Monetary policy may have inflated asset prices, but beyond leading to indirect and increasingly counterproductive wealth affects, it seems increasingly ineffective.
Industrial production has been slowing for some time, but trade uncertainty has arguably accelerated this slowdown. Germany used to be the healthy part of Europe but is now underperforming the Eurozone. In addition, the US is now following Europe, as the effects of tax-cut stimulus fade away.
Monetary policy has, however, led to a rise in wealth inequality - which has led to a rise in populism on both the left and right of politics. As populism rises, so do protectionist policies and regulation, which in turn feeds back into weaker growth and more populism. This forces central banks to respond with more monetary stimulus, which continues to fail to create demand. Here we find ourselves in a negative feedback loop.
If monetary policy is not the solution, it is inevitable countries will look to fiscal stimulus, as we have already seen in the US. China and Europe have the most dry powder, while the US is running emerging market-style twin deficits.
Europe - driven by Germany - has long favoured fiscal austerity but given the current economic backdrop we believe Germany is prepared to loosen its grip. The move to spend is held back only by Germany's desire to balance its budget, which may need rethinking in a world where Germany is being paid to borrow money.
Importantly, the rhetoric in Europe has pivoted towards the need for fiscal stimulus, and the chorus is growing louder. Mario Draghi, the former president of the ECB, said ‘governments with fiscal space should act in an effective and timely manner' - while new ECB president Christine Lagarde explained that ‘central banks are not the only game in town' and is urging the richer eurozone governments, which are either running surpluses or low deficits, to spend during downturns.
A European green revolution
We have started to see some action. Germany's recent €50bn package to reduce carbon-dioxide emissions is a step in the right direction. At more than 1% of GDP, this proposal is significant, similar in size to the stimulus packages announced in 2009. The famously stingy Dutch government has indicated €3bn in additional investment and tax cuts which is 0.4% of GDP, as well as the potential to create a special investment fund of up to €50bn - which will focus on infrastructure, education and innovation.
In addition, in a bid to achieve pan-European carbon neutrality by 2050, European Commission President-elect Ursula von der Leyen has proposed a European ‘Green Deal' - with €1trn earmarked for a swathe of pro-climate policies. With Europe priced for a recession, not for fiscal stimulus like the US, the stage has been set for a major green/infrastructure related spending cycle.
The potential for stimulus extends beyond Europe. For example, South Korea has drafted its most expansionary budget since the global financial crisis a decade ago, while India has announced corporate tax cuts to the tune of 0.8% of GDP and China has the firepower to continue to stimulate.
There is changing of the guard in Europe and a growing army of vocal fiscal stimulus advocates. There is a risk is it takes a recession to get to this point, so there is a need to remain circumspect in regard to the valuation of cyclical stocks.
Nevertheless, populism and fiscal stimulus are ultimately inflationary, and we must question what this means for bonds and bond-like equities - which have grown significantly over the past decade and now account for almost half of the global market cap. Indeed, now is not the time to sell quality cyclicals, with embedded structural growth opportunities.