Policies of Change

Guiding Principles That May
Help Shape the Global Economy

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Today, we’re at a crossroads between open trade policy and protectionist sentiment, when policymakers around the globe are looking for ways to spur economic growth and appease their constituents.

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How should investors position their portfolios?

Changes in policy can impact the choices investors should make.

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Key Events and Global Policy Initiatives of the Past Four Decades

A look at events that have impacted financial markets since the 1980s.

Four Key Policy Types

Each year, many government policies are enacted globally to organize and manage civil society, economic sectors, and the natural environment. There are four principal types of policy that tend to affect financial markets.

Monetary Policy is action by central banks to influence interest rates and money supply.

Those actions typically include:

  • Stimulative measures (increasing money supply or lowering short-term interest rates) when an economy is weak.
  • Restrictive measures (decreasing money supply or raising short-term interest rates) when an economy is at risk of higher-than-desired inflation.

The influence of central banks also may extend to supporting economic growth and stabilizing financial markets.

Central Banks Have Used Their Balance Sheets to Support the Markets

Total central bank assets continue to increase in the E.U. and in Japan, but the Federal Reserve has begun to reduce its balance sheet.

Source: Bloomberg as of 06/30/2017

U.S. Corporate Income Tax Rates Are Among the Highest in the World

U.S. legislators are considering significant tax reform, including lower corporate tax rates, which may impact corporate spending.

Source: The Organization for Economic Co-operation and Development (OECD) as of 12/31/2016. The OECD is an intergovernmental economic organization with 35 member countries, who describe themselves as committed to democracy and the market economy.

Fiscal Policy encompasses taxation and spending.

Fiscal policy can affect growth in two ways:

  • Directly, through greater government spending.
  • Indirectly, through tax changes that affect consumer and business spending patterns.

Deliberate changes in governmental borrowing (budget deficits) often have the greatest short-term effect on economic growth.

Regulatory Policy mandates what is permitted in the marketplace.

Typically, governments have a set of regulations for a variety of areas, including:

  • Labor
  • Banking and insurance
  • Environmental safety

Regulatory policies often pose risks for economic growth through increased costs and losses in productivity.

Insights Into Top Problems Facing Small Business

  • The cost of health insurance has been consistently the #1 problem for small businesses over the past 30 years.
  • Unreasonable government regulations are currently the second top concern.
  • Tax complexity and tax rates have been a consistent issue since 1986, the last time the U.S. underwent major tax reform.
  • Business cost concerns have shifted from telephone rates in the 1980s to commodities prices (e.g., natural gas and gasoline) in the 2000s.
The Policies of Change report includes a complete list of the top five issues facing small business over the past four decades and what it means for small business today. Source: National Federation of Independent Businesses (NFIB). Small Business Problems and Priorities Report, August 2016.

The Relationship Between Trade and Economic Growth

Since the financial crisis, global trade and global economic growth have expanded at approximately the same rate.

Dotted lines indicate estimates.

Source: International Monetary Fund, World Economic Outlook Database, April 2017

Trade Policy sets rules and regulations for trade between countries.

These policies are either country-specific or set by a trading bloc such as the European Union (E.U.). Often, these policies are formulated to boost a nation’s international trade and grow its economy.

A trade policy typically includes:

  • Import and export taxes
  • Inspection rules
  • Tariffs and quotas

U.S. Policy Trends

Taxes Take Center Stage

U.S. legislators are considering significant tax reform, including lower corporate tax rates. From an investor’s perspective, lower corporate tax rates should benefit companies whose earnings are primarily domestic and taxed near the current marginal rate (35%).

What Wells Fargo Investment Institute Is Watching

  • Corporate tax rates: If these are lowered, U.S. companies could be more competitive globally.
  • Individual tax rates: If these are lowered, households and consumers could have more cash to spend, potentially benefiting consumer goods and services companies. Housing could be negatively affected if the mortgage deduction is less than the new standard deduction for many taxpayers.
  • Repatriation of overseas profits: This may benefit shareholders of multinational companies that have large overseas assets.

S&P 500 Companies: Foreign Earnings Held Overseas By Sector

Multinational companies have been able to shelter their international earnings from domestic taxation by holding assets overseas. Some U.S. policymakers have proposed offering incentives to encourage corporations to repatriate overseas profits.

Source: Strategas as of 9/19/2017. Unremitted foreign earnings obtained from the 10-K report of each S&P 500® Index company.

Developed Market Trends

Focus on Economic Growth

Recently, European labor and financial markets have improved as economic growth has recovered and political concerns have dissipated. Meanwhile, in Japan, economic growth has risen during each of the past five consecutive quarters — its longest positive stretch in more than a decade.

What Wells Fargo Investment Institute Is Watching

  • U.S. foreign policy. It is a key geopolitical uncertainty, particularly with respect to European and Asian policy.
  • Anti-euro skepticism. In our opinion, most of the legitimate populist concerns appear largely priced into the region’s financial markets.
  • Italy’s 2018 elections. Any weakness related to this election may be an opportunity to add to developed market equities.
  • Brexit. The U.K. could be headed for an exit from the E.U. without a comprehensive trade deal with its former partners.

Inflation in the Eurozone and Japan Remains Below Central Bank Targets

Rising rates or reduced quantitative easing are likely for the U.K. and Eurozone, though easing is likely to continue in Japan.

Source: Bloomberg as of 07/31/2017

Emerging Market Trends

Building on Success

Exports from emerging markets increased in 2017, thanks in part to the stabilization in China’s economy, as well as steady growth in the U.S. and a rebound in Europe. We expect this trend to continue into 2018, but supportive policies are needed for these countries to continue on their trajectories.

What Wells Fargo Investment Institute Is Watching

  • Protectionist trade policies. These are a risk for global trade and growth. However, we do not see this slowing growth in the emerging markets in 2018.
  • Rising government debt levels. This threat is most pronounced in a handful of countries whose debt is largely denominated in dollars.
  • China. We expect China’s economy to continue to progress as President Xi Jingping’s policies support its transition from an export-led economy to a consumption-driven economy.

Emerging Markets Increase Their Share of Global Growth

The stabilization in China’s economy, coupled with steady growth in the U.S. and a rebound in Europe, boosted emerging markets’ exports in 2017.

Source: International Monetary Fund, World Economic Outlook Database, as of April 2017

* Purchasing Power Parity is the rate at which the currency of one country would have to be converted into that of another country to buy the same amount of goods and services in each country.

Insights for Investors

The full Policies of Change report has additional details and insights from Wells Fargo Investment Institute that can guide investment strategies in 2018.

  • How Central Banks Are Impacting the Global Economy

  • Global Geopolitical Concerns and Their Impacts

  • U.S. Tax Policy and Regulation Reform

  • Implications of Enhanced Spending in Foreign Markets

Investment Expertise and Advice to Help Clients Succeed Financially

Wells Fargo Investment Institute is home to more than 100 investment professionals focused on investment strategy, asset allocation, portfolio management, manager reviews, and alternative investments. For additional investment insights and timely market commentary, visit our website.

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