Government Interventions and Global Turmoil Challenge Investors to Adapt
The global economy has witnessed a shift in the balance between government and markets, prompting investors to reconsider their strategies. Historically, leaders like Ronald Reagan and Margaret Thatcher championed free-market principles, ushering in an era of economic growth fueled by trade liberalization. However, the 2008 financial crisis and subsequent events have seen governments take a more active role in shaping economic fortunes, making it imperative for investors to identify assets that can thrive in this new landscape.
Reagan’s embrace of free-market ideology, influenced by figures like Milton Friedman, revolutionized the global economy. Following a period of protectionism, stagnant growth, and soaring inflation during the 1970s, the advent of “Reaganomics” ushered in a new era of free trade, deregulation, fiscal austerity, and reduced welfare states. The world trade volume skyrocketed from one-fourth of the global economy in 1970 to over half in recent years, fostering economic growth and allowing interest rates to decline as inflation remained subdued.
However, the 2008 financial crisis led to a temporary reversal of these trends. Governments in developed countries intervened on a massive scale, launching programs such as the $426 billion Troubled Asset Relief Program in the United States. Although these measures initially stimulated the economy, subsequent fiscal austerity measures and lackluster growth ensued. Central banks, left to stimulate their economies without government support, resorted to pushing interest rates to record lows.
The COVID-19 pandemic was a game-changer. Governments worldwide stepped in to protect businesses and consumers as economies faltered. While the health crisis appeared to be subsiding, Russia’s invasion of Ukraine in February 2022 rocked global energy markets and international commerce, necessitating further government intervention.
The pandemic and geopolitical tensions have hampered globalization, leading governments to prioritize energy security and vital supply chains. As a result, national industrial policies such as the $370 billion Inflation Reduction Act in the United States and China’s support for electric vehicle manufacturers have gained prominence. Economist Réka Juhász and her colleagues noted a rapid increase in industrial policy interventions worldwide over the past decade.
However, a more interventionist government comes at a cost. Escalating public spending, coupled with the financial burden of an aging population and the fight against climate change, has led to soaring debt levels. For example, the US government’s cyclically adjusted budget deficit is projected to remain above 7% of GDP until 2028, compared to just 2.7% in 2014. Advanced economies, on average, will have spending exceeding income by over 4% of GDP for the next five years, twice the level seen a decade ago.
These increased expenditures, combined with rising wages, are likely to keep inflation above the 2% target of major central banks. Consequently, interest rates will struggle to return to the ultra-low levels witnessed after the 2008 crisis.
In light of these developments, investors must adapt their strategies and consider government actions when selecting assets. While higher debt levels, inflation, and interest rates traditionally signal trouble for bonds, a lot of the pessimism appears to have already been factored into prices. Capital Economics estimates that yields on 10-year US Treasury bonds will hover around 4.5% in 2030, similar to current levels. The situation is comparable in the United Kingdom, Germany, and Japan.
Government intervention can significantly impact the stock market. Higher bond yields tend to dampen valuations, as investors require greater compensation for holding riskier equities. Capital Economics suggests that a rise in the “risk premium” from the current level of around 1% to the long-term average of 4% would reduce the price-to-earnings ratio on the S&P 500 Index to around 16 times by 2030, down from the current roughly 30 times.
However, not all stocks will be equally affected. Vincent Deluard of StoneX proposes a distinction between intangible and tangible companies. Intangible companies, such as tech giants like Meta Platforms, have dominated the stock market in recent years. Nevertheless, the increased involvement of the state could favor tangible companies, such as industrial and defense firms like General Electric and Lockheed Martin, which benefit from government spending.
Companies receiving subsidies may also enjoy advantages. Semiconductor group Micron Technology, for instance, witnessed its shares rise by over 30% in the past year following the announcement of a $40 billion investment in memory chip manufacturing after the passing of the $53 billion CHIPS and Science Act by the US Congress.
Moreover, energy giants like Exxon Mobil and Shell stand to benefit from power shortages resulting from geopolitical conflicts. These companies can also take advantage of government subsidies aimed at accelerating the transition to greener forms of energy. British housebuilders, such as Barratt Developments and Persimmon, may experience growth if planning laws are reformed under an incoming Labour Party government. Additionally, commodities could see an uptick in demand due to geopolitical unrest and the need for specific materials to achieve decarbon
More detail via Reuters here… ( Image via Reuters )