In three weeks, I’m going to try to run the New York marathon. I’m pretty nervous about this – it is my first, and undoubtedly last, marathon, and it would have been easier if I had attempted it 20 years ago. Still it has been fun training for a goal and I’ve learned a lot about the science and psychology of long-distance running over the past few months.
One thing I’ve realized is that a marathon runner, in the later stages of the race, has a shortened horizon. It is easier, on aching legs, to think only of the distance to the next bend in the road, the next mile marker, or the next water stop. It is very hard to plan past the finish line.
The American people have now suffered through their own marathon…a thoroughly dispiriting election campaign, dominated by insults and scandal rather than any serious discussion of the issues that are supposed to divide Republicans and Democrats. From an investment perspective, it has been a perpetual distraction and the three weeks left in the campaign feel a bit like the last three miles of a marathon. However, for investors, it is important to think past the finish line and consider the investment environment after the election.
One aspect of this will likely be a decline in uncertainty and relief that it is over. This, on its own, could be a positive for economic and market sentiment. However, fiscal policy under a new administration could also add to demand in the economy.
This view is not based on a careful analysis of the policy positions of either candidate. Even if we assume that both candidates are firmly committed to those policies, it needs to be recognized that, barring a political earthquake, the House of Representatives will remain in Republican control, with Paul Ryan as Speaker of the House.
Consequently, the most important post-election reality is that either Hillary Clinton or Donald Trump will have to negotiate with Mr. Ryan, and, given his comments on both candidates, it is highly unlikely that he, or Congress in general, would rubber-stamp the policy agenda of either potential president. It is possible that the outcome of the election could give new impetus to immigration reform or corporate tax reform. However, on other issues, much less change is likely to be delivered than is being promised.
Having said this, one likely outcome, under either potential president, is fiscal expansion. Last week, the Treasury department announced a federal deficit for fiscal 2016 (which ended on September 30th) of $537 billion or roughly 3.2% of GDP, up from $439 billion or 2.5% of GDP a year earlier. This fiscal year, even with no policy changes, the deficit would likely climb higher. However, with a strong populist tide in both political parties, there will be significant pressure to increase infrastructure spending, cut taxes on middle-class Americans and to further relax the “sequester” cuts, boosting the deficit.
All of this could add to aggregate demand in an economy which is already showing signs of healthy growth and some inflation pressure. Data due out this week should confirm this. Reports on Industrial Production for September and the Philadelphia and New York Fed Manufacturing Surveys for October should show improvement while Housing Starts and Existing Home Sales should both show robust gains. More significantly for markets, CPI Inflation data, due out on Tuesday, should show solid increases, with headline inflation of 0.3% for September and 1.5% over the past year and inflation outside of food and energy maintaining a 2.3% year-over-year pace. If oil prices hold steady over the next few months then headline CPI should reach 2% year-over-year by December and the headline personal consumption deflator should surpass the 2% year-over-year threshold by February of next year.
All of this adds to the significance of Fed Chair Janet Yellen’s speech last Friday. In it, she suggested that “….temporarily running a “high-pressure economy”, with robust aggregate demand and a tight labor market…” might boost both labor supply and productivity.
While this may be so, it also carries with it a risk. The Fed has saturated the economy with liquidity for years and both households and corporations are holding vast cash balances. If a “high-pressure economy” became a higher inflation economy, many might feel the need to convert these cash balances into goods or services or assets, thereby further stoking inflation. For many the years, the Federal Reserve has recognized that its actions only impact the economy with a lag and thus its policy needs to be preemptive. However, over the past decade, the Fed has slid from being preemptive to being data-dependent, to being reactive and now, based on Chair Yellen’s words to perhaps not being that reactive to signs of rising inflation.
An experienced marathon runner has a plan for the 27th mile. What are they going to drink and eat after the race? Where will they meet friends and family? How will they get some rest? In the same way, investors today need to have a plan for after the election. With both the Federal Government and the Federal Reserve looking to further stimulate an already full-employment economy, adding to growth but also adding to inflation, that plan should probably tilt towards equities relative to fixed income or cash.
Chief Global Strategist