By all indications, the global economy is moving into a new stage of the growth cycle, and for investors trying to understand what comes next, a good barometer is the United States. The world’s leading economy has continued to recover from the 2008 crash and this is before tax cuts and various deregulatory actions were enacted, which primed business for more growth.
According to IFM Investors’ April 2018 Economic Update, despite fluctuations in financial markets — largely driven by tariff disputes, inflation and interest rate decisions — the real economy in the United States continues to perform well.
Economic growth has been even better than first thought, with revised U.S. GDP figures showing a 2.9 percent expansion, (or 2.6 percent year-over-year). “This was an upwards revision from the previously estimated 2.5 percent seasonally adjusted rate,” the IFM report notes.
The boost to the U.S. economy has led to moderate increases in inflation, as well, allowing the Federal Reserve to continue to act to bring interest rates back to more normal, higher levels.
“The latter is impacting financial markets globally in terms of equity market performance and the gradual rise in bond yields,” says Alex Joiner, IFM Investors’ chief economist and author of the April economic report. “It is also notable that the global economic upswing is usually synchronized, so while the U.S. economy is performing well, it is benefiting from the overall positive backdrop.”
For infrastructure investors trying to gauge this shift in growth and inflation and what it could mean for investment, the uncertainty associated with rate and tariff and trade policy presents not only worry but also opportunity.
“Uncertainty will always impact investment decisions,” says Joiner. “However, there are a number of concerns facing investors currently around both the economic outlook and geopolitical concerns. On the former, the Fed and other global central banks are embarking on removing record policy accommodation — a feat not attempted before; there is significant uncertainty on just how this cycle plays out. For investors, the issue reverberating around markets currently is the Fed’s response to rising inflation pushing long-term rates materially higher as this has a potential to see broad valuation pressures emerge across asset classes.”
Tough talk on trade and tariffs by the Trump administration, meanwhile, also has affected economic and investment decision making for countries and investors. But it remains to be seen whether the talk turns into real action.
“It is unlikely any country can fully insulate itself from an escalation of ‘trade wars’ between the U.S. and China,” says Joiner. “This is due to the momentum globalization has had over recent decades, making the prospect of financial market and economic contagion significantly higher. And indeed the two key protagonists, the U.S. and China, are extremely reliant on each other in terms of trade but also investment, with China being a key holder of U.S. treasuries.”
If tariff barriers were to materially impact trade, Joiner goes on to explain, and the United States and/or the Chinese economy were to suffer economic setbacks as a result, then countries that rely on these two global growth engines would also suffer.
As an example, Joiner notes China is Australia’s largest trading partner for goods and services, accounting for a third of total trade. Consequently a reversal in growth in that country would have a material impact on the Australian economic outlook.
“From a global perspective, the supporters of protectionism have too readily discounted the economic benefits of globalization, particularly for consumers, while looking to support often inefficient domestic industry,” says Joiner.
Investors and investment managers with capital to allocate and invest have a tricky job of assessing how infrastructure companies and assets will perform in the current environment. Those infrastructure markets that are welcoming of capital continue to be favorable and opportunities in developed markets continue to arise, but there is another trend in transaction markets that is converging with the shifts in tariff policy, and inflation and rate conditions — investment prices are about at their peaks and competition is strong.
“To continue to sustain return targets, additional risk may have to be assessed and taken by investors, in terms of the type of infrastructure asset being considered and the geography in which the asset may reside,” says Joiner.
Trying to assess all of these variables is difficult, to say the least. Will rising bond yields undermine returns for unlisted infrastructure, for example? But rising rates and bond yields are not a negative factor across the board; they also can reflect better outcomes for inflation and economic growth, a positive for most investments.
“These factors will support returns even while risk-free rates are rising very gradually,” says Joiner. “Protectionism and tariffs are increasingly a risk especially in growth exposed sectors of infrastructure. However, populism more broadly is an increasing investment risk with nationalization of assets a possibility.”
And how will Australia’s, or the U.K.’s or Japan’s economy react to tariffs should they be enacted? These are the kinds of questions investors and their advisers are considering in today’s shifting markets.
