Should You Invest In The US Economy (What To Expect?)
In this article, we’ll be examining the viability of investing in the United States of America’s market.
In particular, we will be assessing (1) the future headwinds and (2) tailwinds that will affect its future economic developments and also the (3) viability of having a US market exposure from a portfolio perspective.
The article itself will be focusing on a macro-level analysis and while I recognize that the stock market does not represent nor reflect the economy, investors have to have a good understanding of how the economy may perform in the future as it does affect the stock market’s performances.
To elaborate, as investors who are investing in businesses, it is important that the economy in which the business is operating in is a healthy state and has a sustainable growth potential. This is because, depending on how the economy is performing, it will have a direct impact on the business's ability to stay profitable and grow which will directly affect the return on our investments.
With the disclaimers out of the way, let’s first examine the future tailwinds of the US economy.
1. Future Tailwind
1.1 USD Global Dominance
The biggest advantage that the United States commands today and in the future is the fact that its currency – the United States Dollar [USD] - is the world’s global reserve currency.
Since the end of World War II, the USD has served as the primary reserve currency globally, leaving little room for other currencies to grow as an alternative monetary system. As a result, many countries are economically dependent, exposed and sensitive to the USD, thereby providing the United States with an unrivalled economic bargaining power on the global stage.
While there has been a long-term trend of countries diversifying away from the USD reliance, the value of the USD will continue to remain strong moving into the future as it is in the interest of other advanced economies and the rest of the world given the fact that they hold a significant amount of USD denominated assets.
Furthermore, at the moment, there is no other alternative currency that could “step up” and replace the USD in its role as the global reserve currency. As such, it is unlikely that the strength of the USD or its position as the world’s reserve currency is going to be significantly weakened moving in the future.
The global dependence on the USD is what had allowed the United States to run years of the budget deficit and “print” shit tons of money over the years without really suffering from any major consequences as the increase in USD supply is easily absorbed by other countries on the world stage.
Apart from having the ability to run unsustainable fiscal and monetary policies without having to deal with the negative consequences, the United States, via the control of its currency, also have a high degree of influence over the activities and policies of other government that are dependent on the USD via things like sanctions.
Morality aside, having the ability to influence other governments to shape their policy in favour of your domestic economy is a priceless strength that will allow the United States to continue to grow their economy at the expense of other countries that are dependent on the USD.
With how intertwined the USD is in the current global system, it is going to take a few more decades for other countries to achieve proper diversification away from the USD assuming that a better alternative appears or the world adopts a more balanced use of the different major currencies.
Until then the United States will likely continue to benefit and make full use of its position as the global reserve currency to drive its own economic and political interest. Because of this, the United State’s economy will likely continue to grow at a higher rate as compared to another advanced economies (i.e. Europe or Japan).
Apart from the USD alone, there is also another reason why the United State’s economic behaviour is an exception among the advanced economy when it comes to long-term growth and that brings me to the next point.
1.2 The Capital Market of The World
Despite accounting for only around 15% of the world’s GDP, the United States accounts for almost half of the world’s global market capitalization as it houses public companies across the globe and is often ranked the first capital market to go to by companies looking to source for funding.
In addition, the United States also houses many notable global multinational companies which provide the country with the ability to “import growth” from developing countries. This is one of the main reasons why the United States economy can grow so steadily as opposed to other advance and mature economies.
Similar to the dominance of the United States Dollar, the global dominance of the US capital markets is almost unrivalled on the global stage and is expected to continue to be that way moving forward given the fact the favourable business stance that the country has and the depth of the capital markets.
As such, we can expect the United States economy to continue to benefit from their ability to attract, house and nature global multinational companies which will contribute to higher foreign direct investments, more efficient allocation of resources and hence higher economic growth rate.
2. Future Headwind
2.1 Demographic trend
2.1.1 Aging population
As with every advanced economy, the first demographic trend that the United States would have to deal with revolves around the issue of an aging population.
The population growth of the United States is projected to be at 0.3% per year from 2023 to 2053 which will be driven mainly by immigration instead of domestic growth as the fertility rate continues to remain below replacement rate.
In addition, the growth of the productive population (age 25 to 54) is expected to stagnate while the share of the non-productive population (age 64 and above) is expected to increase. This will result in an economic drag as firstly, there will be a lower proportion of the population that can produce and contribute to the economy.
Secondly, a higher share of future production will have to go towards non-return-generating budget allocations such as social security and healthcare to provide for the higher share of the non-productive population instead of towards more return-generating allocations such as investments in infrastructure and education.
As a result of the impacts of an aging population, it is highly unlikely nor realistic to expect the United States domestic economy to produce and perform as it did in the past when a larger share of its population is still productive and a larger share of its production are re-invested in return generating budget allocations.
2.1.2 Widening income gap and Inequality
The second demographic trend that the United States will have to deal with is the widening income gap and worsening economic hardship among the middle to lower-income groups. This is important because the source of sustainable long-term economic growth is often found in the middle-income class.
While the overall income of the United States has increased alongside the economic growth over the years, the distribution of income for lower and middle income has remained relatively unchanged and their purchasing power has decreased over the years as a result of inflation.
This means that both the middle- and lower-income population’s ability to consume and contribute to future economic growth has decreased as compared to 20-30 years ago. As a result, while the United State’s economy had indeed experienced a decent level of growth in the past, the disproportionate distribution of the very growth itself is what will hinder growth in the future.
Another issue with widening income and wealth inequality is the increase in political and social instability and risk of an uprising as the middle to lower income continues to struggle with high and higher prices while witnessing the improvement in the lives of the upper-income class thereby resulting in a sense of unfairness, powerlessness and a diminished trust for political institution.
2.2 De-globalization trend
2.2.1 Higher Protectionism Stance
As the United States shifts their focus towards being more inward-looking and more protectionist of its economy, the political stance and policies that will be rolled out in the future will cause a decrease in attractiveness for collaboration and trade between the US and the rest of the world.
This will have two dire consequences on the future of the US economic growth.
The first is that it will reduce the United State’s ability to attract and retain foreign talent which is vital in cultivating and promoting innovation. Given that innovation had always been a cornerstone of the United States' economic growth, a slowdown in the quality and quantity of innovation will result in slower economic growth in the future as compared to that of the past.
The second is that it will reduce the United States’ ability to profit from cheaper foreign labour and resources thereby resulting in a higher cost of production which will be reflected in higher inflation. This will result in further deterioration of the purchasing power of the middle and lower-income population.
In response to this, the government will be forced to take action to maintain price stability or be forced to deal with the increase in the risk of political and social instability. Unfortunately, more often than not, the actions taken to maintain price stability are contractionary which will result in a decrease in economic growth.
Overall, while protectionism does have its merits – in areas of local job creation – the negative implication of being more protectionist and a shift away from globalization may negate the positives of it.
This is especially so given the demographic headwinds that the United States will be facing in the future – mainly the reliance on immigration for population growth coupled with the stagnating income and wealth growth of middle- and lower-income populations.
2.2.2 Reduce Reliance on USD
Another notable de-globalization trend is the increasing number of countries shifting away from their use and reliance on the USD.
While we have previously established that the global dominance of the USD is not going anywhere in the next 10 to 20 years, it is still a fact that there has been a long-term trend towards currency diversification and a steady reduction in the global adoption of USD.
The reduction in the reliance on USD will have two main implications for United States’ economy.
The first implication is the reduction of the United States government’s ability to impose sanctions and economic pressure on other countries to progress their economic interest.
That said, as countries reduce their reliance on the USD, the United States government will be faced with more challenges moving into the future as they have lesser control to dictate the government and economy of other countries for the benefit of the United States.
The second implication is the potential weakening of the USD as the demand for the currency decreases over the years. Given that the United States imports more than they export, a weaker USD will result in a higher price of import which will directly contribute to higher inflation which may force the government to adopt contractionary policies to maintain price stability.
That said, while the value of the USD may depreciate as a result of a reduction in demand for the currency, it is unlikely that the demand nor the value of the USD will depreciate significantly given the high levels of foreign ownership of the USD.
2.3 Political trend
The last major headwind of the United States economy has to deal with lies in its political systems and the poor allocation of the federal budget which are driven by the politician’s desire to win votes in the short term as opposed to having a longer-term strategy for the country and its economy.
Despite running years of a budget deficit, the bulk of the United States budget is primarily spent on “non-revenue” generating items such as defence, social security and health-related expenses while the allocation for “revenue” generating items such as education, infrastructure, economic security programs often pale in comparison.
Mandatory spending aside, the amount spent between the defence and non-defense discretionary spending had stayed proximate to one another over the past two decades which highlights the government’s priority and preference in maintaining their military capabilities at the expense of other, more important areas such as local infrastructure, education and research.
This poor allocation of the federal budget is a result of the imperfections of the political system (or democracy in general) which places more emphasis on winning votes in the short run as opposed to having a longer-term vision and strategy for the country and its economy.
The implication of having such a narrow vision when it comes to budget allocation can and will only be seen decades down the road as the allocated budget provides no yield or return to the domestic economy which then creates an economic drag as the government continues to allocate their federal budget on expenses rather than assets.
By contrast, here’s how the Chinese government has been spending their government budget.
It would not take a rocket scientist to identify the contrast in priorities between the government and from there infer what the future would look like given the government budget’s investments today.
The topic of China will be discussed here – Read More: Should You Invest In The China Economy (What to expect?) [W.I.P]
3. The Viability Of Having US Exposure
3.1 Opinion On the Future of the US Economy
Overall, I feel that the United States economy will continue to enjoy a decent level of growth rate - though not at levels seen in the past - as they continue to benefit from having the global reserve currency status and one of the most established and sought-after capital markets.
While the domestic economy will experience a slowdown as a result of demographic, global and political headwinds, it will be partially negated by the United States’ ability to “import growth” from other developing markets due to the exposure that their global multinational companies have.
The United States Dollar and its positioning as the global reserve currency will continue to weaken in the future but it is unlikely that the currency’s position will be fully replaced and neither will the strength of the USD depreciate too drastically.
As such, moving forward, I expect the United States economy to be relatively stable while growing at a slower pace - an average of around 0 to 2% per year over the next two to three decades.
3.2 How does it fit in our portfolio
On a portfolio level, having broad-based exposure to the United States economy (via the S&P500) is essential as it provides a natural diversification, stability and some degree of growth to its investors.
That said, given that the economic growth is expected to slow down in the future, investing in ONLY the S&P500 is not wise if you are still at your wealth accumulation stage as the return on investment is expected to be significantly lower in the future as compared to the past.
If you are investing in the S&P 500 and hoping to receive a double-digit return as it had performed in the past (since 1950), perhaps you might want to reconsider your underlying exposure by including either emerging or developing market exposures or having a more narrow industry or sectorial exposure within the United States itself.
If you are looking at investing in just the United States alone, you should align yourself with where the trends are favourable (i.e. healthcare) and avoid those in which the trends are not (i.e. consumer discretionary).
You would probably perform well if you focus on sectors and companies that have more global outreach (i.e tech, finance) instead of those that only focus on the domestic economy itself (i.e. utilities) to gain exposure to the growth of other developing markets instead of being affected by the slowing domestic growth within the United States itself.
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Daniel is a Licensed Independent Financial Consultant with MAS and a Certified Financial Planner (CFP®).
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This article is meant to be the opinion of the author
This article is for information purposes only
This article should not be seen as financial advice
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