Are The Bears Coming Out Of Hibernation?

If you’re going to be a bear, now is the time. Between the geopolitical risks in North Korea and Syria, and the inability for congress to do anything on healthcare, tax cuts and infrastructure, it’s “Houston, we have a problem” time.

In politics, the hawks are chirping about boots on the ground in Syria, setting us up for Libya 2.0 or — worse — an Iraq quagmire that leads to a Cold War with the Russians again.

The U.S. and China seem to disagree on how to handle North Korea.

“If the U.S. ever lobbed missiles into North Korea to knock out its nuclear capabilities, that would be a huge geopolitical problem that would absolutely affect markets,” says Andy Rothman, investment strategist with Matthews Asia in San Francisco.

Meanwhile, from a pure Wall Street perspective, the market here is expensive. Emerging markets are cheaper, but geopolitical risks have retail investors worried and so despite the opportunities there, RIAs may stand down before buying into riskier assets.

The secular stagnation thesis has become a popular narrative for explaining the post-crisis world economy, where central banks rule the roost. However, even before the financial crisis, there was a notable decrease in productivity across the global economy. Ex-Treasury Secretary-turned-financial-pundit, Larry Summers, is one of the loudest believers in the secular stagnation thesis. He believes the world economy has been constrained by a substantial increase in savings and deleveraging not only in Asia, but also here in the U.S. ( an oldie but a goodie by Harvard man Summers)

Professor John Taylor — an ECB death watcher if there ever was one — believes slower post-crisis growth is the government’s fault.

During the 1980s and 1990s, tax reform, regulatory reform, monetary reform and budgetary reform proved successful at boosting U.S. industrial production. Consider this for a second: south of the border, Mexico is growing at more than 2.5% for the last several years. It’s the emerging economy of NAFTA. But despite this great trade deal and a stable to strong U.S. economy, Mexican industrial production rose a meager 0.1 percentage points higher in February and is down 0.1% on the year. Mining output fell 1% on the month and 10.6% on the year. Oil and gas production fell 0.9% and 13.5% respectively. Yet, it’s biggest market up north is supposedly growing like gang-busters with near-full employment.

From the academic point of view, the stagnation of the 1970s and recent years is associated with a departure from tax reform like low marginal tax rates, more regulations and monetary policy getting zero support from legislators on the fiscal side. Taylor points to the period from 2011 to 2015, when productivity grew only 0.4% a year, compared with 3.0% from 1996 to 2005, another post-crisis year.

As President Donald Trump is finding out, implementing tax reforms and fiscal expansion at a time of rising debt is practically a non-starter for his own party, which leads both houses of congresses and to date has enacted no policy initiatives.

Many empirical studies find that GDP growth slows roughly one for one with declines in the labor force and population growth. The U.S. has a better demographic outlook, so this helps longer term investors. It’s the short-term thinking that could finally see a correction in the S&P 500.

Economists like Taylor are warning that we are still not there yet on ensuring a return to stronger and sustainable rates of economic growth. A new outlook may be emerging here. Stay tuned.

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