Current economic trends: An in-depth look with Eric Lascelles

April 2017 - Transcript

What has been driving the recent rally in equities?

Eric Lascelles:

We see two reasons why the stock market has been as strong as it’s been  really since the middle of last year, and one of those reasons is very much rooted in economics: the global economic trend has improved greatly since the middle of 2016, and so quite logically stocks have responded enthusiastically to that, and earnings have gone up, as well. That was arguably the prime driver, at least up until last fall. And then, since then, arguably a second force, a much more speculative one has come online and that relates to the U.S. election. This new Trump administration is creating a lot of excitement, in particular in the business community, because of the prospect of fiscal stimulus and even more acutely the prospect of corporate tax cuts. So, as much as companies care about the economy and so on, what they really care about is their own earnings, and the corporate tax cut is a very direct means of increasing corporate earnings, and that is bleeding its way quite nicely through to the stock market.

We think those are the two key forces. If we were to talk about Canada, we might say the resource recovery is also a relevant factor there, as well. But broadly, it's the global trend, and it's the optimism that's been unleashed by the Trump presidency.

As we look to the future, of course, the question is whether this can persist or not, and I will confess that's an open question. Our suspicion is we can continue to see some gains going forward. We think that most of this economic recovery is real and at least part of it can stick. We do think that the Trump administration may bring a little bit more growth in the short run, at least, helping stocks, as well. We should acknowledge also that this is not just a stock market move, it's a risk asset move, and that means that, indeed, stocks are higher, but credit spreads have narrowed, government bond yields have gone up, and in fact the U.S. dollar has gone up, as well, and those are all part and parcel to one another.

What are the potential implications of the rise in populism?

Eric Lascelles:

This rise of populism is undeniably the key theme, not just for 2016 and '17, but arguably for many years to come. It really does reflect a profound shift in the types of government that are coming to power. Really, the first thing we can say about the implication of that shift is that there's a lot of uncertainty in the world. This is a new ideology, a new form of government, that hasn't been seen, at least in the developed world, for some time, and so the first answer is uncertainty is extremely high. Lots of policy uncertainty in particular. What will tax rates look like? What will tariffs look like, et cetera? I think that's one of the big ones.

Obviously, we're still parsing the populist implications of the U.K. Brexit vote, and the U.S. presidential election, as well, and in general you can say that populism tends, over the long run, to reduce economic growth a little bit. It tends to, over the long run, increase inflation a little bit, as well. Those aren't overly attractive features, and for now that really isn't the market's focus because there are some nice short term elements, as well, in some cases, but there are some longer term concerns, certainly, that we have with this, also.

As we look even further into the future and contemplate other parts of the world that are perhaps at risk of tilting in a populist direction, continental Europe very quickly comes to mind. It just so happens that 2017 is a year defined by quite a number of European elections. We know that European political sentiment is tilting in a very populist direction, as well, and the stakes are so high for Europe because, of course, the risk would be a Eurozone break-up, and while that's a low probability event – in fact, the most likely scenario is centrists manage to retain power in all of the elections that are coming – there is clearly a populist risk in Europe, as well.

How will the Trump administration's proposed policies impact the markets?

Eric Lascelles:

When we think about the Trump administration's proposed polices, we really see a divide between the short term implications and the long term implications. On the short term side of the ledger, we can say that this commitment to tax cuts, both personal and corporate, and more military spending and more infrastructure spending and some deregulation, as well, those are all actually positives for the economy. They can quite plausibly allow the U.S. economy to grow faster in 2017 and in 2018, as well. So, in the short run, we can see extra growth.

The thing that concerns us, though, when we shift focus to the longer term, is the protectionist element, the idea that there could be tariffs or a border adjustment tax or some variation on that that could impede the flow of, really, goods and services across borders. We know, as well, that there's an inclination to restrict immigration in the U.S. Those two sorts of actions tend to slow economic growth down.

And so, at least right now, acknowledging the massive uncertainty around every single one of these policy proposals, we think that the U.S. economy is going to grow faster this year and next, but then ultimately start to slow and perhaps grow a little less quickly than normal in the outer years. Our suspicion is, over the long run, the negatives could dominate the positives, but they're certainly not doing so right now.

What is the outlook for interest rates in the U.S. and Canada?

Eric Lascelles:

The Fed has already started some tentative tightening over the span of 2015 and 2016, and it does look as though it's now ready to begin moving a bit more briskly higher in 2017 and 2018. It is raising rates. That's being reflected in bond yields, as well, and we think that's actually the right decision. When you take a close look at the U.S. economy, it's clearly made quite significant strides over the last few years. The unemployment rate is now below 5%, which by any measure is a sign of success, and if the Fed is to shield the U.S. economy from excess inflation, which is one of the big goals of Central Banks, they really do need to start raising rates.

We think they deliver it. The good news, though, is because it's the right thing to do, because it's not a policy error, arguably markets should take it fairly well. This is the Central Bank trying, in fact, to keep the U.S. economy on its best possible growth trajectory, and so we don't think markets will take that too, too badly. It does certainly represent the end of an era of sorts, after this extraordinary monetary stimulus that's dominated over the last several years.

When we pivot to Canada, the Canadian situation is a bit different, actually. In Canada, we don't see much prospect for rate increases in the span of 2017, and really that's because the Canadian economy story has been quite different recently. Canada was hit very hard by the resource shock. It took a few steps backwards as a result of that, and it's just not in a position yet to need to tighten policy. It needs to first make some strides forward, and let's recognize, as well, that there are some risks to those forward steps, because in Canada the protectionist threat of the U.S. is very relevant given the depth of the trading relationship between those two countries, and similarly we think the Canadian housing market is beginning to wobble and so perhaps won't be as helpful in terms of its contribution to growth, as well.

Is fiscal stimulus poised to replace monetary stimulus globally?

Eric Lascelles:

Well, the last decade has been dominated by monetary stimulus, and arguably in bits and pieces that is starting to come off. The Fed is raising rates now, and it is the world's bellwether Central Bank. There's a bit less excitement elsewhere we might say in the sense that there's only tentative action coming from Europe and from the U.K. in terms of unwinding a bit of their extreme stimulus delivery. But it is nevertheless fair to say that the era of peak monetary stimulus is perhaps beginning to fade, so we think the monetary stimulus side is coming off a little bit. The question is whether the fiscal stimulus side is picking up that slack.

The answer there really is yes and no. It's very much a mixed proposition depending on what countries we're talking about. In the U.S., very clearly, monetary stimulus is coming off and fiscal stimulus is coming on; that's a bit part of the Trump administration's short term plans. In Canada, we can say there is a bit more fiscal stimulus coming, as well.

However, when we abstract out to the global level and look at the global fiscal impulse, that impulse is actually roughly flat, if not slightly negative, so we really can't say there's going to be much more fiscal stimulus on a net basis for the world. One of the implications of that is when you lose one source of stimulus and you don't get another one, conceivably some of the particularly exciting growth we've seen recently may need to come off a little bit over the next several years.