Fis­cal stim­u­lus still needed to sus­tain growth mo­men­tum in US

The Star Malaysia - StarBiz - - Bizwealth - By TEE LIN SAY lin­say@thes­tar.com.my

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?”

Buyable mar­ket: For­est sees any cor­rec­tion as a buy­ing op­por­tu­nity at the mo­ment.

EU eas­ing: Wade sees the EU loos­en­ing some fis­cal rules in light of the Span­ish sit­u­a­tion.

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