Quarterly Investment Strategy
United States: Will policy support prolong the expansion?
In a nutshell:
Late- to end-of-cycle economic conditions limit the Fed’s leeway to hike rates and put pressure on the Treasury to deliver more fiscal support.
While still solid, consumer spending is likely to moderate somewhat – there is a limit to how much households can draw on their savings.
The capex outlook remains subdued, but oil- and dollar-related downside pressure should continue to subside.
Eight years into the expansion, qualifying the US economic cycle as mature is a no-brainer. Early next year, it will rank third longest of the post-war period – the record belonging to the technology-driven boom of 1991-2001. Peaks in corporate profits, employment, vehicle sales and the shale revolution, alongside trade and current account deficits that have stopped improving and limited capex growth , are clear signs that the cycle has reached an advanced stage. Which is not to say that US activity will stop expanding just yet.
Household consumption, by far the largest contributor to Gross Domestic Product (GDP), actually grew at breakneck speed during the 2nd quarter, fuelled by a sharp decline in the saving rate – itself probably related to the recovery in private wealth relative to income. Still, there is a limit to how much households can draw on their savings to finance spending. Over the latter part of the year, we expect real consumption growth to ease to between 2% and 2.5%.
One of the (many) unusual aspects of this cycle has been the average 1.1% per annum decline in government spending, in contrast to a typical 3.0% per annum gain across all expansions since 1949. While we are not counting on massive productivity-enhancing policies in the near future, both presidential candidates do intend to ease fiscal policy next year. Add to that solid state and local government spending since the beginning of 2016, a trend that should continue thanks to growing property and other tax revenues.
Although the Fed has taken its first step toward monetary policy normalization, the process is slow and the yield curve still far from flat enough to induce a recession. Economically, the Fed would have been more justified in hiking interest rates during the past two years, when non-residential fixed investment and corporate profits were still accelerating. Right now it is difficult to argue that the economy requires monetary tightening to prevent overheating. Rather, the Fed is concerned that the prolonged period of low non-volatile yields is driving investors “to reach for yield and could lead to the misallocation of capital and mispricing of risk, with possible adverse consequences for financial stability”. Forthcoming Fed hikes will thus be the result of a fine balancing act between ensuring financial stability and avoiding excessive damage to an already fragile economy.
What if Trump were to be elected ?
We believe that markets are rather apolitical, so do not usually attribute a large weight to politics in our analysis. Although not our base case, Trump as possible next US President clearly represents the greatest potential for dramatic change – and thus the greatest uncertainty.
Control of Congress is likely to remain in republican hands, so a Clinton victory would have to face opposition in Congress. The policy environment would therefore be status-quo vis-à-vis the current Obama administration.
A Trump victory would have three implications as regards the economy: aggressive fiscal stimulus (much lower corporate tax levels, massive government spending on infrastructure and a repatriation bill), protectionist measures on trade and immigration (mainly affecting the US relationship with Asia and Latin America) and a more restrictive monetary policy (with Janet Yellen to be replaced by a more hawkish Fed Chairman). All this would add volatility to the US dollar (USD), equities and yields, putting financial pressure on the rest of the world.
At this stage, we hold to our base case of a (divided-government) Clinton victory, but closely monitor the risk of a Trump Presidency – with the impact on portfolio positioning discussed in the asset allocation section. Note: Unless otherwise stated, all data mentioned in this publication is based on the following sources: Datastream, Bloomberg, Lombard Odier calculation.