October was a down month in markets as investors prepared for election uncertainty in the United States. Equities fell across the board, with foreign stocks declining more than those in the US markets. Bonds also declined as interest rates rose along the yield curve. In our opinion, the steepening of the yield curve was driven by several factors with the main driver being some increase in long-term inflation expectations driven by potential US fiscal policies.
At this point, we think what happened in October can be thought of as ancient history. The US election was concluded more or less on election night, and markets are trying to make sense of what the future might hold under a new administration from an economic perspective. Since November 5th, equity markets have generally welcomed a definitive outcome and the yield curve has not materially changed.
When we evaluate the evolving economic environment, we try to do so from a neutral and dispassionate point of view. From strictly an economic perspective, there are numerous potential changes that come with pluses, minuses, and tradeoffs.
First, the potential pluses as we see them. The potential for tax rates to move meaningfully higher seems to be less of a risk, and there is some possibility they could move lower. Resolving this should allow businesses to plan and invest with more certainty. It also seems clear that decreasing regulatory burden is a priority, which, in our view, would be a plus for the overall business climate. Decreasing the regulatory burden may be more of a benefit to smaller businesses and companies, as the costs to comply tend to be more meaningful and less easily absorbed. An “America First” economic approach may also benefit more domestically oriented companies, which tend to be smaller. However, what that approach could mean in practice is still to be determined.
Now, the potential minuses and tradeoffs, as we see them. In our view, tariffs are controversial and economically less efficient in an “all else equal” academic world. In the real world, all else is rarely equal, and it is hard to know how much of the tariff talk is posturing in the context of pursuing broader economic and trade goals. To the extent there are tax cuts or an extension the Tax Cuts and Jobs Act, there will likely be spending cuts on the table. There is a desire to reduce the size and influence of government, but how or if that happens is still an open question. Presently, the amount of deficit spending is a positive for today’s nominal GDP growth but pressures real GDP growth with incrementally higher inflation today and possibly structurally higher inflation over the long term. Cutting back on government could pressure nominal growth in the near term but help real growth in the long term. The extent to which the government shrinks, if at all, and how it happens could tip the economy into a recession.
It is hard to talk about these various items with much certainty. The one thing we are sure of is change. Markets and the economy are complex, adaptive systems. The specifics of the change and the downstream effects are highly uncertain.
