“And your large speeches may your deeds approve, That good effects may spring from words of love.” – King Lear
The need for approval or even adoration is nothing new in our leaders. Whether this is even more the case in a world where a reality TV star can become President of the United States (and its nuclear arsenal) is open to debate of course. In any case, now that nearly every single human being has the capacity to hear every utterance and suffer every tweet, the job of working out what we investors should and shouldn’t listen to has become tougher.
Government shut down
The continuing slide in his approval ratings perhaps help explain President Trump’s recent return to probably the most popular theme of his campaign trail – Mexico. A $3.6bn wall and a likely much more costly abandoned trade deal were the solace he offered again in a speech this week to his cheering core in Phoenix. So far so normal, however, his promise to use the threat of a government shut down as leverage to deliver on his promise sent ripples though markets already nervous about the fast approaching deadlines on the annual budget and debt ceiling.
The government will run out of money on 1 October unless a hyper-partisan Congress finds a way to approve new government spending by then. By inserting $1.6bn of funding for the border wall as a pre condition of his signature on the wider spending bill, President Trump has likely made it easier for Senate Democrats to veto. An unedifying confrontation between the Senate Republicans and President Trump awaits. With the political heat rising, there is every chance that markets may be needed to apply their own brand of pressure to force an agreement on both the debt ceiling and the spending bill.
For investors, the question is whether any of this is sufficient to take avoiding action in portfolios. Our view remains a firm no. The first point to make is that we would expect any government shutdown to be relatively brief. This is a game that has been played before, many times, most recently back in 2013. The funding gap began on 1 October and was ended with the Continuing Appropriations Act, 2014 being signed into law on 17 October. Federal employees were furloughed for this period, but were eventually retroactively paid as if they had been at work during the shutdown period.
The direct economic effects are obviously hard to perfectly disentangle from the other influences on the economy at the time, however the hit to output is likely best characterized as moderate and more importantly, temporary. In fact, it is precisely the relatively mild nature of the economic effects, providing the shut down does not extended for more than a couple of weeks, that makes this a relatively painless political game for congress and the President to play, so increasing its likelihood.
The same cannot be said for the debt ceiling, where the consequences of a breach would be profound. An immediate cut in spending equal to approximately 3.5% would be required. Such a cut in federal spending, allied to the damage done to private sector confidence, not to mention the US Treasury’s reputation as a borrower would likely push the US, and perhaps even global, economy into recession if the situation persisted. Capital markets would respond in kind. Nonetheless, the severity and immediacy of the consequences, both political and economic, likely make an agreement much easier to find. Much as with this US administration’s many threats on trade, we are reliant on simple economic self interest to avert a debt ceiling breach.
More broadly our message remains the same. Global economic growth is broadening and strengthening still. European lead indicators out this week are consistent with further above trend economic growth in the region. In such a context, it is no cause for alarm that the world’s major central bankers plan to become less lenient. Quite the reverse in fact, we welcome more concrete moves to a more normal monetary environment as a sign that the central bankers agree with us. The politicians admittedly look set to continue generating plenty more unnerving headlines near term, which may make for more volatile markets. However, investors should remind themselves that good copy doesn't always make for good investment. The health and prospects for the world economy, rather than the various characters presiding over it, remain where investors will be most profitably focused in our opinion.