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Is Trump’s ‘Red Meat’ the Right Long-Term Diet?

Neil Dwane | 27/02/2017
Printed currency

Summary

Within hours of assuming office, President Trump began issuing executive orders and policy proposals to fulfil his campaign promises. But if Mr Trump really wants to “make America great again”, is he addressing the long-term structural problems that sorely need fixing?

Key takeaways

  • In the initial days of his presidency, Mr Trump appears focused on trade and immigration; other issues popular with his constituents are waiting in the wings.
  • Yet as in Europe and Japan, US policy needs a far-reaching overhaul, and it is unclear whether Mr Trump will enact the structural reforms needed to restore the American dream.
  • Among the areas in need of strategic reform are the soaring costs of education and health care, unsustainable pension promises and ballooning entitlements.

The United States has a new president who has clearly set out his policy priorities for the first 100 days, including repealing “Obamacare”, reforming the tax code, boosting infrastructure and defence spending, renegotiating trade agreements and cracking down on immigration – measures that many view as “red meat” for his political base.

Yet while President Donald Trump vows to “make America great again” with these headline-grabbing initiatives, we believe the longer-term health of the US can only be addressed by long-term structural reforms that will re-energize the American dream, which has been somnambulant in recent decades. But this demands the kind of far-reaching and critical policy overhaul that has so far eluded Japan, Europe and the US as they all try to recover from the Global Financial Crisis.

Eight Areas in Need of Strategic Structural Reform

1. Education

The US rightly has a great reputation for higher education, but it has become ruinously expensive. Costs for a college education have soared so high that the amount of government-backed education debt has reached USD 1.2 trillion, and more than 10 per cent of it is as bad as a 2008 sub-prime loan – except these defaults can’t be wiped clean by bankruptcy. This has led to a situation where the average US student under 30 has negative net worth, and the average millennial has USD 30,000 in student loans.

The irony is that all this debt has improved not the bargaining power of the students, but the pricing power of the education providers – many of whom overcharge for what they provide as they leave America’s youth unprepared to compete in the digital job market of the new millennium. Over the long term, this is one of the key issues hurting the United States’ ability to be “great again”.

2. Health care

The US spends around 17 per cent of GDP on health care, nearly twice the amount of other OECD countries. But are Americans twice as unwell or are there other important issues at stake? Neither Obamacare nor Mr Trump’s proposed changes to the health-care system have successfully addressed many of the core problems: many health-care providers have profit margins over 20 per cent; many patients do not see the final price of their treatments; and many drug and service providers have engaged in price-gouging.

With the US ageing rapidly, demands on health-care will keep rising. Unless the efficiency of providing health care is improved, health-care costs will prevent scarce resources from being strategically invested in other areas of the economy.

Health Care Spending as a Percentage of GDP (2000-2015)

Health Care Spending as a Percentage of GDP (2015)

Source: OECD Health Data 2015.

3. Consumption and trade

There is rightly much discussion, much of it understandably fearful, about where Mr Trump will take US trade policy in the next few years. Yet it is clear why trade, and specifically the US trade deficit, should receive increased attention, given that other avenues for growth in the US are losing steam. Consumption is hovering around 70 per cent of GDP, and housing is stuck near 5 per cent. Wage growth has been slow to emerge, and we may not see more government spending or investment anytime soon. That leaves Mr Trump focused on boosting net exports; however, the language being used in his tweets and policy proposals betrays a mercantilist view on trade relations, which may not actually end up promoting more trade.

Regardless of whether or not he is successful, it is clear that the current US business model of spend, borrow and spend some more has reached its logical conclusion, especially now that US consumers can no longer use their homes like ATMs to access stored capital.

4. Innovation

US R&D spending has been falling for decades, and it never truly recovered from NASA’s space shuttle failures. The social media explosion certainly seems innovative, yet it has created vast wealth rather than vast employment: Facebook, although one of the largest companies in the world by market cap, has only 13,000 employees. This is exacerbating the larger issue of wealth inequality, and there are legitimate questions about whether this high-tech innovation is actually resulting in productivity gains or contributing more to distraction and depression.

For its part, government has been suppressing innovation for years with unnecessary regulations. Consider a recent survey from the Weidenbaum Centre, suggesting that the cost of enforcing government regulation adds up to around USD 60 billion per year, not to mention the USD 400 billion it costs per year to comply with the US tax code. Meanwhile, China is filing the most patents of all the major economies, while its corporations are acquiring much of the prime intellectual property in robotics, automation and other high-tech fields. China has also been training the most engineers and addressing its longer-term strategic needs to move up the global value chain, even as the US has outsourced much of its production capacity to Mexico and Asia.

5. State and government pension obligations

Hidden by local politics, a huge and deepening liability has been growing unseen and unaddressed. During the heady days of exceptional investment returns, politicians offered pension members packages and cost-of-living adjustments that are now simply unaffordable. With budgets and cash flows already strained, city and state pension funds are facing diminished solvency and falling returns masked by inappropriate return expectations. As in "old Europe", the real costs of welfare and pensions in the US are being hidden by pay-as-you-go accounting.

Managing this dynamic – and the social triage needed between pensioners, pension members, taxpayers and government – will be one of the key strategic generational challenges of the Western World. In the meantime, only slightly more than half of the full-time workers in the US participate in any workplace retirement scheme, and the average 401(k) holds only around USD 130,000 – a demonstrably insufficient amount to retire on.

6. The Federal Reserve and the US banks

Mr Trump has rightly criticized the influence of the Federal Reserve and may soon be able to significantly change the membership of its Board. Yet with so many ex-investment bankers on his staff, he is not addressing the excessive “financialization” of the US economy. Since the early 1980s, the share of US profits derived from financials rose from seven per cent of GDP to more than 20 per cent, which can be a drain on the US economy: One IMF study showed that an oversized financial sector lowers GDP by 2 percentage points per year.

Moreover, even as the US still feels the sting of the huge costs associated with the Global Financial Crisis, many of the largest Wall Street banks still show they are too big to fail, too big to manage and detrimental to the smaller regional banks that support job-creating small businesses. Quantitative easing and other loose monetary policies, as well as regulatory blind spots, suggest that US monetary policy has been co-opted by the finance industry, for whom lower interest rates mean more leverage and elevated asset prices. In this environment, large corporate entities are favoured over typical homeowners, who are facing soaring housing costs, higher lending standards and even underwater mortgages.

7. Entitlements

It is entirely bizarre that the Democrats have so forsaken their traditional supporters that Mr Trump, a billionaire, holds so much appeal with ordinary working-class voters. Regardless, income inequality is now so bad in the US that a European-style welfare state is emerging, with transfer payments from government now representing 20 per cent of personal incomes. Moreover, these transfer payments in the US are – as in Europe – building a huge and unfunded government liability, estimated at USD 8 trillion to 10 trillion. Of course, don’t forget the Medicare and Medicaid liabilities of around USD 60 trillion that will be due in the coming decades.

8. DC politics

One trend that has been building momentum for years is America’s frustration with government gridlock and the Washington DC “bubble”. This has led to dismal approval ratings for the US Congress and a growing suspicion that special-interest groups have more influence over policy than the electorate. Mr Trump has promised to “clear the swamp” to address entrenched and nepotistic government bureaucracies by imposing limits on how long legislators can serve and how quickly they can then move to the more lucrative private sector, so it will be interesting to see if this can be achieved in only one term of office.

Will the president’s populist prescription work?

As befits a country that boasts both the world’s largest economy and one of its best-established democracies, the challenges facing modern America are complex and deep-rooted. Many presidents and public servants before Mr Trump have tried to solve its issues, with varying degrees of success.

Yet in the minds of President Trump and his supporters, the status quo is a failure and a direct result of politicians who have been busy protecting their own self-interested goals – not the people they were charged to lead. As a result, we are witnessing new policies and proposals that pander to popular concerns in not just Mr Trump’s America, but in the post-Brexit UK and, potentially, in other countries to come. Whether these populist policy prescriptions actually result in the body politic’s short-term revival or its long-term health remains to be seen.

Don’t be Trumped by short-termism; invest for the long term

Some of Mr Trump’s proposals may work, but they may also be short-sighted by design. In our view, unless governments and other institutions address much-needed long-term structural reforms – whether in the US, the European Union or elsewhere – we believe economic growth will remain low, debt levels will increase and interest rates will stay lower for longer. All the while, ageing populations will continue to draw down on their entitlements while the working class continues to struggle.

Of course, individuals can always circumnavigate some of these strategic challenges by doggedly saving for themselves, investing in their own futures and reducing their reliance on the system for welfare, health care and education. Owning high-quality companies with good dividends and returns on equity – and tapping into the power of long-term compounding – is a solid strategy that can also help buffer against burgeoning inflationary threats. More immediate-term saving, more long-term investing: That is one way to return at least some power to the people.

Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. Investments in commodities may be affected by overall market movements, changes in interest rates, and other factors such as weather, disease, embargoes and international economic and political developments. Investments in smaller companies may be more volatile and less liquid than investments in larger companies. Investments in emerging markets may be more volatile than investments in more developed markets. Dividends are not guaranteed. Bonds are subject to interest rate risk and the credit risk of the issuer. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.

The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.

This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations.

This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association]; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

117930

Expert-Image

Neil Dwane

linkedIn
Global Strategist
Neil Dwane is a portfolio manager and the Global Strategist with Allianz Global Investors, which he joined in 2001. He coordinates and chairs the Global Policy Committee, which formulates the firm’s house view, leads the firm’s bi-annual Investment Forums and communicates the firm’s investment outlook through articles and press appearances. Neil is a member of AllianzGI’s Equity Investment Management Group. He previously worked at JP Morgan Investment Management as a UK and European specialist portfolio manager; at Fleming Investment Management; and at Kleinwort Benson Investment Management as an analyst and a fund manager. He has a B.A. in classics from Durham University and is a member of the Institute of Chartered Accountants.

Onward, Comrades! 5 Priorities for a Resurgent Russia

Neil Dwane | 02/03/2017
View of Russian skyline

Summary

One hundred years after the Russian Revolution, the tsars and the USSR may be gone, but Russia itself is alive and well. With the US becoming more isolationist, Russia has a chance to revise its standing with the US and EU – but this time, as an equal.

Key takeaways

  • President Putin sees the USSR’s collapse as one of the world's greatest disasters, and he is using his country’s proud national identity to re-establish its prominence not militarily, but economically
  • Five priorities for the new Russia: turning around its economy, transforming its energy sector, flexing its geopolitical muscle, dealing with its demographic issues and locking down its leadership
  • With reduced legal protections for international investors, many Russian assets will stay cheap, but Russia and many CEE nations offer sovereign debt with attractive yields

As Russia commemorates the 100th anniversary of the Russian Revolution, a major geopolitical event that shaped much of the 20th century, it is easy to imagine its citizens taking stock of what went right and what went wrong since the 1917 uprising. From our perspective, we see at least three enduring legacies from the past 100 years:

  • The failure of communism. After the tsars were overthrown, Russia pursued a path to communism that was ideologically appealing yet economically unsustainable. Even China, long ruled by its Communist Party, seems to have found its capitalist heart.
  • Major military-industrial successes. Russia’s World War II defeat of Nazi Germany in the Ukraine came at a horrific cost and is still generally under-appreciated by the West. After the war, the Union of Soviet Socialist Republics’ technological feats in the space and nuclear races still rank among the 20th century’s defining scientific achievements.
  • The systemic misallocation of resources. As the Cold War raged, Russia kept its huge energy sector going to feed its defence efforts at the expense of its other markets and industries. Unable to keep up with the United States’ 1980s-era “Star Wars” spending, the USSR eventually collapsed.

Russia on the rebound

Yet even though the Soviet Union rose and fell during the past 100 years, Russia itself is alive and well today. President Vladimir Putin – who has described the USSR’s collapse as one of the world's greatest disasters – is using his country’s sense of history and proud national identity to re-establish its prominence not militarily, but economically. Russia retains a great deal of influence over the "Stans” of Eurasia and other neighbouring countries, and it can still exercise its might even though it has been weakened by sanctions. With the US becoming more isolationist under US President Donald Trump, and with China’s influence rising in the East, Russia sees an opportunity to revise its standing with both the US and the EU – but this time, as an equal.

Five priorities for the new Russia

So how will Russia celebrate its centenary with its Mr Putin at the helm, and what will its new goals be? Here are five issues worth watching:

1 Turning around the economy

Many European countries – especially Italy, France and Germany – are keen to normalize trading relationships with Russia. Sufficient rapprochement would particularly benefit the economies of Central and Eastern Europe, which remain troubled by migration issues and the European Union’s austerity measures.

Although Russia’s economy is overly reliant on commodities, rising oil and gas prices could be an accelerating story in 2017. If additional government revenue slows Russia’s two-year recession, consumer confidence and investment could rise as interest rates fall and the rouble strengthens. But without help from oil prices, Russia’s economy should remain relatively dull, and weaker oil prices could create trouble in the coastal and interior regions. This is because Russia’s economy is highly regionalized, with more than one-fifth of its wealth generated in and around Moscow. The central government may face regional resentments as it makes a tough choice between implementing additional austerity measures and reducing military spending.

2 Transforming the energy sector

Allianz Global Investors has been constructive on energy prices for some time, given the global factors of constrained supply and rising demand. If prices climb, Russia should see not only more government revenue but also more investment, as efficiencies developed in the US shale industry are put to work in Siberia’s vast energy fields; the Bazhenov Shale alone is the size of the US! Still, Mr Putin will take pains to make sure the new Russia avoids the fate of the Soviet Union, so we expect him to move away from energy and revitalize the formerly strong industrial, space and technology centres that once competed with the US. Much of this can be accelerated with eager investment from Italian, French and German companies that have long-established ties to Russia.

3 Flexing its geopolitical muscle

The West is still struggling to recognize how badly Russia wants to be a major player on the global stage. For its part, the US and Russia are fast becoming “frenemies”: Mr Putin has celebrated Mr Trump’s presidential victory, and Mr Trump has expressed his admiration for the Russian leader. At the same time, there is growing scrutiny of pre-election contacts between their administrations and Russia’s election-hacking efforts, and Russia still must navigate sanctions placed on its intelligence agencies on the eve of Barack Obama’s exit from office. With its vast size, Russia can be engaged in many world theatres, though Crimea and Ukraine are its highest priority. If Mr Trump were to ease sanctions there, further rapprochement could be possible.

Syria, on the other hand, is of little strategic value to Russia; it merely offered an opportunity for a little muscle-flexing as the US prevaricated. While it is unclear how this conflict will be resolved, particularly with ISIS in the mix, the Middle East is another story. The battle for Mosul in Iraq rages on, and the regional Sunni vs Shia struggle could last another 25 years – with long-term repercussions for Eurasia as the conflict resonates across Islamic regions from central Africa to China.

Mr Putin may also forge closer ties with China, potentially to the detriment of the US. Both Russia and China face growing threats from radical Islam, and Russia should find it easy to support China’s "One Belt, One Road" initiative, which aligns with its own economic prosperity. Elsewhere in the region, Mr Putin is trying to clear up historical legacy issues in Asia, including its disputes with Japan over Pacific islands.

4 Dealing with demographics

Russia will face a dramatic demographic crisis in its next 100 years. The consequences of a rapidly ageing society, low fertility rate and low life-expectancy rate are palpable. Change will require more than mere legislation, yet change is essential to the future health, prosperity and credibility of the nation. Russia’s government is facing intense pressure to fix these social issues – pressure that would re-intensify if the price of oil were to fall again.

5 Locking down leadership

Russia has always prospered under strong leaders, but it isn’t entirely unclear in which direction the Kremlin is headed. In late 2017 or early 2018, Russia will hold its first presidential elections in five years. Mr Putin has spent much of his time in office extending his rule, using sleight of hand from allies, but he now seems uneasy of his own political security; he has been removing any potential opposition to his authority and appointing not just loyalists, but people with no political identity or heft. These “political purges” – permitted under the pretence of fighting corruption – seem similar to what President Xi Jinping has been doing in China ahead of his reappointment in late 2017. Will Mr Putin continue with his reign or will Russians wish to rejuvenate the presidency? This question will remain critical over the next few months.

Revolutionary reflections

One hundred years after the February revolution, Russia remains as Churchill once described it: “a riddle, wrapped in a mystery, inside an enigma”. In the short term, there are questions about Mr Putin’s strategy: Is he sincerely looking for a reliable, strong global partner in Mr Trump, or is he reckoning for a distracted US and a destabilized Europe to provide him with room to pursue his own agenda? Either way, Russia has serious domestic problems – including financial inequality, mass immigration and high unemployment – that echo the environment that gave rise to populism in the West. So while there may not be a new revolution during the centenary of the last uprising, unless Russia begins to re-define its future and its purpose for the post-Putin world, there may well be one on the horizon.

Key considerations for investors

  • Many Russian assets are cheap and are set to remain so, since legal protections are not truly afforded to international investors.
  • However, a lowering of trade and political tensions would offer European companies significant new market opportunities.
  • Sovereign-debt issues from Russia and many CEE nations offer attractive yields in US dollar and local currency terms, and their underlying economies have the potential to achieve the living standards of their EU cousins.
  • With Eastern Europe thawing, European investors once again have access to an interesting emerging market that offers growth potential at a time when de-globalization and trade frictions are causing sluggishness elsewhere.

Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. Investments in commodities may be affected by overall market movements, changes in interest rates, and other factors such as weather, disease, embargoes and international economic and political developments. Investments in smaller companies may be more volatile and less liquid than investments in larger companies. Investments in emerging markets may be more volatile than investments in more developed markets. Dividends are not guaranteed. Bonds are subject to interest rate risk and the credit risk of the issuer. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.

The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.

This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations.

This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association]; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

119763

Expert-Image

Neil Dwane

linkedIn
Global Strategist
Neil Dwane is a portfolio manager and the Global Strategist with Allianz Global Investors, which he joined in 2001. He coordinates and chairs the Global Policy Committee, which formulates the firm’s house view, leads the firm’s bi-annual Investment Forums and communicates the firm’s investment outlook through articles and press appearances. Neil is a member of AllianzGI’s Equity Investment Management Group. He previously worked at JP Morgan Investment Management as a UK and European specialist portfolio manager; at Fleming Investment Management; and at Kleinwort Benson Investment Management as an analyst and a fund manager. He has a B.A. in classics from Durham University and is a member of the Institute of Chartered Accountants.
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