This year's "Mr. X" issue from Bank Credit Analyst (BCA) is skeptical that the new Washington leadership will deliver much fiscal stimulus this year. They go further and consider developments in the rest of the world.
The Japanese government has boosted government spending again, but the IMF estimates that fiscal changes added only 0.3% to GDP in 2016, with an even smaller impact expected for 2017. And a renewed tightening is assumed to occur in 2018 as postponed efforts to rein in the deficit take hold.
The euro-area peripheral countries have moved past the drastic fiscal austerity that was imposed on them a few years ago. Nevertheless, there is not much room for maneuver with regard to adopting an overly reflationary stance.
It is one thing to turn a blind eye to the fiscal constraints of the EU's Growth and Stability Pact, and quite another to move aggressively in the opposite direction. In sum, a move to fiscal stimulus is not in the cards for the euro area.
In conclusion, looming shifts in fiscal policy will be positive for global growth in the next couple of years, but are unlikely to be game changers.
As much as I would like to forecast either gloom or euphoria, we rarely get too much of either.
U.S. inflation will rise
On trade, BCA sees little risk of a trade war and notes that trade actually ceased to be a net contributor to world growth several years ago: Global export volumes have been growing more slowly than GDP. That's mainly a result of China's growing domestic production.
Inflation and bond yields in the US have passed a cyclical turning point, but this does not mean that a sustained major uptrend is imminent. Let's start with inflation. A good portion of the rise in the underlying U.S. inflation rate has been due to a rise in housing rental costs and, more recently, a spike in medical care costs. Neither of these trends should last…
The main reason to expect a further near-term rise in underlying U.S. inflation is the tightening labor market and resulting firming in wage growth.
Inflation will hit the Fed's target but not get much higher.
As for the stock market, BCA sees reasons for caution but not an imminent crash. They make a good point about wages affecting corporate profit margins.
Investors are excited about the prospect that U.S. earnings will benefit from both faster economic growth and a drop in corporate tax rates. We don't disagree that those trends would be positive, but there is another important issue to consider. One of the defining characteristics of the past several years has been the extraordinary performance of profit margins which have averaged record levels, despite the weak economic recovery…
With the U.S. unemployment back close to full-employment levels, the tide is now turning in favor of labor. The labor share of income is rising, and this trend likely will continue as the economy strengthens.
As they say, this is potentially a major shift for equity valuations.
Stock prices will rise in 2017
The stock market is vulnerable to a near-term setback following recent strong gains, so this is not a great time to increase exposure. However, we do expect prices to be higher in a year's time, so you could use setbacks as a buying opportunity. Of course, this is with the caveat that long-run returns are likely to be poor from current levels, and we have the worry about a bear market some time in 2018 if recession risks are building.
By BCA standards, this is a pretty bold call. "We do expect prices to be higher in a year's time" may come back to haunt them when Mr. X comes around next December.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.