. This could occur as a result of US frustration with China’s apparent failure to uphold its end of an agreement to contain North Korea.
In Europe, unrest in the Spanish region of Catalonia, which represents 20% of the country’s GDP, will likely hit the economy and may have wider implications.
Wade says: “There is the potential for other independence movements around Europe to come forward and that could cause quite a pause in economic activity.”
Forest sees the near-term volatility as an opportunity, however, with any further outbreaks of unrest potentially adding pressure on governments to provide fiscal support.
“It would be difficult for the EU to enforce fiscal rules against this backdrop in Spain. I think they will allow some loosening.” Wade says.
Catalonia also raises the spectre of renewed fears concerning the eurozone periphery particularly as the European Central Bank moves to taper quantitative easing.
Wade warns: “One of the things we are thinking about for 2018 is what will happen to peripheral risk when you take away that buying. Do you see spreads widen out or a return of some of the problems of three or four years ago?”