After Brexit, the already weak global growth is likely to be eroded even further. The world has a wage-depressing surplus of labor and excess capacity. Oil prices will likely plunge even lower than their already low prices. Corporate profits are unstable and deflation is posing an issue for central banks. Given these conditions, it would be logical to expect financial markets to have increased demand for safe-haven U.S. Treasuries. You’d probably also expect to see falling commodity prices, a soaring dollar, emerging market debt, and increasing aversion to junk bonds on the part of investors. This, however, is not the case.
This year, commodity prices such as oil have risen. For months, the 10-year Treasury yield has been flat. Emerging market bonds and junk bonds are attracting increasing amounts of money. It is likely that these conditions may lead to major market correction so that prices will be in line with economic fundamentals once again. When we look at the slow economic growth and negative interest rates that occur in countries with super-aggressive monetary policies, we see that perhaps things are out of alignment and the resolution will be a shocking process for many market participants.
The valuations may not be justified, but there are a few possible explanations for current market conditions that could also serve to lessen the blow of an abrupt reversal. Despite historically high price-to-earning ratios, U.S. stocks still may be cheap. Equities continue to be attractive when the dividend yield on the S&P 500 index is compared to those available on 10-year government debt. When we make this comparison, it seems stocks may be undervalued by more than 60 percent.
There is also a possibility that a fiscal stimulus program will emerge in order to revive growth. Even central bankers are admitting that meaningful economic growth has not been generated by monetary policy, and politicians will be increasingly pressured to their part in both the U.S. and in the euro zone.
Once we have a new U.S. president, both political parties may be able to reach a middle ground through infrastructure spending. The U.S.’s infrastructure certainly needs an upgrade, from the bridges and roads to the public transportation. According the the World Economic Forum’s most recent Global Competitiveness Ranking, the U.S. is third overall in competitiveness, but it ranks 13th for infrastructure quality as a whole. It is estimated that each driver is paying an extra $377 annually due to aging roads and bridges.
The National Association of Manufacturers believes that for the next three years, $100 billion should be spent on major infrastructure each year. The association also points out that between 1956 and 2003, outlays grew 2.2 percent, but from 2003 to 2012, it fell 1.2 percent annually, for a total of drop of 19 percent in the 2003 to 2012 time period.
If the post-election climate brings a better political climate and a decrease in the amount of spending, investors may still be too calm about the outlook. The S&P index is up about 6.2 this year, and the VIX index, a measure of expected volatility for the future stock market, is staying at historically low levels.
If things reverse, the U.S. might follow in Europe’s footsteps. The European region has erased almost all of 2015’s gains with a benchmark Stoxx 600 index that is down more than 5 percent. For investors in this economic climate, it is best to hold universally large cash positions until the future is a bit more clear.
The world is in a time of economic turmoil. The U.S. may not be spending in the best way possible given the conditions, but there is a lot that is unknown in the financial and political landscape of the U.S. Only time will tell where our country’s economy is headed.