Factoring in Geopolitical Risk: Navigating the Soft Landing
As we approach the fall of 2024, the US economy stands at a critical juncture. The S&P 500 has reached record highs, geopolitical uncertainties loom, and internal political strife is intensifying. The S&P 500 hit an all-time high of 5577 points on July 9, 2024. This peak showcases market resilience but also sets the stage for potential corrections in the short-term debt cycle. Chris Aylman, former CIO of the California State Teachers Retirement System, predicts the market may trade sideways due to several factors: summer doldrums, political outcomes in Europe like the French election, the current enthusiasm around AI stocks (particularly Nvidia), and the Fed's tightening of interest rates, whose full effects remain uncertain.
Morgan Stanley warns of a potential 10% market correction driven by internal political conflicts as we near the presidential election. This correction is likely to start to occur by the end of September or early October. The election's outcome will likely create volatility and uncertainty, requiring investors to tread carefully. The economics of immigration are mixed. Trump, as discussed on the All-In Podcast with Chamath Palihapitiya, Jason Calacanis, David Sacks, and David Friedberg, proposed a better green card system for anyone educated in the US, even from two-year programs. However, his stance on tariffs could exacerbate inflation on both supply and demand sides. The podcast hosts believe Trump might not implement these tariffs if he assembles a competent team.
Several economic predictions are worth noting as we move into the fall. Rate cuts predicted for September could impact the timing and outcomes of the election. Jerome Powell's disciplined, apolitical stance has been beneficial, but timing is crucial. November might be an ideal time for a 25 basis point cut as we will have ample disinflationary data, but it could be too close to the election for the Fed to act. Powell’s data-driven approach might delay further cuts to ensure adequate economic cooling. Consumer sentiment is currently low, with pandemic savings dwindling and M&A activity in the consumer/retail sector only now picking up. Balancing these factors with proposed 10% tariffs that could dampen demand further is critical. Delaying rate cuts too much could risk a hard landing as we get to close to the X-axis, especially with the looming commercial property debt crisis. The Fed's focus on granular month-over-month data might not account for time lags in consumption effects, potentially leading us too close to a hard landing.
Conversely, arguments against a rate cut include the current economic strength. The unemployment rate stands at a historically low 4.1%, despite a marginal increase from 3.8% since April 2024. GDP growth remains steady at or above 2%, and continuous disinflation signals a cooling economy. The primary justification for rate cuts would be if the labor market shows signs of rapid cooling, leading to higher unemployment.
The potential reelection of Donald Trump could favor oil and gas markets while posing challenges for renewables. Rate cuts on the horizon might allow renewables to regain growth, paralleling oil and gas market trends if not impacted by Trump’s energy policies. Additionally, the demand for AI and data centers could drive increased demand for renewables and energy-efficient data centers. AI-driven climate tech SaaS could enhance data analytics for physical energy transition infrastructure.
Trump's rhetoric and policies raise moral and ethical questions. His stance on immigration and tariffs could have far-reaching economic implications. For instance, proposed 10% tariffs could dampen demand and impact consumer sectors, while his debate behavior might detract from substantive policy discussions. Biden’s administration has seen 4.1% unemployment and 2% GDP growth, although his second round of stimulus checks did add sizeable inflationary pressures to the economy. Deficit spending remains a significant threat, especially with most wealth controlled by baby boomers, leaving younger generations burdened with high taxation, inflation, and socio-economic challenges.
The upcoming US election has significant implications for US-China relations. The outcome will determine whether the US continues to pursue a policy of derisking and deintegrating with China, or whether it adopts a more conciliatory approach. The US election also presents a choice between two different economic visions: Bidenomics, which focuses on private investment and consistent growth, having created 16 million new jobs, and has implemented initiatives to lower costs for everyday Americans, such as reducing Medicare prescription drug costs and insulin costs. Meanwhile Trump’s Mercantilism, which focuses on tariffs and protectionism, criticized for being ineffective in addressing unfair trade practices and harming US consumers.
American business leaders have a mixed view of the Biden economy. While they acknowledge the economy's strengths, such as job growth and low unemployment, they are also concerned about affordability and the impact of inflation on middle-class families. Recent data suggests that inflation is coming down, and the Biden administration is working to lower costs for everyday Americans. The business community generally likes the current macroeconomic situation, with all major stock indices at all-time highs and a recent rally in fixed-income markets. However, some business leaders are concerned about the extent of government regulation, particularly in areas such as antitrust, technology, healthcare, and energy. While sitting CEOs of major companies do not typically endorse presidential candidates, some may have concerns about the Trump agenda. The Trump agenda includes proposals for new tariffs and mass deportations, which have significant economic implications. A 10% tariff on all imported goods, with a 60% tariff on goods imported from China, is estimated by the Peterson Institute for International Economics to cost the average American family $1,700 per year. Deporting approximately 11 million individuals currently living in the US without documentation could negatively impact the labor market, especially given the current labor shortage, especially in the growing fast-food sector.
In considering the economic and financial benefits of Trump's potential policies, there are several key aspects to highlight. If Trump is reelected, his administration may focus on reducing regulations, which can ease the burden on businesses, making it easier to operate and potentially increasing investment. Lowering corporate taxes, as seen during his previous term, could again lead to increased revenues and greater investment in the U.S. economy. This policy shift might also foster a more conducive environment for mergers and acquisitions, which have been stifled under the current administration due to regulatory hurdles and high-interest rates. Additionally, Trump’s proposed tariffs, although controversial, could provide the U.S. with leverage in trade negotiations, potentially benefiting domestic industries by protecting them from unfair foreign competition, and may give U.S. infant industries like Electric Vehicles sizable short-term benefit.
The economy is currently experiencing a "Goldilocks moment," with modest slowing, low inflation, and steady economic growth. Key indicators include retail sales being down last month, the unemployment rate up a touch, the ratio of job vacancies to unemployed workers down a bit, the inflation rate (Core PCE) below 2% MoM (Month over Month), and the inflation rate (CPI Core) just above 3% YoY (Year over Year). The current economic situation is favorable for financial markets, with the Fed likely to cut interest rates in the near future. Open market interest rates have fallen significantly, with the yield on the 10-year treasury down about 20 basis points in the last month, fluctuating between 4.2% to 4.3%, depending on Jerome Powell's statements in central bank conferences and FOMC presentations.
Two key factors driving the current above-trend economic growth are private fixed investment and immigration. The surge in private fixed investment during the Biden presidency, particularly in the last year and a half, has led to significant job creation and growth. Consistent levels of immigration have contributed to the growth of the US labor force, unlike many other countries. This has given the US an extra advantage in terms of economic growth. As Roger Altman notes, "It's very hard to grow your overall economy if your labor force is falling." The most important factor is to encourage sustainable and strong legal migration into the country that will enhance the productivity of the United States.
The impact of AI and generative AI on the economy cannot be looked over. While valuations of companies like Nvidia might be contentious, the transformative effect of AI on industries is undeniable. Companies are looking to AI to improve productivity, automate processes, increase efficiency, and reduce costs. We shall see the growth of AI going from semiconductors and chipmakers to large-cap software companies and then to the benefits that consumers and businesses receive through increased productivity.
Navigating the complexities of geopolitical risks and economic predictions requires vigilance and adaptability. By understanding the interplay between politics, economics, and market forces, investors can better prepare for potential market corrections and capitalize on long-term opportunities. With the US facing a significant deficit, spending more than it earns is unsustainable in the long run, and hurts younger individuals as baby boomers capture the majority of the country’s wealth while having paid the least in taxes (Source: Scott Galloway). While the exact timing of any potential downfall is uncertain, sound balance sheets for economies is crucial to maintain national stability. The upcoming election will be a critical juncture for determining the future direction of US economic policy and its broader impact on global relations.
So be careful how you account for geopolitical risk as we approach the achievement of this arduous soft-landing. If my analysis is correct, this fall voters will go to the polls for inflation, immigration, and foreign policy in that order of priority.
Disclaimer: The information provided in this blog post is for educational, informational, and entertainment purposes only and should not be construed as financial advice. The views expressed are those of the author and do not necessarily reflect the opinions of any organizations or individuals mentioned. Investing in financial markets involves risk, and it is important to conduct your own research and seek advice from a qualified financial advisor before making any investment decisions. The author and the blog are not responsible for any losses or damages arising from the use of this information.
Sources: Bloomberg, The Wall Street Journal, The Economist, Roger Altman, Ray Dalio, Chris Aylman, All-In-Podcast, ABC News Biden Interview
