American presidents, according to the US constitution, are limited to two terms. Durational statutes do not apply to a persistently enfeebled economy. Since the 2008 election of Barack Obama, in the midst of the global financial crisis, the American economy has been mired in mostly weak economic growth tempered by consistently rising asset prices.
Whatever the final outcome of the 2020 election, chances are receding of a Democratic “blue wave” making a clean sweep of the presidency and Congress. Another four years of lethargy is on the cards. A correction in stocks and higher yield bonds is increasingly probable.
Growth fell by 32 per cent at an annualised rate in the second quarter as the pandemic took hold. The Federal Reserve may finally be out of bullets. Assets prices, notably stocks, have been resilient on high demand. Broadly based profits growth has primarily been a feature of the tech sector.
One way to understand the weakness in aggregate economic demand is to appreciate real interest rates. The 10-year inflation-protected US Treasury in 2006 traded at a yield of between 2 and 3 per cent. Since 2010, its yield has mostly been below 1 per cent including a stint in negative territory both in 2012 and again in 2020.
Meagre interest rates and cheap, low-risk funds have forced asset prices upwards. The ICE BofA BBB bond spread is currently under 2 per cent even with unemployment near 10 per cent. Absolute returns look even scantier measured by a 10-year Treasury yield below 1 per cent. Companies whose revenues have plummeted — cruise lines, airlines, cinemas — have been able to borrow money easily so far in 2020 to survive. Investors have had few higher yield options.
The US Congress and President Trump failed to pass a follow-up stimulus to the $2.2tn Cares Act from March. A divided Congress would likely still struggle to pass a meaningful aid package. S&P recently forecast that the default rate on leveraged loans would reach 8 per cent by the summer of 2021 after being in the low single digits for much of the 2010s. Marginal companies will become increasingly vulnerable to collapse.
Even in a world of secular “stagnation”, an economy still grudgingly grows. The US is instead facing a deep recession with little political consensus on how to deal with it. The S&P 500 is up 4 per cent in 2020 and credit securities are still tightly priced. It is a contradiction that cannot persist.
The Lex team is interested in hearing more from readers. Please tell us what you think of the outlook for US asset prices in the comments section below.