A Different Administration
Everyone in the world who is aware of international events is living in uncertainty regarding the new American administration. While this is always the case with new presidents, the angst and uncertainty regarding policy and direction is perhaps unparalleled since Franklin Roosevelt’s presidency. Investors need some basis for understanding their future, and this article is an outlook based on history, social trends, and accepted economic theory that we currently embrace as a basis for investment decisions.
What do we at KWM see for at least the next four years? While people on polar opposite sides of the political spectrum express their value judgements, we would like to focus on the consumption versus investment decision that confronts all individuals, institutions, nations and even global society. Specifically, all living organisms or groups of organisms make daily decisions about consumption, or immediate satisfaction of needs, or investment, delayed satisfaction of less specific needs in the future. Historically, these decisions run in cycles as people assess their horizons regarding longevity, family and long term imperatives, such as retirement and healthcare, relative to immediate needs and desires. Some of this assessment is rational, some emotional, and some collective.
We may be entering a period of more intense focus on immediate satisfaction of personal and communal needs. If so, expect that long term goals may be disregarded or discounted in favor of more immediate social, political, economic and security desires and needs. One of the signs of such change is intensely public debate regarding core values, spending and political restructuring. The Administration has taken the helm of a party and country both of which are deeply fractured but contesting the application of power in government. There are underlying partisan commitments to economic values such as free trade, a robust international defense policy, low deficits and fiscal responsibility, smaller less Federal government, less regulation and pro-business tax policy. The Administration’s agenda appears to be more protectionist regarding trade, less involved internationally regarding defense and less budget conscious as taxes are lowered and spending on infrastructure is increased. The Administration has also targeted regulation and stated a goal of restructuring the tax code. The existing balance of power in Washington is being contested as well. Historically, such a rapid reorganization of values and direction effects change but often leads to unintended consequences. It is worth remembering that aspects of the 2008 Great Recession were the result of past deregulation such as the repeal of the Glass-Steagall Act. Internationally major government restructurings and revolutions often create power voids that have resulted in actual wars, trade wars, corruption scandals, constitutional crises and economic recessions. Trade barriers, such as the Smoot-Hawley Tariff Act of 1930, can have negative economic consequences. Conversely, Congress has not typically ceded funding power to presidents easily. Also, the electoral blocks who voted for the President desire to see results, raising the question of the ability to meet expectations versus political realities. Furthermore, the longer term effects of significant restructuring may generate political and economic reactions faster than anticipated. Even as we are uncertain about new policies themselves, we are also uncertain about the ramifications of those new policies. Our expectation, despite this uncertainty is that the Administration will order and implement activities that have immediate resonance and defer attention on longer term issues.
We continue to believe that the core issue for the U.S. and international economies is slow productivity growth, which is a problem that involves comprehensive policy on education, demographics, environment, healthcare, regulation, trade, immigration and government spending. More generally, trade barriers immediately promise to save or generate jobs. Long term, trade barriers decrease GDP and may motivate automation that decreases manufacturing jobs. Tax reform takes extraordinary hard work over a number of years to keep it from becoming a special interest bonanza. Repealing health insurance requirements cuts expenses but without a meaningful substitute could eliminate healthcare for up to ten percent of the work force, and create health barriers such as youth un-insurance or pre-existing conditions. Repealing financial regulation streamlines financial processes but could ultimately create voids leading to risky behavior or a financial melt-down. Retreating from military and economic support for allies eliminates national responsibilities but may embolden aggressive adversaries who study our international relationships for potential weaknesses. Thus short term actions can satisfy immediate needs, but often do so at the expense of long term stability or goals. Our government furthermore acts as an example to individuals and institutions facing similar balancing decisions. Finally, markets may react more quickly as investors judge the incoming administration’s competency, capabilities and persistence balancing short and long term plans.
As we at KWM plan investments, the following trends in the U.S. and globally are our base assumptions:
While all out trade wars are unlikely, restricted trading and barriers are likely leading to higher prices and in some cases lower quality. China is the most probable target, and may ultimate replace TPP with their own trade agreement. Global GDP will likely decline as trade diminishes, and in the U.S., automation, rather than job creation, will flourish in manufacturing that does resurface. We suspect a contrarian approach makes sense: industries with stable growth prospects in regions with weak currencies could be attractive.
Defense spending in the U.S. is likely to remain high, though the willingness to commit troops to trouble spots is likely to decline, leading to some parts of the developing world becoming unsafe, criminal or coopted by Russian or Chinese interests. As the world becomes a more dangerous place, defense and armament suppliers in the U.S. and abroad are likely to flourish. Investment in selective defense contractors could present opportunities.
While U.S. policy on climate change is likely to be chaotic or inconsistent, the world outside the U.S. is becoming more concerned and involved in reduced fossil fuel consumption, air quality management, storm preparation, habitat preservation and sea level rising. We expect the market for renewables, remediation and energy transition to grow globally, with both U.S. and international firms vying for share. Expect special political benefits for U.S. fossil fuel production, as the administration hosts numerous past oil executives. Internationally we think alternative energy and civil engineering firms will provide good options.
Health care worldwide is becoming a more critical issue as the demographic age of developed economies increases, and as wealth stratification grows. In short, more people will demand health care but have fewer individual resources to spend on treatment or prevention of disease. We are likely to see further investment in healthcare, but also some tragic healthcare deprivation in the U.S. and globally. Healthcare, like technology, will focus on huge markets even as some simple but low profit health needs languish. Timely values in healthcare stocks remain.
We expect a congressional tax bill that resets current tax loopholes and deductions but does not affect complexity or tax equity. Tax services will continue to offer promising investments.
Technology investments will continue to grow as global demand for mobile devices, cloud computing, connected content, internet security, automation, robotics and autonomous vehicles progresses. Technological reinvention remains a key driver of growth.
Financial conditions are likely to reverse within a few years from deflationary to inflationary due to several conditions. We see six possible causes for this change, but, in the current uncertain environment, the occurrence of these causes, their timing and their magnitude argue for caution when predicting inflation. First, anti-trade tends to elevate prices and create shortages as we live in a truly global economy. Second, the resource production cycle has gone from expansionary, to contractionary, to stability, even as new low cost sources such as fracking have been established. The abandonment of high cost production is in late innings, firming prices. Third, labor utilization, with unemployment under 5%, appears to be reaching saturation, where labor costs begin to rise due to insufficient skills and workers to maintain our technological society. The Chinese economy, a major producer of low cost goods for the U.S., Europe and Japan, is facing escalating costs from an aging population, environmental stress, internal corruption and central planning limitations. Fourth, the needs of global populations are changing from primarily food, clothing, energy and shelter to greater dependency on education, retraining and healthcare, where costs are rapidly inflating. Fifth, governmental fiscal spending is likely to increase, as efforts to generate economic growth accelerate. We expect infrastructure and defense spending increases, both with and without payback to taxpayers. Sixth, there is a global pent-up monetary base from nine years of loose monetary policy by global central banks, which is likely to be activated by the economic impulses described above. The extent of this money corralled and removed from economies as its velocity increases is uncertain and historically central banks tend to be behind the inflation curve. Yet we suspect that the Fed in particular is eager to lead in preventing inflationary surges in the U.S. Interest rates should rise with inflation over the next 36 months, and gains in stocks of companies that demonstrate price setting power. We see no recession in that period, but as our economic expansion is already one of the longer historically, underlying resource, labor and financial imbalances are rising which typically result in recession. Equally likely however is the possibility of a return of “Stagflation”, an environment where growth is unacceptably low and inflation is unacceptably high. Industries beaten down over the past years by economic forces may revive as prices and demand for their products firm. Since the market averages are now highly priced, we advocate defense, holding undervalued U.S. stocks, consistent dividend payers, more cash, contrarian and stable international stocks. We now avoid longer term bonds and bond funds which depreciate as interest rates rise. Active investment management remains a valuable service in both expansionary and contractionary scenarios.
KWM is the abbreviation for KENETEX Wealth Management, in Ann Arbor, MI. KWM is a Member of Advisory Services Network, LLC, a Registered Investment Advisory in Atlanta GA. As we stated at the outset of this article, there are many uncertainties in our government, economies, global relations and public sentiment. There is no guarantee that these assumptions will manifest in reality, nor is there any reliable gauge as to the extent that they manifest. All views/opinions expressed in this newsletter are solely those of the authors and do not reflect the views/opinions held by Advisory Services Network, LLC.