Today, I want to discuss three topics, the Election, the impact of two major hurricanes, and the productivity potential of AI. Then, I will attempt to put a bow around the package tying all three to today’s financial markets.
Let’s start with the election. From an economic viewpoint (the only way I look at elections within these market letters), both candidates have serially introduced new goodies. More tax cuts and giveaways without any hint of how they would be paid for. The latest from VP Harris is for Medicare to pay for senior home care. Virtually all of the tax proposals from each side, plus, for instance Medicare funding for senior care, will require Congressional approval. In the Senate, a process called reconciliation can be used that only requires a majority vote for passage, provided the underlying bill includes just tax or revenue issues. The races in both chambers of Congress are still as close as the Presidential race. But there are differences. The House is now led by Republicans, but as the past year has shown, Republican leadership cannot garner enough votes unilaterally to pass anything of substance. Its majority is not monolithic. As for the Senate, there are approximately 6 seriously contested races. Right now, the most likely outcome is 50-50 (assuming independents align with the Democrats) or 51-49 in favor of Republicans as Tim Sheehy in now about 6-7 points ahead of Democratic incumbent Jon Tester.
Thus, for Democrats to retain control, it would require a Harris win, Tester holding his seat, and Democrats winning all the other contestable races. The Republicans will gain control simply by Sheehy winning. Even if he loses, Republicans would control leadership if Trump wins the election.
To pass any legislation of consequence, the party in charge will need virtually 100% consensus, something the House has demonstrated this year is nearly impossible. Thus, despite whoever wins the Presidential race, getting any legislation passed will be extremely difficult without compromise. As noted in previous notes, the one issue that will likely be resolved via compromise is how to modify the expiring Trump tax cuts of 2017 when they sunset at the end of 2025.
Let me move on for now to the hurricanes. The destruction is heart wrenching. But again, I have to contain my emotions and look at only the economic consequences. Helene and Milton punctuate the costs of a warming planet. Without trying to judicate the causes, the economic consequences are enormous. Florida, along with the other Gulf states is in the bullseye of hurricanes. The carnage from storms over the past several years has forced many property insurance companies to leave the state, premiums they would be required to charge will simply be too high to justify chasing that business. In response, Florida created its own catastrophe fund that subsidized part of the costs borne by insurance companies resulting from major storm damage. It was funded by mandatory payments made by insurers operating in the state. But it is likely that Helene and Milton will deplete the reserves requiring some combination of future further reinsurance, floating additional bonds, and assessing the insurance providers. We don’t know yet how this will play out precisely but most likely, insurance rates will rise significantly once again, and some more insurers will simply leave the state.
Florida had the double hit this year but it isn’t alone. California and other western states bear the costs of annual wildfires. Phoenix had 70 days this year with temperatures over 110 degrees, triple the number of just a few decades ago. The incremental costs of electricity are enormous in addition to the detrimental health impact of the heat.
It may take years to see the full impact of weather changes. How often can barrier islands be rebuilt? How do you protect from fire risks? In the West, homeowners have to replace cedar shake roofs with composite materials or face a meteoric rise in insurance premiums. The message from Ashville, North Carolina is that if you are in a flood plain and eligible for flood insurance, take it. Zillow is beginning to display risks related to climate change within its listings. Escaping state income tax to move to Florida or Texas and face the increased costs to insure against hurricanes or tornadoes may not be worth it.
I haven’t even mentioned the health risks directly related to heat, impacts beyond stronger hurricanes emanating from a warmer ocean, the lack of snow in ski areas, etc. Milton and Helene simply make us all aware that living in a warmer planet has real and consequential costs. Over time, these changes may well impact where and how we live.
Now onto AI. I want to note two items from a recent AI summit. From Lockheed Martin, AI drones can now perform autonomous inspections of transport planes like the C-130, using and interpreting digital imaging which turns a multi-day process into a 1-2 hour event. At Northrup Grumman, AI digital twins model satellite communication and cooperation, shortening the ultimate manufacturing cycle by 50% or more. Legal searches require a fraction of the time previously expended by paralegals. And those searches are likely to be more comprehensive and accurate than before. When ChatGPT was introduced less than two years ago, it was eye opening. Typically, however, the media tried to poke holes in it, highlighting funny sounding book reports, tricking it into absurd outcomes. You don’t see those stories anymore. ChatGPT is now in its fourth iteration and each one has been hugely more capable than the previous one. One definition of GDP growth is to multiply population growth times the rate of productivity improvement. Population growth, a function of birth rates and the pace of immigration, might increase either side of 0.5% depending on any given year. Over the past many decades, productivity gains have averaged about 2% or a little less. Most of the gains were related to improved technology. AI has the promise of elevating those gains for a very extended period of time.
Now, let’s try and pull all this together. Stocks set new all-time highs Friday. Economic data almost universally says that we are headed for a soft landing if there is to be any landing at all. The labor market is still robust, consumer spending is solid, capital spending is led by the buildout of the AI infrastructure, and home construction remains solid. Credit markets show few signs of stress. The only big issue is valuation, which is either fair or a bit stretched. The Presidential horse race will play itself out but there are few signs of major economic disruption ahead. While the proposed goodies of both candidates would explode the deficit, there is little reason to believe that Congress will let either run amok. While climate change is likely to be increasingly expensive unless or until weather trends change, the impact will be very geographically and industry specific. Throughout the sunbelt, costs for insurance and electricity are going to be an increasing burden to both homeowners and manufacturers. But these costs should be offset by the productivity gains to be generated by the rapid development and expansion of artificial intelligence.
If you query leaders throughout the expanse of technology, virtually everyone will tell you that they are awed by the speed at which AI is expanding. To be sure, there will be bumps along the road. Capacity growth may exceed demand at times leading to brief pauses. But ultimately the impact will be pervasive throughout all the economies of the world. Acceleration of the pace of economic growth, despite moderating increases in population, should lead to a sustained period of growth equivalent to any industrial revolution of the past. Stay tuned.
Today, Usher is 46. Ralph Lauren turns 85.
James M. Meyer, CFA 610-260-2220