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Macroeconomic & Geopolitical

Why Investors Should Re-Read the State of the Union

12 February 2019 - 3 min read

The political climate in Washington, D.C. – including the recent State of the Union speech and growing field of Democratic presidential hopefuls – traditionally provides the future trajectory of economic policy. While far from certain, some elements are nevertheless coming into focus.

As the field of Democratic presidential hopefuls grows and bitterness in Washington rises, investors may be excused for their mounting sense of confusion and frustration. Still, President Trump’s State of the Union speech last week offered a few clues around near-term events that may give them comfort. The longer-term trajectory of U.S. economic policy remains harder to discern, but some early outlines may nevertheless be coming into view.

The most important conclusion from the speech is that a deal on the budget looks likely next week, in spite of the president’s personal instincts. While negotiations may go down to the wire, the government seems likely to remain open. Republicans want to avoid a shutdown at all costs, and the absence of an ultimatum amid long passages on border security suggests the president himself understands this now.

Second, there will probably be a trade deal with China in spite of the fact that few people believe it will be enforceable. The speech treated President Xi with so much respect you might have thought he was among the gallery guests. It would be a shock to be talking about a bi-lateral summit meeting without some kind of a deal in sight.

Third, markets can spend the next two years assessing financial results and valuations. Other than Fed meetings, there will be very little coming out of Washington that will change the economy or the market. Debt ceiling negotiations may bring some brief periods of volatility, but the chances of economic reform or investment incentives that boost growth are slim.

That doesn’t mean investors can ignore some of the deeper currents in American politics.

“Change is afoot as both political parties fashion economic messages that can win support in an era of polarization and bitterness.”

This polarization, in many ways, has become structural. Newly drawn boundaries have made Congressional districts more ideologically pure. Rising campaign costs force politicians to court single-interest groups. And a crowded media landscape rewards extreme and outlandish positions far more than measured analysis.

The bitterness is a little harder to explain when unemployment is at 50-year lows. Still, the combination of globalization and technology has brought wrenching disruption to wide swaths of the American workforce. Middle-income Americans have seen their wages rise at one-third the rate of richer households. Political leaders find it tempting to tap into this anger and frustration.

Current polls suggest the president continues to face an uphill climb to re-election. Still, there is a lot of time before the first 2020 votes are cast and a lot of sorting to be done among a growing and indistinguishable Democratic field.

 Regardless of who actually wins, there is an emerging case that U.S. economic policies will gradually embrace more government intervention in markets, resort more quickly to retributive tariffs and a steady expansion of deficits.

The early Democratic presidential candidates have received attention with eye-catching proposals that include worker representation on corporate boards and limits on share buybacks. These are mainly popular with party activists and few stand any chance of actually becoming law. Still, they will increasingly shape the debate and the initial reflex will tilt to broader government involvement.

Meanwhile, for all his warnings about encroaching socialism during the State of the Union, the president’s own economic ideas seem to involve more government control over the forces of free markets. While he touts the regulations he has slashed, his main proposals include reducing prescription drug costs, expanding paid family leave and boosting infrastructure spending. This latter idea included some intriguing wording last week, as he apparently called for more government investment in “cutting edge industries of the future.”

On other economic issues, the trends are easier to see.

“Just as it takes little courage to predict the Democratic nominee will not be a free trade champion, there is now overwhelming evidence that the likely Republican nominee doesn’t share his party’s traditional concern for deficits.”

As long as Washington remains in gridlock, these debates may do little to roil markets. Campaign emotions will continue to build, however, and so will political teams’ hopes on both sides for a mandate that is unlikely to involve smaller government, balanced budgets or free trade.

That State of the Union of 2021 will probably be the time for investors to turn their attention back to Washington and weigh the chances that new laws and economic policies may fundamentally reshape their expected returns.

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