Reality may trump hope if sensible US economic policies are not adopted
IT HAS been an extraordinary few months in the US. The American economy and financial markets are embracing hope wholeheartedly and, at least for now, totally avoiding reality.
Who can blame them? After eight years that have been mostly wasted by American politicians and the Federal Reserve, investors and citizens alike want to believe that a new dawn of hope is truly coming.
The fact that it is President Trump supposedly playing the role of the economic messiah, having until recently been considered an economic pariah, is a moot point because sentiment indicators and market action suggest that the future is bright. But is that optimism justified?
In the run up to the election I was definitely bearish on the widely assumed combination of President Clinton and Fed Chair Yellen. More of the same was not what the US needed. My view was that a bear market in equities, triggered by a shallow 2017 US recession was a likely outcome, based upon the likely policy actions of Clinton and Yellen.
It is fair to say that I am more optimistic on growth having read economic policies that have been proposed by Trump and his nascent administration via Twitter.
The fact that Yellen could well resign or be forced out by Trump next year would also be a positive in my eyes, given that she has been a chief navigator of what we believe to have been an erroneous monetary path for the last few years.
Of course, she could well be replaced by someone totally useless, but again in the monetary field change is needed.
Our latest forecasts for US economic growth are undoubtedly higher than where they were only a few months ago and our fears of a US recession have receded. We can certainly understand why investors have wanted to buy into the new vein of optimism. As we stand now, the global economy has picked up pace and 2016’s momentum is following through to 2017 at a decent pace.
That said, we are approaching 2017 and the new US economic policies mix with a large amount of scepticism. For a start, we wonder about how the newly proposed stimulus measures are going to be paid for and believe strongly that there is a case to be made for Trump wanting to write cheques that cannot be cashed.
In particular, we wonder how the negotiations with the Tea Party element of the Republican Party will go in March when they have to raise the debt ceiling, especially as previous efforts have caused much discourse.
In addition, a similar argument can be made about how discussions will go in relation to Trump’s desire to slash corporate tax rates. Indeed, taking all of his policies at face value, it would appear that President Trump is intent on taking the US deficit from $600 billion to $1 trillion due to a reduction in revenues and a ballooning of government spending.
We therefore have to assume that there is going to be a heap of new US Treasury issuance that will start to crowd out private debt, particularly at a time when the previous major buyers of US Treasuries, namely China and the Middle East, are unable or potentially unwilling to fund the US government’s largesse.
If government bond yields start to rise aggressively and the cost of capital rises, we wonder how well equity and credit markets will take the news. In particular, higher quality credit could start to suffer badly, given that yields are low and spreads are tight.
The mix of decent growth, recent dollar gains, rising bond yields and accelerating inflationary pressures makes the outlook for US equities uncertain. Chuck in high starting valuations and the picture is muddied yet further.
On the positive side, a cut in corporate tax rates should help, but margin pressures and the strong dollar will certainly hinder.
Unless any move higher in the markets is backed up by healthy corporate-profit growth and sensible US economic policies, then reality will trump hope.
‘‘ We believe that there is a case to be made for Trump wanting to write cheques that cannot be cashed
Tim Wishart is senior investment director at Psigma.