Third Quarter 2016 Economic & Capital Market Summary

In order to make sense of what is taking place in our economy, capital markets and even our society, we are working within a paradigm in which we assume that our form of democracy and capitalism is changing at a more rapid pace than before. While our form of government is stable our form of democracy is evolving. This assumption underscores the current debate around such issues as direct government intervention in our capital markets, domestic surveillance on the “war on terror, “ the ability for large banks to fail, and what the appropriate price is for a consumer to pay for a drug produced by a pharmaceutical company. American citizens have a high degree of freedom in our society, including the ability to participate in politics and choose our leaders. But, many issues that may include social justice, power, wealth, regulation, and corporate ambition continue to shape our democracy in evolving ways and impact our capital markets. This presidential election, with two of the most unpopular candidates in recent history, may be another example of this evolving democracy.

The most frequent question we have been getting recently is: “How will the election impact the financial markets?” While political uncertainty may marginally weigh on economic growth, at the end of the day, the Presidential election does not matter. The surviving candidate will need to work with Congress in order to effectively legislate and govern this country. The dysfunction playing out in the election campaign, for the moment, is taking the focus off the dysfunction that has besieged Congress over the past eight years. And, at the end of the day, there is still no political will to address the growing cost of the entitlement programs, which now represent over 60% of the annual government outlays. Since 2008, U.S. debt has grown to 100% of GDP from 60%; however, the domestic economy has grown by less than 1% adjusted for inflation. The use of debt to fund our way of life is not limited to just the United States. According to a study published by the Bank for International Settlements, global debt hit 235% of gross domestic product at the end of 2015. This is up from 212% prior to the Financial Crisis.

In order to maintain a modicum of economic stability and growth during the fragile economic recovery that followed the Financial Crisis, our central bank, along with most other central banks of developed countries, has flooded the capital markets with money which helped to grease the wheels of commerce by lowering interest rates. However, these aggressive monetary programs, which in some countries have produced negative interest rates, have supplanted sound fiscal policy initiatives. Remember, monetary policy and fiscal policy should work together alongside each other to propel growth in an economy. The leadership of our evolving form of democracy does not have the vision, the courage, or the political will to implement fiscal reforms which will help limit the growth in debt and set a foundation for domestic economic growth. With this presidential election, we expect four more years of dysfunction between the administrative and legislative branches of government regardless of who is elected president.

A growing concern from our economic analysis is the increase in dispersion in income levels in the United States. We thought the class system that defined life in Great Britain, Europe and the United States at the turn of the 20th century was long gone. After World War II, a college education and job training provided a strong catalyst for a growing middle class. However, flying back to the United States from London last week, we were struck that Virgin Airlines has a passenger travel status called “Upper Class”. Sadly, we wonder if this were true of society today as well. We view the growing income inequality in the United States as one of the more devastating trends in our democracy. In his recent book Capital in the Twenty-First Century, French economist Thomas Picketty makes the point that unless we do something, capitalism today is on a one-way journey toward inequality. Since the Financial Crisis, we have been living through years of wage stagnation, lopsided tax policies and distorted labor markets which are influencing our political agenda and priorities as a society. The recent years of dysfunction in Congress have done little to help change this direction.