Dear Valued Investors,
Fiscal policy seems to be on everyone’s mind these days. There may be various reasons for this: one, the U.S. presidential election is upon us, and there is nothing like an election for bringing to the surface grandiose plans for government spending; two, there is a widespread belief (one that I don’t entirely share) that monetary policy has reached its limit and can do no more; and three, there is continued disappointment with the rate of global economic growth. This has spurred, in part, higher commodity prices and a rally in some of the region’s more cyclical sectors.
How much government spending should we expect and how will it affect our portfolios? Well, this depends on the need to spend, the ability to spend and the willingness to spend. These differ across the world. Let’s first look at the U.S. Clearly, among the two major candidates for president, there is a willingness to spend. But in so far as the Republican-dominated legislature is unwilling to back such plans, perhaps what the candidates say is less important than what the legislators think. The U.S. does have an ability to spend. The budget deficit is back down to a reasonable level, after all. But is there really a need? With unemployment below 5%, there doesn’t appear to be a big unemployment problem. In addition, with a current account deficit, any stimulus might be better reserved for monetary stimulus via a weaker dollar. And finally, and in some contrast to this last point, the Federal Reserve has been increasingly hawkish—talking about the need to raise rates soon. Any government spending splurge would surely just hasten the Fed’s desire to increase rates and, therefore, as a stimulus plan would be ultimately self-defeating.
In Europe, budget deficits too are not too severe. And the region does have a current account surplus. So, the ability to spend is there. The need to spend is also there. A weak banking sector, high unemployment, and a single currency that requires all countries (economically strong or weak) to take the same monetary policy—all these things add to the urgency for Europe to spend. I still believe that the need for government spending could be mitigated if the European Central Bank would be more radical in its monetary policy. But it has proven itself institutionally, culturally and politically unable to be as radical as the situation requires. This has ultimately given rise to radical politicians gaining favor in the parts of the E.U. that are languishing and has caused stresses in the system that threaten to break the E.U. apart. But Germany, the country that has the budget surplus and the current account surplus to give it the most leeway globally to spend, refuses to do so. It also still seems reluctant to step in and rescue its own failing megabank—Deutsche. So, the hard money tough love advocated by Berlin threatens to hamper European and global demand. Plenty of need, and ability, but no willingness!
As for Latin America, it appears to have little room to maneuver. It is still too small a region economically to make much difference. In addition, it is mired in budgetary excesses and current account deficits. No ability to spend here, even though the need is pressing as the commodity price downturn of recent years has hit hard. Recent commodity price rebounds have eased some of the strain but it remains to be seen how sustainable these price moves are, given the still weak economic and policy backdrop elsewhere.
This leaves Asia as a white knight for the world! There is some ability to spend here. Budget deficits are generally no worse than the U.S. or Europe. In China’s case, one can argue with the way the government calculates its budget deficit—and indeed the International Monetary Fund does. But there still seems room to spend. Elsewhere, governments, such as Thailand, are more inclined to use tax cuts as a preferred means of fiscal policy. Infrastructure spending, of the sort envisaged by Keynesian economics, is more likely to take place in economies such as India and Indonesia, which see it as more of a structural issue rather than short-term stimulus, and which are in any case, less well-placed in terms of ability to spend than their Asian peers. Elsewhere, however, Singapore, Taiwan, South Korea and Hong Kong, all have the ability to stimulate through government spending. Though, in these economies, will it be infrastructure-led, or perhaps focused on technology research and development and cutting taxes?
Given this current landscape, you should not expect to see a lot of movement in portfolios. It seems unwise to rely on fiscal stimulus hopes to support commodity price rises or infrastructure spending across the region. Nor should one be too keen to try to base stock decisions on short-run assessments of government policy. You can be wrong on both the size and the quality of profits to be generated from such deals. Rather, there is at least some hope that Asia, with its relatively high savings and robust current accounts, does at least have the luxury of turning to fiscal policy—meaning tax cuts or infrastructure spending to boost growth, should it so desire. But none of this undermines, in my view, the need for central banks to continue their stimulatory policy, particularly as inflation rates remain low across the region. Rather, this ability to spend is probably a key reason that is underpinning confidence in the markets. Even in the face of concerns over the end of globalization and a more protectionist world, Asia has the ability to support its own domestic demand.
But markets have also factored this in, with valuations that have risen significantly over the past few months. So, the key response to the current environment across our portfolios has been to trim positions where we see that valuations have run ahead of fundamentals—where the market’s hopes of short-term stimulus have driven prices beyond what seems reasonable. Nor do we see any reason to change our strategic focus on companies that will derive profits from sustainable domestic demand growth over the long term, no matter how acute the rallies in cyclical stocks might be in the short term. We believe that at times like this, we have to maintain our long-term horizon and be vigilant about valuations.
Robert Horrocks, PhD
Chief Investment Officer
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