Against a backdrop of positive economic “facts”, worrisome “damned facts” and a slew of confounding “alternative facts”, we suggest that investors focus on realities—good and bad—and remain prepared to ride out short-term turbulence.
Facts: Global economy is growing and business spending is set to rise
Underpinned by healthy fundamentals, economic growth has been improving in most regions, pushing volatility levels below long-term averages and equities to near historic highs. Business fixed investment is also starting to finally pick up after years of underinvestment. Since the economic downturn in 2008, businesses have reduced investment in fixed assets as a way to preserve margins and keep profitability high. Over the short term, there are no immediate consequences of low capital investment.
After years of underinvestment, though, productivity growth is languishing and now rising wages are starting to squeeze company margins. New restrictive immigration policies will likely exacerbate this wage increase. Building a wall, or any other large infrastructure project, combined with a big shortage of legal, skilled workers will drive wages up even faster. In this environment of low unemployment and rising wages, businesses can more easily make the case for undertaking capital projects to boost productivity. With a strong underlying economy and financing costs that are still low, the environment for capital investment is near perfect. The long-awaited resurgence in capital spending could also give legitimacy to the recent stock market rally.
The latest release from the Bureau of Economic Analysis1 shows that business fixed investment is indeed rising. In the oil and gas sector, there is also tangible evidence of an upturn, while utilities are making investments to shift from coal-produced energy to natural gas. Large solar arrays in desert regions have also become competitive, so we are likely to see continued investment in this type of infrastructure despite the Trump administration’s sceptical position on climate change. This all provides further evidence that conditions are favourable for capital investment, which is an important component of sustained economic growth.
Damned Facts: Risks of inflation and policy contradictions
On the “damned facts” side, inflation appears to be picking up. We are seeing this not just in the United States, but also in Europe and in Japan. Although positive in the sense of avoiding a deflationary or recessionary environment, the problem with inflation is that it is very difficult to control once it takes hold. Inflation leads to significant increases in bond yields, which have already risen in the U.S. and have started to rise in Germany and even Japan. If damned facts like this go too far, they can become damaging to the economy in the long term.
Another related damned fact, depending on perspective, is that U.S. unemployment is below 5%.2 The trick with unemployment is to keep it low enough to fuel growth, but just above the inflection point at which it sparks inflation.
This brings into question the wisdom of additional stimulus from the Trump administration that could push unemployment to an even lower level that would unleash inflation and potentially force the Fed to raise interest rates in an effort to cool the economy. The contradictory policies could be a source of volatility and concern for investors.
Alternative facts: Presidential tweets and other frictions
President Trump continues to believe that the U.S. economy is in need of significant protection, that it is not growing at a sufficient pace and that U.S. workers are suffering due to a lack of jobs. The evidence suggests otherwise—which is what makes it an alternative fact—leading to the possibility of overstimulus.
Alternative facts that have no direct connection to the economy also create noise, concern and political uncertainty. “Trump Twitter Turbulence”—the president’s practice of spontaneously tweeting without regard to hard facts—has been a source of market jitters on numerous occasions. Finally, there is the potential for conflicts between the president and Congressional Republicans, which could stymie meaningful political initiatives while leading to some significant headlines and volatility.
Conclusion: Just the facts, please
Alternative facts have a tendency to be resolved by real facts at some point. We believe investors need to shift their focus from alternative facts to the real facts and possibly the damned facts. For now, the strength of the underlying global economy and strong signs of a rebound in capital investment give them plenty to cheer about.
1 U.S. Bureau of Economic Analysis (BEA), News Release: Gross Domestic Product: Fourth Quarter and Annual 2016 (Advance Estimate), 27 January 2017. www.bea.gov
2 Bureau of Labor Statistics (BLS), 31 January 2017
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