As we start into the second month of 2017 I would like to cast the focus on the United States of America, its economic outlook and ponder on the crazy thought that Donald Trump actually might be right.
2017 is likely to be a year of transition and huge importance for countries all around the world. Geopolitical conflicts in the middle east, strengthening populism in Europe, weakening emerging markets and the rising threat of terrorism characterize the uncertain global environment. And let us not forget about the mad man who just took over the role as American president. This year is not going to be boring in any case.
Given this global theme, there are compelling reasons to look more closely on the prospects of the world´s most powerful nation. The conclusion: American equities still offer strong potential!
Given the current price levels of equities and the DOW JONES to new, historic highs this may seem like a courageous statement . In fact, US equities have been more expensive than current levels only 10% of the post world war 2 time.
I think, there are three factors to consider:
The General Global Economic Development
The trend of positive economic growth is expected to continue and even accelerate in 2017. This not only goes for the US but can be expected globally. Besides the United Kingdom, which may suffer from Brexit symptoms, the European Union is expected to continue its recovery. The repercussions of the UK leaving the European Union are likely have only effects. Whether London can survive as Europe´s financial hub is just one question the British nation will have to face.
A threat for European development may pose the rise of populist parties. Of special concern will be the elections in both Germany and France. While I do not expect the populist party “Alternative Für Deutschland” (AFD) to dramatically affect the outcome of the elections, terror attacks and sexual abuse by people with a refugee background will strongly strengthen the far right. Nevertheless, a political revolution is not to be expected. Similar counts for France where Marine Le Pen will most likely not take over as the new French president. However, in 2016 both Brexit and Trump´s election were regarded as highly unlikely and therefore we cannot preclude more Black Swans in 2017. Besides Europe, a slight recovery in the Emerging Market lead by plagued Russia and Brazil may strengthen the global outlook.
Monetary and Fiscal Policy
Much has been talked about the threat of inflation in the last few months. However, the main global concern still should be disinflation. Globally there is excess capacity both in terms of labor supply and industry supply. For inflation to emerge, excess demand or a shortage of supply are prerequisites. However, given the fact that one may be more concerned about a shortage in demand, it is difficult to imagine a major inflationary period. On this background the balance sheets of central banks such as the EZB and the BOJ are expected to further increase. Supportive monetary policy will be accompanied by active fiscal policy in the United States. Donald Trump will act according to his promises and fiscal policy may take the form of infrastructure programs and/or tax cuts.
Much has been written about Donald Trump and his public lapses. But it may be appropriate to look through his outrageous personality and highly questionable views on equality, religious freedom and immigration and think about economic effects of his aimed protectionist policy.
“Sadly, the American dream is dead!”
That´s what Donald Trump claimed during the election campaign. He quickly spotted a guilty party – China. China flooding the world with low price products and America´s subsequent loss of manufacturing labor constitutes “the greatest theft in the history of the world” according to the new man in the white house.
Economists, indignantly claimed this to be ridiculous. In international economic thought free trade is beneficial for everyone. Every country produces the product which it has a competitive advantage in. In the American-Chinese case this means China exports cheap, labor intensive manufactured products while the US skill intensive goods and services. Economic theory predicts a mutual increase of GDP per capita as a result of this integration. Jobs lost in manufacturing will be replaced by jobs in higher paying higher skilled labor and at the same time consumers can buy cheaper products. It is a win-win. As a student with a bachelor´s degree in economics this was my direct response as well.
Sadly, while it may be true that in aggregate nations become wealthier through trade, there are severe distributional repercussions. Skilled labor becomes even more demanded while unskilled labor is not needed anymore. The wage gap widens. The claim that workers just choose the next best job is not applicable to reality. People in general will not leave their family, home and friends to move to another state looking for a job, just to start all over again. More importantly, manufacturing workers will not directly be qualified to work in high-skill labor jobs. The reallocation process in fact seems to be slow. Losses in manufacturing jobs in a geographic area correspond to overall job decline of the same magnitude for as much as ten years. This loss of jobs may result in the end of industries and may be exacerbated through decreased local demand. The death of communities is the result.
Even though it sounds populist the American loss of manufacturing work can be partly attributed to China´s rise. Through the Chinese “Reform and Opening” in the 1970s hundreds of millions of people migrated from the rural less productive agricultural industry to cities to work in production. Between 1991 and 2013 Chinese exports grew from 2% to 20% of global exports. China has developed from a backwards nation to a world class competitor. While this has elevated hundreds of millions of Chinese workers out of poverty it has affected the Western world.
China entered the World Trade Organization in 2001. During the time frame between 2000 and 2007 an estimated 1 million manufacturing jobs were lost in the United States due to China´s increased trade with the US. As much as 40% of the drop in manufacturing activity may be due to the trade shock that followed China´s entry into WTO even controlling for technological effects.
Why do I mention all of this? The point is, that it may in fact be beneficial to not disregard manufacturing workers. Even though protectionist reforms can be truly harmful and the lost manufacturing demand will most likely not be restored, Donald Trump in fact may have reason in protecting the “weak”. After all, increased manufacturing labor would increase domestic demand.
Sharmin Mossavar-Rahmani, chief invetsment officer of Private Wealth Management at Goldman Sachs mentions more factors in favor of American equities. She estimates the probability of a 2017 recession in the United States to be 15%. On the other hand during an expansionary period the probability of positive equity returns is as high as 86%.
She makes the claim that another argument for American equities is the general condition of the country. Since the financial crisis people have tended to be very pessimistic about the US and optimistic about other parts of the world such as China.
But while both private households and the financial sector in the united states have considerably saved and improved their balance sheet since the end of 2008, (previous economics contractions where accompanied by dissavings) the Chinese Credit to GDP gap (defined as the difference between Credit to GDP ratio and its long term trend) widens strongly, implying increasing debt burdens. Additionally, China is fighting capital outflows of 1.3 Trillion Dollars while the US was the main target of inflows and foreign direct investment in the recent past.
Thus, despite differing views, the gap between the US and many other countries is actually widening. In terms of GDP per capita, it is still the richest major economy in the world. The oil sector has increased, making the US produce as much as 10 million Barrels a day. Still the country is unprecedented in terms of economic strength, R&D and innovation and the aforementioned points summarize why I consider the US to offer much potential in 2017.