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Slowing Growth, Fiscal Response

April 10, 2019 | Global/Emerging Markets


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When assessing the near-term outlook for asset returns, we look at growth, liquidity, and valuations—and the story those factors are telling is that growth is supported more by fiscal measures.

Growth is slowing, especially in the euro area. Financial conditions remain tighter than they were in the third quarter of 2018, especially in the United States. And valuation discounts in equities have largely disappeared after a strong rally earlier this year.

But around the world, we're seeing fiscal expansion. The euro area, for example, is set to experience its first fiscal expansion in a decade. The Chinese government continues to roll out tax cuts. And the United States is maintaining an expansionary fiscal policy stance.

Germany: € 150 Billion Allocated Over the Next Four Years

Beginning in Europe, German Finance Minister Olaf Scholz has set aside approximately €150 billion for much-needed investment in infrastructure, education, housing, and digital technology over the next four years.

The fiscal stimulus slated for this year is primarily intended to increase consumer spending. Higher unemployment and pension benefits, together with a tax cut for lower-income earners, are expected to boost purchasing power by 0.5% of gross domestic product (GDP).

The solidarity surcharge, an income tax that was used to help rebuild a unified Germany in 1991 after East and West Germany were joined, is also set to be abolished. It accounts for 5.5% of additional income tax and will be reduced beginning this year.

Meanwhile, government construction orders have soared, increasing 12.2% quarter-over-quarter in the fourth quarter of 2018. They will likely advance further in 2019.

France: Yellow Vests Spur Extra Spending

President Emmanuel Macron has responded to the “yellow vests” movement by announcing measures to boost the purchasing power of households by about 0.4% of GDP. These include canceling the increase in social charges on pensions, increasing the activity bonus for employees paid the minimum wage, creating a tax exemption on exceptional year-end bonuses, and increasing income from overtime.

China: More Tax Cuts Support Domestic Activity

Meanwhile, the Chinese government has continued to roll out tax cuts following its two-year effort to streamline and digitize tax collection.

In the first quarter of 2019, the government announced a 2 trillion CNY tax cut on business activity. Effective April 1, VAT in the top general category was reduced from 16% to 13%—on top of reductions in the employer contribution to social security from 20% to 16%. Together with household income tax reform implemented last year, these measures will continue to support domestic activity.

At the same time, the scope for further adjustments on the fiscal side is not exhausted, as the State Administration of Taxation continues to report an increase in aggregate tax collections in excess of expectations.

United States: Still Expansionary

The United States continues to maintain a highly expansionary fiscal policy stance. Although major corporate tax cuts boosted domestic activity in the first half of 2018, the U.S. budget deficit is expected to be even larger this year, at nearly 4.5% of GDP, despite the domestic economy expanding at an annual pace of 2%-plus.

Outlook

In summary, fiscal policies in the key demand centers around the world are likely to support domestic activity in the United States, euro area, and China.

Companies benefiting from consumer spending, especially in the euro area, will likely see improved growth prospects in the near term.

Within portfolios, we maintain our focus on companies with sustainable and durable earnings trends and recurring-revenue business models, which add growth visibility this late in the economic cycle.

Olga Bitel, partner, is a global strategist on William Blair's Global Equity team.