Ignore the Volatility, the Economy is OK

Uncertainty is driving US politics and asset prices, says U.S. Advisory Council

04/03/2016 Barcelona

IESE U.S. Advisory Council

(L to R) IESE U.S. Advisory Council members John Schmitz, John Sturm and Eric Weber / Photo: Jordi Estruch

“I urge you in your business career to decouple what’s happening in the stock market from what’s happening in real economy,” said Edward T. Reilly, president and CEO of the American Management Association.

U.S. share indices have fallen since the start of 2015 but Reilly encouraged a capacity audience on IESE’s Barcelona campus on March 4 to look at the bigger picture. “Despite what you may have read about fragility, the U.S. economy is actually in pretty good condition. GDP will rise two percent by end of year. It’s not a goldilocks economy, but it’s OK.”

Reilly was one of four members of IESE U.S. Advisory Council introduced by Associate Dean Eric Weber. The council advises and supports the school in its activities in the U.S. The panel had been invited to answer questions from MBAs and give their insights into the political and economic situation in the U.S. during the current election year.

The Markets: What’s Weighing Them Down

Noting that the slow economic recovery since 2008 had been categorized by weak first-quarters in asset markets followed by stronger performances later each year, Reilly said that the biggest drag on the markets was falling oil prices. Importantly, he said, this fall was due to increased oil supply, not reduced demand. In fact, lower oil prices lead to lower production costs in other sectors.

“If you look at the non-energy 450 companies of the S&P 500, earnings are up,” he said.

Another factor negatively affecting share prices was the massive liquidation of assets by “about a dozen” sovereign wealth funds. This point was picked up by Carlos Padula, managing partner at Stelac Advisory Services, an investment advisory company for ultra-high-net-worth individuals and families.

“Last year those funds sold approximately $300 billion over the average in fixed income securities. We don’t know how much they’re going to sell this year. Regular inflow is about $1 bn per day. So consider how huge $300 billion beyond the average is. Because of this uncertainty, there is reduced demand,” he said.

Padula broke down the disconnect between market performance and economic fundamentals into three main factors: the unknown consequences of economic growth in China slowing to around 6 percent; oil oversupply – pointing out that 20 percent of S&P500 revenues come from the energy sector – and doubts about whether or not the Federal Reserve and other central banks would need to raise rates more than once this year.

Wage costs and consumer pricing, he said, indicated that the economy was growing but flattening yield curves and the negative stock market were indicators of recession.

“The fundamentals are telling us we’re fine,” he said. “But there’s uncertainty.”

The New Rules of U.S. Politics

The future of U.S. politics is equally uncertain as voters select their candidates for the forthcoming presidential elections. U.S. Advisory Council member John Schmitz offered first-hand insight: as well as being a part of Republican Party candidate Jeb Bush’s campaign team, the former White House lawyer has worked with Ronald Reagan and George Bush Sr. At present, Schmitz is partner at Bingham McCutchen, and splits his time between Berlin and Washington D.C. advising transatlantic companies.

Despite most European economies being weaker than the U.S., with higher unemployment and greater immigration issues, European voters were considerably less angry than their U.S. counterparts, he said. “Trump has tapped into that anger, and his rise is rewriting the rules of American politics.”

John Sturm, former president and chief executive officer of the Newspaper Association of America (NAA) and current associate vice president of federal and Washington relations at the University of Notre Dame, said that as a registered lobbyist he dealt with the U.S. Congress on a daily basis.

In his opinion, the “disenchanted, disillusioned and disappointed” voters who have seen their real incomes fall or plateau over recent decades have led to the rise of candidates from the fringes of the Republican and Democratic parties.

He believed that the likely eventual nominees would be Donald Trump and Hillary Clinton. This would be a choice that many voters did not relish but the panel thought it unlikely that a third party or independent candidate would be viable under the current U.S. electoral system.