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Monthly Commentary
October 2016
Marathon
In two weeks, I am going to run the New York marathon. I am pretty nervous
about this – it is my first, and undoubtedly last, marathon, and it would have
been easier if I had attempted it 20 years ago. Still it has been fun training for a
goal and I have learned a lot about the science and psychology of long-distance
running over the past few months.
One thing I have realized is that a marathon runner, in the later stages of the
race, has a shortened horizon. It is easier, on aching legs, to think only of the
distance to the next bend in the road, the next mile marker, or the next water
stop. It is very hard to plan past the finish line.
The American people have now suffered through their own marathon… a
thoroughly dispiriting election campaign, dominated by insults and scandal
rather than any serious discussion of the issues that are supposed to divide
Republicans and Democrats. From an investment perspective, it has been a
perpetual distraction and the two weeks left in the campaign feel a bit like the
last two miles of a marathon. However, for investors, it is important to think past
the finish line and consider the investment environment after the election.
One aspect of this will likely be a decline in uncertainty and relief that it is over.
This, on its own, could be a positive for economic and market sentiment.
However, fiscal policy under a new administration could also add to demand in
the economy.
Dr. David Kelly, CFA
Chief Global Strategist
J.P. Morgan Asset Management
This view is not based on a careful analysis of the policy positions of either
candidate. Even if we assume that both candidates are firmly committed to those
policies, it needs to be recognized that, barring a political earthquake, the House
of Representatives will remain in Republican control, with Paul Ryan likely
reelected as Speaker of the House.
MONTHLY COMMENTARY | OCTOBER 2016
Consequently, the most important post-election reality is that either Hillary Clinton or Donald Trump will have to
negotiate with Mr. Ryan, and, given his comments on both candidates, it is highly unlikely that he, or Congress in
general, would rubber stamp the policy agenda of either potential president. It is possible that the outcome of the
election could give new impetus to immigration reform or corporate tax reform. However, on other issues, much
less change is likely to be delivered than is being promised.
Having said this, one likely outcome, under either potential president, is fiscal expansion. In mid-October, the
Treasury department announced a federal deficit for fiscal 2016 (which ended on September 30) of $537 billion or
roughly 3.2% of GDP, up from $439 billion or 2.5% of GDP a year earlier. This fiscal year, even with no policy
changes, the deficit would likely climb higher. However, with a strong populist tide in both political parties, there
will be significant pressure to increase infrastructure spending, cut taxes on middle-class Americans and to further
relax the “sequester” cuts, boosting the deficit.
All of this could add to aggregate demand in an economy which is already showing signs of healthy growth and
some inflation pressure.
In particular, third quarter GDP should show a significant acceleration in growth relative to the 1.4% gain reported
in the second quarter. If this transpires, it will mainly reflect the end of the inventory drag that has dogged GDP
growth for more than a year. However, it should also reflect solid gains in private demand and, most notably real
consumer spending. The GDP numbers should confirm that, in its eighth year, the U.S. economic expansion is still
ambling forward.
The earnings season has also started well. With just over a quarter of market cap reporting, 77% of companies
have beaten expectations with only 5% falling short - a better-than-average result. However, more importantly,
these analyst expectations were not particularly conservative and it now appears we will see a solid year-overyear gain in operating earnings per share for the first time in two years. As year-over-year comparisons on oil
prices (and consequently energy company profits) continue to improve, earnings per share should see further
gains.
Meanwhile, global economic growth, while by no means explosive, continues to edge up. Third quarter Chinese
GDP data were in line with expectations while flash PMI data for Europe and Japan and the U.S. all registered
multi-month highs. As the drag from weak commodity prices and a manufacturing inventory cycle fade,
international economic data should continue to confirm global improvement.
Finally, inflation pressures are rising but only at a gradual pace. Headline CPI prices rose 0.3% in September and
have risen by 1.5% over the past year. However, year-over-year inflation outside of food and energy actually fell
back to 2.2% in September and compensation growth still seems to be relatively modest. Nevertheless, if oil prices
hold steady over the next few months then headline CPI should reach 2% year-over-year by December and the
headline personal consumption deflator should surpass the 2% year-over-year threshold by February of next year.
All of this adds interest to Fed Chair Janet Yellen’s speech to a Boston Fed conference on October 14. In it, she
suggested that “….temporarily running a “high-pressure economy,” with robust aggregate demand and a tight
labor market…” might boost both labor supply and productivity.
J.P. MORGAN ASSET MANAGEMENT
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MONTHLY COMMENTARY | OCTOBER 2016
While this may be so, it also carries with it a risk. The Fed has saturated the economy with liquidity for years and
both households and corporations are holding vast cash balances. If a “high-pressure economy” became a higher
inflation economy, many might feel the need to convert these cash balances into goods or services or assets,
thereby further stoking inflation. For many the years, the Federal Reserve has recognized that its actions only
impact the economy with a lag and thus its policy needs to be preemptive. However, over the past decade, the Fed
has slid from being preemptive to being data-dependent, to being reactive and now, based on Chair Yellen’s
words to perhaps not being that reactive to signs of rising inflation.
An experienced marathon runner has a plan for the twenty-seventh mile. What are they going to drink and eat
after the race? Where will they meet friends and family? How will they get some rest? In the same way, investors
today need to have a plan for after the election.
Both the Federal Government and the Federal Reserve may further stimulate an already full-employment
economy, which should add to growth but also to inflation,. As such, while an investor’s appropriately balanced
portfolio should always be tailored to where the investor is in life, it should also reflect the changing economic
growth and political environment with a tilt towards equities relative to fixed income or cash.
J.P. MORGAN ASSET MANAGEMENT
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