A record-setting bull run in equities can have investors feeling like the markets are almost too good to be true. So what unexpected events are on the horizon that could bolster the vague feeling of unease?
Three key factors that could seriously impede economic growth in the coming year are debt, demographics and economic inequality, said Eric Winograd, senior vice-president and senior economist at Alliance Bernstein, during a presentation on the 2018 economic outlook in Toronto on Wednesday.
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In the United States, debt is already worryingly high, and the latest fiscal policies aren’t likely to mitigate the problem, said Winograd. “I don’t think that the fiscal stimulus in the U.S., that the tax cuts will pay for themselves and won’t boost growth enough to offset the fiscal hit, which means that deficits and debts have to go up,” he said. “U.S. government debt has already grown to the highest it’s been since World War II. We’re close to 90 per cent now, which isn’t as high as other countries around the world but is still pretty high.”
And the issue isn’t just government debt, said Winograd. “It’s been real cheap to borrow money and people have,” he said. Without even touching on mortgages, which is a more normal instance of consumer borrowing, Americans and Canadians have piled up large amounts of credit card and revolving debt, he said. “The debt-to-disposable-income rate in Canada is at a record high, approaching 175 per cent, and that’s despite efforts from the Bank of Canada to tighten monetary policy, to tighten financial conditions,” said Winograd.
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With both governments and consumers deep in the hole, investors should see the situation as a natural hindrance to growth, he said, noting that if interest rates rise, that debt is a huge liability, which is one of the reasons central banks have been so gradual in adjusting monetary policies. There are, however, certain situations that are out of central banks’ control that could create a sharp uptick in interest rates, he said. They include the possibility of China stopping its purchases of foreign sovereign debt.
“If they cease to buy sovereign debt from outside China or if they slow in their purchases, you could see a sharp rise in interest rates for reasons that have nothing to do with the economic cycle and are out of control of the central banks,” said Winograd. “And if those rates rise, the cost of paying back debt in the U.S. and in other countries goes up dramatically.”
As for demographic trends, “the good news is that demographics move slowly; the bad news is that they are extremely easy to predict,” said Winograd.
What many observers have predicted is that the number of retirees is likely to rise continually for the next few decades such that dependants will vastly outweigh the working population, said Winograd. That’s another hurdle for growth, as there are only two potentially younger economies that could make up for the lost consumption from aging societies: India and, more broadly, Africa. “Can they contribute enough in terms of production to offset the loss of production as the world ages?. . . It’s not impossible, but it’s reasonable to be skeptical,” he said.
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Also of major concern is the issue of economic inequality, said Winograd. “People ask economists what keeps you up at night, and this is it.”
Since the end of the earlier technology boom, there has been a major divergence in U.S. workers’ earnings and corporate profits. “From 1970 all the way to 1993, they moved in lockstep,” he said, adding that up until just 15 years ago, people could still make the argument that if corporate profits were rising, they would have a direct and measurable positive effect on working Americans.
“But since then, I mean, it’s not even close. And that includes a horrible recession that crushed corporate profits, and it doesn’t matter. The growth rates of corporate profits are so far beyond what’s going into the household paycheque that there’s almost no point . . . there’s no relation here,” said Winograd.
Why does that matter for investors from a purely economic standpoint? “If you want to boost growth, you’re better off giving money to people who don’t have very much and are living paycheque to paycheque. So the unequal distribution of gains limits growth,” he said.
Winograd also referred to the issue of corporate behaviour, particularly when it comes to tax cuts. If given a tax cut, are corporations going to spend that on productive growth? he asked. “Or are they simply going to do what they’ve done, which are dividends and share buybacks — things that boost financial wealth. History tells you more the latter than the former,” said Winograd.
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