As investors have seen repeatedly for the last 80 years, U.S. government gridlock has generally been good for U.S. stocks. “Gridlock” just means that neither political party controls both houses of Congress and the presidency.
Historically, gridlock has produced few new initiatives that either major political party can tout, but it has produced generally higher stock prices. Additionally, the third year of the presidential cycle has produced stock market returns better than any other year of the presidential cycle.
Gridlock: Frustrating For Politicians, But Good For Stocks
As regular readers know, the U.S. currently has good GDP growth, good corporate profit growth, and very strong employment trends. Most importantly, U.S. wages are growing faster than inflation, which puts more money in consumer pockets. U.S. wages are growing at the largest rate over inflation in many years. All of these facts argue for a continuation of the rally in U.S. stocks after the recent pullback in prices occurring in September and October. It also argues for a continuation of interest in fast-growing technology leaders and in consumer stocks.
Many who have been nervous about the U.S. market have pointed out that China will collapse because they are being hurt by heavy debt loads, poorly managed loss-making state owned enterprises, and the ongoing trade conflict with the U.S. Such a negative outcome is a possibility, but not a probability.
In order to reverse their economic slowdown, China has recently unveiled the same type of expansionary credit policy that it has used several times in the past few years when it feels that their economy is flagging. In every case, about nine months after the introduction of such policies, China has had the boost in economic growth that they were seeking. We believe that the current policy actions will have the same effect, creating a rise in China’s growth rate starting about July 2019.
While we believe that the market will resume its rally, it will not be a straight-up affair. Volatility will continue as trade disputes with China, and news of political battles that have been so prevalent in the last few years, will continue. We will also see continuing good economic news from the U.S. for at least a few more months, and possibly longer. We do think that future trade news with China and continuing positive economic news will cause the market to fluctuate up and down within an uptrend.
There is a group of investors who believe that the Federal Reserve will cause a recession by raising interest rates too fast. We do not agree. The Federal Reserve carefully watches the Fed funds rate versus the 10-year Treasury yield to determine if rates should fall or rise. Currently there is a 1% differential between the two rates. In our opinion, the Fed will raise rates a bit more, and will stop short of the 10-year yield, which is currently 3.2%. This will be perceived by investors as a moderate stance, and will not wreck the economy.
U.S. Stocks and the Dollar
U.S. stocks and the dollar were affected by the election. Gridlock is perceived as good by the market, which draws courage from the past history of gridlock periods, and U.S. stocks rose the day after the election.
Meanwhile, the U.S. dollar fell modestly. Clearly, the U.S. market is affected by the U.S. dollar’s price action. A very strong U.S. dollar will be bad for exports. A very weak dollar will put pressure on inflation. As a result, investors view the dollar’s continued range-bound trading as a positive.
If the new Congress allows the pace of deregulation to continue, we will have continued strong economic growth. If Congress moves to reverse the tax cuts or the regulatory environment, economic growth will slow down. Faster economic growth is better for stock prices than slower economic growth.
European Stocks
In our view, European stocks can temporarily rally, but have no follow-through, due to fears about the stability of the EU and of the banking systems of some European nations. We will continue to avoid Europe.
Asia and Emerging Markets
China is the lynchpin of the Asian markets, and of the emerging markets in general. This is not only because it is the biggest Asian country, but also because China farms out much of its low-value-added work to regional neighbors.
We believe that China is being hurt by trade friction with the U.S. and many other trading partners, who have demanded that China stop unfair trading practices. We expect Chinese stocks to underperform until the government’s recently expanded credit policies begin to take effect and the Chinese public begins to display increased confidence in their stock market.
Cryptos
Auction house Christie’s will be selling the world’s largest private collection of modernist art — the Barney A. Ebsworth Collection. They’ll be partnering with a blockchain firm, the Artory Registry, to link artworks’ history, provenance, and ownership to an unalterable record.
Jackson Pollock, You’re On the Blockchain
Artory Registy’s CEO noted:
“The Ebsworth Collection auction will occur just like any auction we’ve seen before. However, for the first time in history, after a purchase is made, the Christie’s sales rep will follow up with the new owner and give them a Certification Card. This Card then becomes the “key” for a new owner to go to the Artory Registry, use the card to login and see their artworks provenance, history, and additional historical documentation, all while remaining completely anonymous to Artory. As the owner of the Digital Artory record, they will always be able to prove ownership.”
Thanks for listening; we welcome your calls and questions.
