America’s fiscal follies and the road ahead
Now that the dust has begun to settle from Washington's debt ceiling drama which included a 16-day government shutdown, investors are left focusing on the damage done and what's ahead for the world's largest economy.
Clearly, America's ongoing fiscal debates and successful resolutions at each step in the attempted deficit reduction process are critical to advancing the US economy which has lately been an important driver of global economic growth.
Whether or not America can continue to lead global growth and provide further stabilisation to struggling regions such as Europe and the developing countries will depend upon how quickly the US can pick up the pieces and move ahead.
In the meantime economists believe that the government shutdown, including the knock on effects to business and consumer confidence, will shave anywhere from 0.25% to 0.6% from this quarter's Gross Domestic Product (GDP) growth.
While the path ahead seems daunting, we remain guardedly optimistic that an accommodative Federal Reserve combined with the historically adaptable and resilient US private (non-government) sector will be largely constructive for growth.
In fact, America's free enterprise system primed by loose monetary policy has already been in play, so far successfully offsetting much of the political circus in D.C. this year.
For example, accommodative monetary policy which established record-low mortgage rates has recently succeeded in pushing real estate prices upwards all across the country.
The National Association of Realtors reported home prices increased by 11.7% year-over-year for September following a record 13.4% year-over-year increase in August.
A report released by the International Monetary Fund (IMF) earlier this month stated that while tighter American fiscal policy (sequestration and higher taxes) is expected to shave 2.5% from US GDP this year, the agency expects an ongoing real estate recovery to contribute to economic growth of 2.6% next year deflecting much of this year's belt tightening and political wrangling fallout.
Pent up demand for automobiles may also be boosting the private sector.
Consumers held back on replacing their cars and light trucks during the lean years of the Great Recession in 2008 and 2009 leaving America's auto fleet currently at a record 11.4 years old. Annualised automobile sales averaged 16.8 million units from 1998 to 2007 but fell to just nine million units during the depths of the recession.
Sales have since recovered, but to just 15.2 million annually according to industry data.
Meanwhile, up to 20 million cars may still need to be purchased at some point over the next few years to replace ageing vehicles.
For these and other related reasons, economists forecast the US to continue to be the ‘cleanest dirty shirt' in the global laundry bin.
The Bloomberg consensus of economists forecast the US to grow faster than most of the other G10 countries next year and faster than all of the other nine members in 2015.
Many key pieces are in place for the private sector to carry the growth torch, but government obstacles remain.
Importantly, while the debt ceiling has been raised and a default crisis averted, the latest resolution is designed as only a temporary fix.
Early next year the entire process must be revisited once again.
Expect the path ahead to be a perpetual series of successive resolutions to fund government programmes for just a few months at a time before further roadblocks are encountered later.
On the plus, the risk markets have begun to look through these regular impasses, anticipating the inevitable resolutions sooner.
For example, this time around the S&P 500 stock index fell just 4.0% from its near term peak to a trough, compared to a 7.3% decline during last year's ‘fiscal cliff' showdown.
Already, bond stock and bond markets have advanced smartly since the end of the government shutdown.
As of this writing, the S&P 500 has increased 5.9% from its nadir on October 8th, while the Barclays Aggregate Bond index has advanced 0.8% over the same period.
Perhaps the most important silver lining of the government shutdown is that lower growth reduces the likelihood of the Fed tapering its $85 billion monthly bond purchase programme for now.
Over the summer months, bond yields soared and prices fell with the benchmark ten-year US Treasury bond yield nearly doubling from a low of 1.6% in early May to a peak of 3.0% on September 5th on fears of Fed tapering.
The jump in interest rates crimped the mortgage refinancing market, softened retail sales and slammed emerging markets.
Emerging market were hit particularly hard as funds were repatriated back to the US on the higher rate outlook.
Countries such as Brazil and Turkey were then forced to hike their domestic interest rates in order to stem the tide of out flowing capital causing the unintended consequence of further slowing their domestic growth. We believe any delays in tapering will be helpful for emerging markets and the developed countries which increasingly rely on them for exports.
Through at least the end of this year, we see the bond market maintaining a strong bid as tapering is likely pushed back until early 2014.
This past Tuesday, government debt rallied the most in a month after the delayed US payrolls report showed job growth in September was substantially less than analysts had projected.
Also looking attractive in my opinion are stock dividend strategies and select emerging markets, many of which have lagged the market year-to-date through the end of the third quarter.
When longer term interest rates pushed higher last summer, investors fled dividend-paying stocks in the telecommunications services, energy and developing market sectors. With the taper scare likely off the table in the near term, we have been increasing our focus on lagging companies with a track record of returning cash to shareholders through both dividends and share repurchases.
Bryan Dooley, CFA is a senior portfolio manager at LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information.
This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.