Merlin Weekly Macro: The countdown to 5th November

Federal Reserve Chairman Jerome Powell must be keeping all his fingers and toes crossed. Because notwithstanding (or perhaps more accurately despite) the most aggressive policy tightening programme in US history outside wartime, the US economy is proving stubbornly resilient.

While most other western economies are flirting with recession, the US is still powering along at the kind of growth rates that were not uncommon when interest rates were virtually zero and not 5.5%. The latest data released this week demonstrates the point: after that phenomenal annualised growth rate in the third quarter of 2023 of 4.9%, a more reasonable 2% annualised consensus rate was forecast for the fourth quarter; the initial published estimated outturn (yet to be finalised by the authorities) was in fact 3.3%. Full year GDP growth finished at 2.5%, well ahead of the 1.9% recorded in 2022; in the past decade, only 2015 (2.9%), 2018 (3.0%) and the extraordinary post-pandemic recovery year of 2021 (5.9%) have been higher.

Lies, Damned Lies and Statistics

As ever, depending on your agenda, you can make what you will of the results. The policy doves, those who believe that the path to lower interest rates, and sooner, is assured, will point to the slowing quarterly momentum, that the steam is gradually coming out of the economy, supported by employment data showing the number of job vacancies is falling, consumer spending growth is also slowing and the savings ratio is rising as consumers take advantage of higher deposit rates on their bank balances. The doves’ thesis is that the medicine is working, and the effect of those successive rises in interest rates through to last autumn will continue to moderate consumer behaviour, gradually slowing the economy towards the Fed’s stated intention of an economic soft landing. What the doves explicitly do not want to see is interest rates remaining so high for an over-extended period such that eventually the economy collapses under the weight of its own debt.

On the other hand, the policy hawks, those in the higher-interest-rates-for-longer camp, say that nearly two years into the programme of significantly tighter policy, the consumer still isn’t getting the message. While the momentum in spending might be slowing, it is still growing at 2.8% and by now it should not be; further, in a tight labour market with unemployment steady at 3.7% (and by convention, a rate below 4% is seen by economists as ‘full’ employment on the basis that what remains is either not seeking work, is ineligible or is unemployable), wages are still rising and faster than the rate of inflation. Oh, and by the way, the most recent inflation print was up at 3.4%, not downwards, and headline CPI has done no better than trend sideways at a rate consistently between 3% and 4% since June of last year, stubbornly above the 2% target.

2024, a pivotal year

In any year this would be difficult to manage. In a Presidential election year, and particularly this one given the characters involved, what happens to the economy takes on a heightened sense of importance. “It’s about the economy, stupid” is that well-known trope of US presidential electioneering tactics. Among many other policy battlegrounds, Trump will be particularly keen to point to Biden’s fiscal recklessness, that the government has run out of money not once but twice in the past year; it should not be teetering on the brink of shutting down public services, it’s a national embarrassment. On the other hand, Biden will be able to point to a strong economy far outstripping America’s main competitors, rising wages (remember him standing on a picket line last year telling striking workers they were worth “a damned sight more that you’re being paid now”?), and promising the fruits of inward investment from the fiscal green incentives encapsulated in his Inflation Reduction Act. Why jeopardise all that? What Biden will be praying for as they head towards polling day in November is that Powell’s monetary tightening does not suddenly cause the economy to take a nosedive spelling disaster for Biden and handing electoral manna to Trump on a plate.

Bang! And they’re off.

The starting gun has certainly been fired in the US Presidential election race. The noise is with Trump and he is now almost guaranteed to be the Republican nominee. He is fairly consistently ahead of Biden in the national polls and while both candidates have their rock-solid fan bases, as ever in binary US elections, the outcome will be decided by the minority of floating voters. This race to the White House is far from over. However, with a landslide in the Iowa caucus, and a significant win for Trump in moderate New Hampshire over Nicky Hailey now in a straight-forward head-to-head contest, we have the strongest flavour of what is around the corner from Trump’s victory speeches were he to be elected President. The content is entirely unreconstructed, especially on subjects such as immigration and MAGA (Make America Great Again), as you would expect given the nature of the man.

Trump polarises opinion like no other. It is almost impossible for commentators not to have a view and therefore bias (either way), even in the mainstream media. In the aftermath of the Iowa caucus, for balance and moderation and a reasonably neutral view on Trump 2.0, the author listened with keen interest to Lord (Kim) Darroch, former UK Ambassador to the US and the UK’s one-time National Security Adviser. It can best be summed up as the rest of the West has to be prepared to both deal with Trump the disruptor and Trump the nationalist but also constructively to engage with him because the US remains the leader of the free world and NATO’s underwriter (looking at it another way, however much you dislike him, deriding and dismissing him as some latter day barbarian is entirely counterproductive; as he demonstrated in 2017 in his first term, his memory is long and his vindictive streak far-reaching; those such as Angela Merkel who were downright rude about him subsequently found themselves on the wrong end of his wit, in her case with a hefty US export tariff). Leaving aside domestic US policies, from an international perspective, Darroch noted the particular challenges of what we know to be of Trump’s agenda (and the easy thing about Trump is it’s all out there, absolutely nothing is hidden, there is no obfuscation): Trump will stop all military and financial aid to Ukraine and he will demand compensation from other NATO members to pay for the disproportionate quantity of US munitions and military hardware sent to Zelensky thanks to those countries not pulling their weight; he will abandon US membership of the Paris Climate Accord (“we’re gonna drill, baby, drill”); he wants to apply a blanket 10% tariff on all imports into the US; he will actively de-couple all US interests from China.

We have our own election in the UK to preoccupy us in 2024. But the real action of greater interest to global investors, is across the Atlantic. We will be developing the themes over the next few months in the countdown to 5ᵗʰ November. Controversial? Most certainly. Crazy? How can it not be, especially with Trump’s string of court cases and a cartload of criminal indictments. Consequential? You only need to consider Darroch’s observations to understand that a second-term Trump would potentially have far-reaching geopolitical and economic effects. But unlike 2016 and his win, and 2020 and his refusal to leave, in 2024 there are many fewer outright surprises with Trump. Unless he becomes the first President to be elected from jail!

Investment Perspective

From a Jupiter Merlin perspective, while we of course weigh up these factors in our investment approach and asset allocation, we do not gamble on events such as elections or referendum results that have binary outcomes and that are unpredictable. Our approach is to make preparations for different permutations, to consider the final result, and then take the appropriate action. While it may cost some short-term performance, we are always mindful of Warren Buffet’s saying, “it’s only when the tide goes out that you see who’s swimming naked”. We prefer to keep ourselves well clad and our modesty intact.

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each.  With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.