With political uncertainty out of way, market’s focus is back to monetary policy. Federal Reserve’s Nov meeting brings in improving context for a Dec rate hike and so not surprisingly USD and yield are strengthening again.
The US midterm elections results brought in the needed checks and balance in US polity with Democrats seizing control of House of Representatives, even though Republicans maintained their control over Senate. This coincides with Trump’s two years of the election victory and a period marked by broad-based growth phase for the US economy wherein central bank had quickened its pace of interest rate normalization.
On the whole, midterm results should provide downside protection from the policy risk emerging from executive actions.
With polity risk out of the way, markets are expected to focus its attention back to monetary policy and corporate earnings. While the Q3 earnings season has been strong, Fed’s November meeting signals for a Dec rate hike.
Chart: S&P500 vs. Nifty price index (Indexed to 100 in Oct’16)
Source: Moneycontrol Research
Trump’s two years – Trumponomics
US midterm elections also marks the two years of Trump’s election and the resultant Trumponomics which broadly rests on tax cuts, trade deals and infrastructure push.
Initial financial market reaction to Trump’s election was kneejerk, but later, prospects of fiscal stimulus, among others, aided the dream run for the stock markets. S&P 500 surged by 37 percent before cooling off recently, wherein MSCI World index (includes only developed markets) and MSCI All Country World index (includes Emerging Markets also) rose by 22 percent and 20 percent respectively.
The economic context was already positive for Trump at the time of election. Federal Reserve had embarked on the process of policy interest rate normalisation but at a very gradual pace. Labour market was strong with 4.9 percent unemployment rate. Non-farm payrolls addition was already higher than 200,000 per month and CAGR growth (Oct’10 – Oct’14) was 1.8 percent.
Since then, labour market employment trajectory hasn’t derailed. Unemployment rate has, in fact, declined to fifty-year low of 3.7 percent. Fed’s assessment suggests that some industries have witnessed shortage of skilled labour in recent times. While lower unemployment and qualitative demand-supply factors point to a scenario of wage growth, recent data (2.9 percent average hourly earnings growth rate) is still below the historical standards. Also when inflation is hovering around 2 percent, improvement in purchasing power is limited. Having said that recently there has been steady firming up of the wages numbers.
Chart: The USA Non-farm payrolls addition (in thousands)
Source: fred.stlouisfed.org, Moneycontrol research
Note: 6m average, seasonally adjusted
Chart: The USA average hourly earnings – 2 year rolling CAGR
Source: fred.stlouisfed.org, Moneycontrol research
While it is difficult to ascribe Trumponomics' contribution to the labour market improvement, current administration’s stance for outsourcing, deregulation and emphasis on domestic investment have had a positive effect on the kinds of jobs opening in the labour market. Mining and Oil & Gas have been amongst those sectors benefiting, although there seems to be a positive rub from the cyclicality in these industries.
Another important lever under Trump’s era has been fiscal stimulus which in turn could boost the core of GDP: personal consumption and corporate investment. Tax Cuts and Jobs Act, enforced from 2018 beginning, lowered corporate tax to 21 percent (from 35 percent) and provided income tax relief till 2025. Different estimate suggest cumulative deficit ranging from $500 billion to one trillion dollar, wherein US treasury is hopeful that new revenue from investment and deregulation can more than offset this.
Tax cut benefit already translated to higher earnings growth for US corporates. While US Q3 earnings season is mid-way, S&P 500 earnings growth expectation is 24.9 percent YoY. Not surprisingly, earnings multiple has moderated and S&P500 is trading at 15.6x 12m forward earnings (vs. ~17x in Nov’16)
Third aspect which Trump has been harping during his tenure has been focusing on lowering trade deficit or simply the third factor of GDP equation – net exports. Implicit in it is also the get the jobs back lost to globalization/outsourcing and also protect US’s technological prowess that is coming under threat due to China’s endeavor to leap frog in the high technology areas. While long term benefits of trade wars are debatable, currently the escalating trade war with China to protect America’s long-term interest, may be resonating well with Trump’s voter base. However, higher import tariffs are distorting the manufacturing supply chains and an adverse impact on the downstream industries remains a concern.
US midterm: Implications
While most of the economic parameters have improved during Trump’s tenure so far, various periphery risks have had emerged during the course. Trade diplomacy is one of them. While initially anticipated to be a tool for corporate style manoeuvre in foreign affairs, it has emerged as a key factor behind moderation in global growth expectation. Trump’s not so palatable stance on immigration, outsourcing, globalization and an apparent favoritism for certain segments of people have had weighed on his approval ratings.
Stock market reaction to the midterm results have been well anticipated. Equity led by technology and healthcare stocks rallied. US dollars and bond yield initially eased but are now firming up. Clearly consensus expectations had not been priced by the market as there were possibilities for extreme situation when one of the parties sweeps both the chambers. In case of Democrats, it would have meant a higher possibility of gridlock situation between executive and legislature and in case of Republicans it would have embolden Trump in his global trade diplomacy.
Checks and balances
So is the bipartisanship better? Apparently so, it brings back the legislative checks and balance and potentially reduces the downside risk from trade diplomacy. It can also do some course correction or offer options in the contentious areas like immigration policies (IT), health care reforms.
On the flipside, though current composition doesn’t warrant possibility for impeachment but few situation of stalemate can arise – including and not limited to debt ceiling and sequester relief. Further congressional investigations cannot be ruled out with respect to various executive actions.
Monetary policy back in focus
With political uncertainty out of way, market’s focus is back to monetary policy. Federal Reserve’s Nov meeting brings in improving context for a Dec rate hike and so not surprisingly USD and yield are strengthening again. On the trade war front, however, Trump –Xi meet (30th Nov) at G20 summit assumes importance.Moneycontrol Research page.