"Kee" Points with Jim Kee, PhD.

Over the next few weeks I will be reporting on our 2017 outlook, which will also be covered in our upcoming webcast and annual market updates in Austin, Corpus Christi, Houston, and San Antonio. Consensus estimates (e.g. Barron’s, WSJ, Federal Reserve) seem to be for slightly stronger GDP growth (i.e. 2.1%, up from 2016’s 1.9% according to federal reserve) and about a 5% gain in the market for 2017 on average, with individual market forecasts as high as 15%+ (RBC) based upon expectations of strong earnings growth. The Fed, which raised rates from ½ to ¾ percent in December, is expecting 1.4% by the end of 2017 (that would be ~ three 25 basis point hikes), 2.1% by the end of 2018, and 2.9% by the end of 2019 (3% is considered longer-run normal by fed economists). What follows is a brief summary written for the local press that will no-doubt sound familiar to Kee Points readers!


The Election, Markets, and the Future


The outcome of the 2016 US Presidential election was quite a surprise. Futures markets temporarily pointed to a 750-point loss for the Dow Jones Industrial Average on the night of the election, only to change course rather dramatically by the market’s open on the following day. This surge has continued with the broader S&P 500 index up 5% since the election, and up over 12% in 2016.


Here’s how to think about it:


Markets price future wealth creation, and wealth is created by specialization (production) and exchange: Of these, exchange is primary and specialization is secondary. You can increase a society’s wealth just through voluntary exchange by moving goods and resources from lower valued uses to higher valued uses. In fact, if you had a college-level economics course you might have read about economist RA Radford, a WWII POW. Radford noticed that as soon as prisoners received their rations (of chocolate, tea, cigarettes, etc.) they immediately began exchanging items because they valued them differently, and all were better off (as they saw it) because of it. That’s not true of production. Plants, people, and entire businesses that make sense in a global economy become redundant in a more localized economy when the sphere of exchange is threatened. Larger firms in particular require increasingly larger regional or global markets for growth and wealth creation.


Now consider the “policy mix.” Back in the 1960s economist Robert Mundell, who was awarded the Nobel Prize in economics in 1999, argued that fiscal and monetary policy can be used to accomplish a variety of goals (low inflation, low unemployment), but that each has a unique advantage that makes it best suited for particular goals. Mundell argued that fiscal policy (which includes taxes, spending, and regulation), has an advantage in stimulating output and reducing unemployment by reducing burdens on work, saving, and investment. So fiscal policies are best at stimulating economic growth. Monetary policies, meaning the actions of the central bank (i.e. Federal Reserve), have an advantage at managing inflation by influencing the amount of money in circulation.


Monetary policy is much easier to implement than fiscal policy because it does not require going through the political process, and that’s why we’ve seen mostly monetary policy responses to the Great Recession of 2007-09. But these monetary policies have pretty much run their course globally; it is fiscal reform that’s needed for additional growth. Believe it or not former Federal Reserve Chair Ben Bernanke stressed this often, and fiscal reform—particularly tax cuts and regulatory simplification—were at the center of President-elect Donald Trump’s political campaign. Putting it all together, stronger economic growth should result if Trump sticks to relatively straightforward tax/regulatory simplification and reform, but he has to soften his trade stance relative to the campaign rhetoric. In other words, future policies must facilitate production without decreasing exchange. That seems to be what the market is expecting and pricing.


But will businesses invest for growth? Well, looking broadly, you have on the one hand a tremendous amount of global capital tied up in safe-haven assets like bonds. And on the other hand you have the majority of the world’s population still in need of massive infrastructure spending as they go from rural to urban, and from primitive to modern. And in the developed world you see increasing technological obsolescence as information technology marches on while corporate and consumer spending on technology lags. So reasonable fiscal reforms should encourage some of this capital to address many of these needs, which could provide a lot of opportunity for investors.