There has been much consternation among those writing institutional market research reports – major hedge funds, independent analysis and even banks — about the impacts of monetary stimulus. The consensus seeming to be from my unscientific study of reports that I receive and read is that the economic benefits of central bank central planning have trickled up mostly to the top end of society. It is not difficult to document this by looking at how high stock multiples and low-interest rates correlated during the central bank stimulative era. Enter the concept of fiscal stimulus, where government (or central bank) spending is directed towards the regional infrastructure rather than purchasing government and corporate bonds. It is here Bank of America Merrill Lynch’s Michael Hanson weighs in, providing analysis regarding global fiscal stimulus trend strength and pointing to exposures investors may wish to acquire or bolster if the thesis proves correct.
Fiscal policy integration is happening and momentum is gaining worldwide
Although there has not been much mainstream fanfare over it, “fiscal policy eases (have moved) back to the forefront,” Hanson wrote in an August 21 report titled “The beneficiaries of global fiscal stimulus.”
He says the prospects for fiscal stimulus have improved, with Japan, Korea and Canada on board while economists are forecasting fiscal easing of some kind in the US and UK. In Japan, central bank involvement at one point was being considered as part of their fiscal stimulative measures, but the report did not dive into this topic in depth other than to extrapolate regarding the political situation:
Abe has clearly emphasized economic priorities, while also refraining from making any aspirational remarks about constitutional reform since the election. Our Japan strategists believe this may signal a strategy to first boost the economy and markets through fiscal and monetary easy – recall the Bank of Japan expanded its ETF purchase plan in July – and then pivot to constitutional issues if Abe’s Liberal Democratic Party (LDP) is successful enough in the general election (which he could call early) to extend his presidency for another term.
BAML: Don’t use “countercyclical policies adopted during the financial crisis” and watch for political subversion
For his part, Hanson advocates for fiscal stimulus, pointing to its complement to central bank monetary policy, which he says has “run low on tools.”
In regards to the type of stimulus, Hanson argues for clear benchmark-able projects that are not similar to “countercyclical policies adopted in response to the global financial crisis.”
the key is focusing on productivity-boosting fiscal stimulus. “A particularly strong argument can be made for those fiscal policies that can help boost productivity and potential output, such as infrastructure investment and tax simplification…” he wrote. With infrastructure and tax simplification key issues, Hanson also sees the potential for abuse. This could particularly be the case if fiscal stimulus is “subverted by special interests.”
Subversion of fiscal stimulus by special interests is one of several risks Hanson sees to the program:
There are, of course, risks as well: the wrong kind of fiscal easing under the wrong economic conditions could simply result in higher interest rates, higher inflation, or higher indebtedness. It also can take a long time for democratic political systems to reach compromise on stimulus plans (outside of a crisis), which may increase the risks that a fiscal boost is mistimed. Other risks include policy that is poorly designed or subverted by special interests. However, none of these risks are intrinsic to fiscal policy; well-designed programs should have benefits that far outweigh these potential costs.
BAML: Acceptable debt to GDP levels indicate borrowing from the future still possible
Fiscal stimulus should benefit the economic world in the short term, as acceptable debt to GDP levels have yet to be breached. However, there are practical limits to sovereign budget expansion, Hanson notes.
“Certainly governments cannot borrow with impunity forever – if for no other reason than this is politically infeasible. Policy makers need to be aware of this constraint and design stimulus plans that will maximize the boost to growth,” he wrote, pointing to “supportive fiscal stances” that offset concerns. “As countries have moved toward more supportive fiscal stances and their economies have started to grow again, debt/GDP ratios have stabilized or even declined. Moreover, interest rates are near record lows globally: the bond vigilantes simply are nowhere to be found.”
The “bond vigilantes” of a long ago period before unprecedented yield curve repression were really nothing more than those who viewed market supply and demand balance along the yield curve based in part on a sovereign nation’s ability to repay debt. What Hanson says is that fiscal stimulus, when targeted without political abuse, has the potential to grow an economy beyond its cost.
Citing a March 18 BAML report titled “A fiscal fix,” Hanson points out there is no correlation between government debt levels and the interest rates a nation pays. This report, which did not take into account that interest rates are being artificially suppressed by non-economic buyers, would be slightly different if the correlation was measured only during times where quantitative stimulus was not being used.
Separate analysis indicates long term benefits of the program would be benchmarked against taking the remaining debt to GDP allowance and using it for the current generation. The BAML report did not consider how fiscal stimulus would impact the next generations if their ability to borrow into the future was limited, and this was not listed as a risk.
Fiscal policy implementation will be impacted by the US presidential election, with a divided House making broad infrastructure programs less likely
Fiscal policy in the US could be impacted by the election, which BAML thinks will end up being a Democrat in the White House and a divided Congress that remains in Republican hands.
This could be good for investors, Hanson notes. “A divided government with a Democratic president tends to coincide with the highest average returns to the S&P 500 during an election year.” But this benefit has a double edge. “However, a divided government is arguably less likely to generate as large a fiscal stimulus than a sweep of the presidency and both houses of Congress by one candidate.”
From an investing standpoint, the standard infrastructure plays might apply, but BAML notes a nuanced landscape:
Given the base case of divided government after the 2016 US election, our US economics team expects a small stimulus overall, assuming the two parties can compromise on some tax cuts and simplification along with a modest increase in infrastructure spending that might boost US GDP growth by 0.1pp next year.
Our equity strategists note that the health care sector faces the most uncertainty given the very different policy proposals by the two candidates. Infrastructure spending would benefit industrials subsectors. The technology sector stands to gain the most from changes to tax repatriation given many companies hold more than half their cash overseas. Labor policy matters the most to restaurants.
In other words, it might be easy to overestimate the impact of infrastructure spending as this might require bi-partisanship on issues that don’t get people elected in conservative districts. Tax cuts are the most easily and commonly “subverted” to the same economic group as was monetary stimulus. Labor policy, which is increasingly driven by globalization and trade policies, is an issue that BAML says most impacts restaurants, a point that is debatable.