Yesterday’s elections imply the political situation is moving away from a pro-business tax cutting era to a more of a slow growth, centerist era. Over the next two years I expect the liberals and centerists to grow stronger, resulting in a less business friendly climate, including higher taxes. Perhaps political compromises will enable a hidden back door of tax increases. The situation is likely to lead to a lower degree of deficit supplied stimulus and thus the federal deficit may grow at a slightly slower pace. Rising taxes would act to dampen inflation and growth, making yields go down. Taxes could be increased by closing loopholes (like ending excessive depreciation deductions that only businesses would notice) or raising tariffs (where business would get the blame for higher prices).
This is not the start of a new era of a more business friendly climate; it is the opposite.
Bond yields on the 30 year Treasury bond plunged 6 basis points at the start of the day but by closing time the 30 year bond yield had only dropped by 1 basis point from yesterday. The reason why rates rose towards the end of the day, compared to the morning’s yield, was because of the tremendous increase in stock prices with the SP up 2.12% and FANGS index up 2.92%. I suspect stock buyers were irrationally happy that the uncertainty caused by waiting for elections was over and they incorrectly leapt to the conclusion that it will be business as usual. They didn’t realize that stocks are massively overpriced at double fair value as indicated by PE10 and are thus at extremes that occurred only in the 1929 and 2000 tops. Until stocks drop 50% to reach fair value then it is wrong to buy stocks. Eventually the truth will come out and stocks will go down, motivating investors to buy bonds, making yields go down.
The global economy is like a four engine airplane where China, Japan and the EU are three of the engines. They have a serious lack of credibility regarding topics like massive debts, negative yields, extreme QE, high EU unemployment (33% youth unemployment in Italy, which is the 3rd largest debtor in the world), unreliable financial data and unsafe financial markets in the case of China. The only engine working OK, but not that great, is the U.S. economy. The contingent risk of a deflationary crash in a world awash with excessive debt (higher than ever) implies that eventually a repeat of the 2008 crash will occur. Then the risk is that QE won’t work, partly because rates are too low for the Fed to give a big cut.
A huge source of global growth for the past 30 years, especially after the 2008 crash, has been China. But the Developed world is starting to move towards Cold War 2, trade wars, etc. against China and thus will be less able to benefit from China’s growth. Also China has hit the limits of growth as it has far too much debt for a country which is about 75% poor EM and 25% Developed. When a country is fully Developed its people have more resources to pay debts, but a poor country can’t afford debt. A fully Developed democracy attracts foreign currency investors; a closed economy with capital controls and unsafe capital markets can’t attract foreign depositors. The contingent risk that China’s problems will get worse is a significant probability. This will act to slow down global growth. The slowdown has already surfaced in other countries (Australia, Canada, Malaysia) where Chinese buyers used to buy real estate but are not allowed to export their funds offshore so they have to stop buying foreign property, thus making prices drop.
Investors need independent financial advice about the risks of misunderstanding the risk of a stock market crash.