JOHANNESBURG - The US is now just more than 18 months away from the next presidential election in November next year and the market is arguing whether or not the inverted yield curve is pointing to an imminent recession in the country and the world as such and the impact thereof on financial markets.
I analysed the behaviour or direction of economic and financial indicators from 18 months before previous presidential elections up to the dates of the elections to get an indication of how the markets and global economy can unfold over the next 18 months or so.
Unemployment in the 18 months leading up to the 14 presidential elections since 1964 decreased 11 times and only increased in the periods leading up to the 1980, 1992 and 2008 elections.
It is very interesting to note that in all three cases it culminated in a change of political party. In 1980, the Republicans took over from the Democrats, in 1992 the Democrats took over and in 2008 the Republicans fell out of favour.
Industrial production has increased in the 18 months before 11 presidential elections since 1964 and decreased before the elections in 1980, 2008 and 2016.
In all three cases of declining production, the ruling parties lost the election - the Democrats in 1980, the Republicans in 2008 and the Democrats in 2016 when Donald Trump prevailed.
The US yield curve as measured by the spread between US 10-year government bonds yields and three-month treasury yields and normally a reliable indicator of future economic activity, was, since 1968, inverted at the time of the US presidential election in 1980 and 2000 and virtually flat in 1968. In all three occasions the ruling party lost the election.
How much leeway does Trump have before next year’s election? The average decrease in unemployment in the 18 months leading up to presidential elections since 1964 was 0.4percent while the lowest unemployment rate was in 1969 at 3.4percent. The current unemployment rate is 3.8percent. So, yes, there is scope to get more Americans to work.
Over the same period the average increase in industrial production in the 18 months leading to presidential elections was nearly 7percent. In comparison the average capacity utilisation at the time of the elections since 1980 was about 80percent and compares with 78.2percent currently. Unless Trump pulls a rabbit out of the hat, the upside in industrial production is 2percent.
Capacity needs to expand by 5percent and be utilised to achieve the historical average increase in the final 18 months of Trump’s term.
Also, the average yield curve at the time of presidential elections since 1968 is 1.5percent and compares with the current 0.3percent and history is therefore not on the Republicans’ side. Trump will need to convince the bond market that economic growth is sustainable after the election next year, which will see long-term bond yields rise.
Trump will, therefore, be forced to take drastic measures to ensure strong economic growth leading up to the election for him and his party to remain in office. He already called on the US Federal Reserve to begin with quantitative easing a few days ago as job losses are likely to count against him and the Republicans.
Trump realises that he will need to go soft, hence a truce in the Sino/US trade war is an expected conclusion.
Due to slow economic growth being experienced by the US’s traditional partners, China is the ideal economic partner for Trump in the run-up to the election. The macro-economic policy measures instituted by the Chinese authorities to stimulate economic growth are paying off as consumer sentiment has turned around and is approaching previous highs, while the economy has gained traction again.
I will not be surprised if Trump takes a harder line on some of the volatile Middle East oil producing countries to up the oil price to enhance the profitability of the oil shale producers.
The withdrawal of troops from Libya and further threats against Iran are probably aimed to increase instability and curtail oil supply.
Faster economic growth in China and the US is likely to offset some of the negatives of Brexit and may see global economic growth accelerating as the two countries collectively comprise more than one-third of the global economy.
It may, therefore, postpone a global recession until after next year’s US presidential election. It bodes well for global equities as it will enhance the outlook for company profits and commodity prices.
The average return on the US stock market as measured by the S&P Composite Index in the 18 months before the 14 presidential elections since 1964 was close to 10percent and was positive on 12 occasions or 86percent of the time. That compares with the average return of 9percent in the 18 months before the 36 presidential elections since 1876 and was positive on 26 occasions or 72percent of the time. I will not bet against the odds, but it may be a bumpy ride to next year’s election.
The bond markets and specifically the US bond market will probably continue to anticipate the outlook for the US economy post the US presidential election in November next year.
The probable acceleration in US growth is likely to force the Fed’s hand to hike lending rates but the anticipation of a slowdown in the economy post the elections could keep the US yield curve relatively flat or even inverting as a result of long-term bond yields increasing less than short-term interest rates.
Yes, Trump’s panic could be a blessing for the global economy and global equity markets.
Ryk de Klerk is an independent analyst. Email [email protected] His views expressed are his own. You should consult your broker and/or investment adviser for advice.