Stocks rose once again yesterday as it appeared that a final trade deal with China was imminent. In addition, it seemed that Republicans and Democrats in Congress were close to a spending deal to avert another government shutdown. Maybe Congress and the White House are finally beginning to comprehend each other’s style that will allow some forward progress.
Overnight, the British elections resulted in an overwhelming victory for the Conservatives who gained an absolute majority in Congress. What we saw in Britain was a somewhat conservative Maverick politician with funny blond hair, Boris Johnson, defeat a very progressive liberal who pushed a very aggressive spending agenda. If you think I am drawing an analogy to our election next year, you are right. I know the United States and Britain are very different nations but, politically, we do come from the same gene pool after all. With the overhang of Brexit still existing, the vote last night was a resounding “get it done” mandate. That doesn’t mean a hard Brexit at all. It means that the majority want to solve the issue and move forward with their economic lives. The sticking issues, most notable the border concerns between Ireland and Northern Ireland, are solvable if both sides want to solve them.
Speaking of squabbles where both sides want a settlement, China and the U.S. appear to be creeping closer to either a very small Phase I deal (although our President will never describe any deal as “very small”). The U.S. side says there is a deal in principal, but President Trump still needs to sign off. The Chinese aren’t yet saying any final agreement has been reached nor has President Xi signed off. But it appears very likely that increased tariffs, scheduled for Sunday, aren’t going to happen. We have all heard the expression watch the actions; don’t listen to the words. That aptly applies here. There is a deal when the documents are signed. But getting close enough to defer the next layer of tariffs would be well received by markets. Indeed, that is happening right now judging by yesterday’s actions and this morning’s futures.
With that said, I am in the camp that says that the tariff story has been a bit overplayed in both directions over the past year and a half. Certainly, in specific industries that is not the case. The steel and aluminum industries are cases in point. The same holds for transportation stocks whose fortunes are tied to the volume of trade across the Pacific. But if you want to judge the future path of world economies, I believe looking at both monetary and fiscal policy is most important.
In that regard, we have gotten quite a few positive signals lately. On the monetary front, the Fed this week basically said that it is on indefinite hold regarding interest rates at least until changes in the outlook for economic growth or inflation change materially. Growth in the U.S. has hovered around 2% for years, maybe a bit higher, and inflation still seems stuck at about 2% as well. It has fallen toward 1.5% for a while but appears to be coming back as both wages and commodity prices are trending higher. This morning, the dollar has weakened again, especially against the British Pound. That will help optics in the short run. Central banks around the world also remain accommodative and we see few interest rate changes in sight. While some investors (maybe including President Trump) are also pushing for lower rates, stable rates and consistent monetary policy may be even better.
But the bigger news this week is the expansion of fiscal policy around the world. Both Boris Johnson and Jeremy Corbyn campaigned on a theme of higher spending. Mr. Corbyn’s plans were simply too much and would have resulted in much higher taxes. In France, Mr. Macron is going to have to loosen the purse strings a bit to keep labor peace. In Germany, the Green Party is gaining strength. China is spending to offset slowing economic growth. The list goes on.
With that said, the progressive argument that deficits don’t matter and that governments can spend almost with abandon is pure hogwash. Yes, obviously, if interest rates were zero and there were no debt service costs, one could borrow and borrow and borrow. But ultimately lenders want to be repaid.
Interest rates don’t matter until they matter. Normally they are tied to inflation, but they are also reflective of credit worthiness. Just ask most of Europe what happened six or seven years ago. The spending bill Mr. Trump is going to be asked to sign will once again inflate the deficit. I know an election is coming and politicians on both sides of the aisle like to spread a little pork to insure reelection. But there is a need for fiscal responsibility just as there is going to be a need before too long to rein in entitlement spending. But when isn’t tomorrow and I know I am preaching to the choir for now? When asked how does this long bull market end, I would answer that it will probably relate to the growing mountain of debt throughout the world. Once again, that isn’t today’s problem but just as we saw in 2007, when the probability becomes apparent to all, it’s too late.
But today is one for the bulls and that euphoria will probably carry through to year end.
Today, Taylor Swift is 30. Jamie Foxx turns 52. Finally, Dick Van Dyke is 94.
James M. Meyer, CFA 610-260-2220