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5 WHAT BUCKS THE TREND? Newton's first law of motion states that an object in motion stays in motion with the same speed and in the same direction unless acted upon by an external force. Right now, we think the global economy is beholden to the same principle: Absent an external force, the environment of sluggish growth, low yields and sideways markets is likely to persist. The first external force that changed the dynamic in 2016, the powerful Chinese stimulus, is unlikely to be repeated. First, growth in China isn't as weak as it was when the economy was suffering from industrial weakness and unemployment was rising. Second, there simply isn't policy space to launch a large stimulus that China (and the world) have become accustomed to. Total debt is approaching 300% of GDP, and large imbalances in the housing market limit the extent to which they can ease policy. Concerns over financial stability now outweigh the need to boost growth. For these reasons, we believe they will continue to use piecemeal actions (like targeted tax breaks) to more gradually support activity. EXHIBIT 6: THE INVESTMENT BOOM THAT NEVER WAS Fed manufacturing survey (6-month moving average) and % of GDP Source: BEA, Philadelphia Federal Reserve Bank, NBER, J.P. Morgan PB Econ. Data as of July 31, 2019. Grey bar indicates 2008 recession. Past performance is not a guarantee of future results. The second external force, exuberance over President Trump's reflationary policies, is waning. Specifically, it looks like the corporate tax cuts that were passed at the end of 2017 increased corporate earnings, did little to sustainably increase the growth rate of corporate capital spending (Exhibit 6). In other words, the tax cuts were a sugar high, not a fiber high. Now that protectionism and lower policy rates seem to be priorities for the administration, we think it is unlikely that President Trump rekindles the reflationary impulse and spurs higher yields. So what "external force" could act on the current equilibrium? The clear answer is fiscal policy. With sovereign bond yields this low, policymakers around the world have the leeway to enact expansionary fiscal policy. Several potential Democratic presidential candidates have advocated large spending programs (such as a Green New Deal), and there have been whispers that even Germany is considering a more expansionary fiscal stance. Crucially, the next round of expansionary fiscal policy could be more positive for economic growth but the implications for risk markets are less clear, because it may be financed in part by market unfriendly taxes on corporations, financial transactions, and even wealth. The bad news is that in the current political environment, we think it is unlikely that we will see meaningful fiscal stimulus from the United States, Europe or Japan in the near term. In the absence of an external force, it will take time to work through the inventory overhang. This should help to stimulate manufacturing activity and would be a positive for cyclical sectors of the equity market, and would likely result in a moderate rise in sovereign yields. The problem is that we believe it will likely take at least a year. A less likely candidate to catalyze higher yields would be a resurrection of the "Phillips Curve." In this scenario, we would see the more classic "late cycle" conditions of rising wages, higher consumer prices and a "re-pivot" to central bank tightening. Overall, we think "time" is the most likely (and least disruptive) scenario, but the longer the slow trend growth environment persists, the more appealing a message of fiscal expansion could be to voters in the developed world.

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