Why Friedman is out and Keynes is back
Macro themes do not issue from a pre-populated Excel formula, or similarly linear process. Rather, themes arise from a qualitative approach that entails the continual amassing, sifting and synthesis of new evidence. By dint of analogy, the difference between a history essay and a maths test.
The slow drip of accretive, thematic material is currently pointing to a fresh theme that seems to be insufficiently discounted by markets. We think there is ample reason to believe that faith in the power of monetary policy is depleted, policy makers are looking for alternatives and that red-blooded fiscal expenditure is on the cusp of a comeback.
Friedman is out and Keynes is back.
For context, in the time since Lehman Brothers imploded and fears of systemic failure seized markets, central banks have sought to stimulate economies by cutting policy rates to zero and undertaking unprecedented bond buying programmes, or Quantitative Easing (QE). QE was conceived as a way to add monetary stimulus when rates had reached the zero bound and couldn’t be cut any further. The intent was to drive down long-term rates by swapping privately-held long-term debt for cash and amplify the impact of low short-term policy rates.
Inarguably, QE succeeded in averting systemic implosion. This should be balanced, however, by cool appraisal of economic performance in the interim. The global recovery has been shallow and growth sits short of pre-crisis trend, productivity gains have been negligible, but inflation is muted. With rates lodged at zero, evidence suggests that subsequent and larger doses of stimulus will not change this. Leave aside the issues of whether QE is stoking asset price bubbles and has exacerbated social inequality.
Why has QE failed to encourage a return to normal economic conditions?
Explanations vary from the deleveraging that follows financial busts (Rogoff & Reinhart), to a secular decline in innovation and growth (Gordon). But the most popular insight comes from Larry Summers’ resurrection of ‘secular stagnation’. Summers, along with the IMF, argues that sluggish, post-crisis growth is a symptom of a long-term shortfall in aggregate demand, which results in a preference for saving over investment and has pulled down real interest rates over several decades. From this perspective and absent negative interest rates, policy can’t push rates low enough to excite the animal spirits of business and consumers.Summers’ prescription is lifted from the Keynesian playbook.
With borrowing costs at historic lows and markets seemingly untroubled by government indebtedness, he urges politicians to borrow and finance infrastructure projects. He sees two benefits: a short-term fillip to employment and aggregate demand with an attendant economic multiplier; and a capital outlay that lifts long-term economic capacity.
For us, the issue is not whether Summers is right, but whether his analysis is influencing policy and is likely to find realisation in government action. There is reason to believe this is so.
Both candidates in the US election have promised substantial infrastructure packages; presumably with a view to a large wall in the case of Donald Trump. Only in December, lame duck President Obama garnered bipartisan support in passing a five year $305bn Highway Bill.
With the qualified exceptions of Ronald Reagan and Bill Clinton, fiscal activism is characteristic of the post-war American settlement. If anything, nominally conservative figures like Eisenhower and Nixon have been the most enthusiastic Keynesian acolytes. This is second-nature to American politicians.
Where the US leads, the UK follows. When not discussing shortbread on mumsnet, Jeremy Corbyn advocates an infrastructure-focused ‘People’s QE’. Stephen Crabb, in his failed bid for Conservative leader, endorsed a £100bn ‘Growing Britain Fund’ to finance transport, social housing and schools. Guided by Brexit anxieties, Chancellor Hammond has jettisoned his predecessor’s fiscal consolidation timetable and hinted at an infrastructure maintenance programme and housebuilder concessions.
And whilst we wouldn’t expect the Autumn Statement to open the fiscal sluice gates, Theresa May’s criticisms of QE imply that fiscal policy is held more favourably.
How to capitalise?
We own bulk commodity names Rio Tinto and Anglo Pacific, in recognition of the fillip to steel demand presaged by shifting US political attitudes and several decades of infrastructure underinvestment. We have increased exposure to diversified construction businesses Galliford Try and Kier Group, in expectation of a more benign operating backdrop and modestly higher infrastructure spend. Housebuilders Barratt Developments, Persimmon and Taylor Wimpey have been added to our existing holding of Telford Homes, to reflect the well-publicised arithmetic of the UK housing market and the probability of further ameliorative policy.
Ultimately, macro-themes are dynamic and uncircumscribed. In likelihood, the theme will mature and transmute. To our minds, if fiscal activism succeeds where monetary policy has failed, both growth and inflation expectations will rise and richly rated Income Fund mainstays, like tobaccos and consumer staples, seem vulnerable to de-rating.
Jamie Clark is co-manager of the Liontrust Macro Equity Income fund