The Old Year

The Arab Spring is turning into an Islamic Winter for the middle east, with some added cold wind, reminiscent of the Cold War. Russia and Iran are seemingly aligned against a US-backed Saudi Arabia and Turkey. The intricacies of the religious, political, military, and historical events taking place are complex to say the least. “Outrageously unstable,” is an understatement. Millions of refugees are voting with their feet.

To make matters worse, China is in economic trouble. Don’t expect a collapse, but central-planning always fails. Joseph Stiglitz, former World Bank Chief Economist, argued that China is a model for the US. Think he has some explaining to do?

Added to these uncertainties is the recent rate hike by the Fed. But despite the pessimism, the US economy has continued to grow, just like it did in the 90s after the Soviet Union and Japan collapsed at the same time. Growth is slower now in this decade than it was in the 90s, but it’s still growth, not recession. We won’t know fourth quarter results (or the full-year) for another month, but estimates are Q4 real GDP will be up around 1.5%. This means US real GDP expanded at 2% in 2015, slightly less than real growth of 2.5% in 2013 and 2014.

Three things stand out when we look at 2015. First, the US grew in spite of a massive decline in oil prices. Second, 2014 tapering by the Fed didn’t stop growth. Third, in fiscal-year 2015, the size of the US federal government grew for the first time since 2009 as a percentage of GDP. That’s not good.

Let’s take these one at a time. First, conventional wisdom has always said a fall in energy prices is a “tax cut” for the economy. Since everyone must use energy, a decline in the price supposedly boosts spending, productivity, and demand. We didn’t see that in 2015. Energy prices create winners and losers. Falling prices help consumers and energy-using companies, but they hurt drillers and ancillary support activities. Orlando wins, Fargo loses.

Gold fell for 2015 to around $1050 and has now posted three consecutive annual losses. Good news last week was the December Consumer Confidence Index numbers registered 96.5 and were ahead of consensus expectations. The jobless claims report ended the year on a note  as the rate increased in excess of expectations.

The second factor is the interest rate bump. Quantitative easing was never viewed as a driver of growth by most economists. The tapering was unlikely to hurt the economy. In fact, during the 52 weeks ending 12/23/15, the M2 money supply grew 6.1%, and commercial and industrial loans grew 11%. This shows there was no slowdown from the QE reduction.

This is likely to be true of the most recent interest rate hike. Before the rate hike, the banking system held roughly $2.5 trillion in excess reserves. After the rate hike the banking system holds about $2.4 trillion. The rate hike had little effect on the money supply at all, and the world is still awash in dollar liquidity.

The third factor is the size of government. If anyone wants to find the real culprit for the drop in real GDP growth rates during 2015, look no further than the size of government. In Fiscal Year 2015, federal government spending was 20.7% of GDP, up from 20.3% of GDP in 2014. In 2016, these same forces are still aligned. The free market will continue to push back against the government spending, taxation and regulation. In addition, the markets will deal with the Middle East and the flailing attempts by Chinese central-planners to boost growth using command-and-control.

There are no promises. But, facts are facts. Despite the increase in the past year, government is no bigger today than three years ago, stocks remain undervalued, and money isn’t tight. There are no economic bubbles or issues that would explain why there are market jitters.

Since this coming year is an election year, there are typically fewer laws passed. However, President Obama is threatening to increase his executive orders to achieve social change he has not yet accomplished. The US will be occupied by the election which typically means the markets will rebound and interest rates will stay relatively flat. World conflict is unlikely to abate. But after a poor year in the market, the S&P 500 is likely to rebound and bring the whole market with it.

Guy Baker
Managing Director - USA

Posted In : UK, Investments, USA, Market Commentary