Weekly Update: Will trickle-down economics work?

01-13-2017

I traveled this week to sunny Denver and its spectacular mountains. Several very polite groups just shook their heads in dismay as I mentioned the word “Trump,’’ leading into a discussion of the election’s investment implications. I shared my view that the market has been cheering not Trump per se, but a Republican sweep of the White House and both houses of Congress, a setup not seen since 1952 and Eisenhower. An evening event at the historic Cherry Hills Country Club had pictures of Ike—turns out this was his favorite golf course during his presidency. My host informed me that Ike played approximately 800 rounds of golf at Cherry Hills during his 2 terms. I was also told Cherry Hills boasted one of the first golf carts, to help Ike get around the course. Through golf, Eisenhower bonded with the captains of industry who would spur him toward politics and later serve as golf posse to the president. The initiative came straight from the Oval Office and was code-named “Operation Rocky Mountains.” It called for an elite unit to be mobilized and flown to Denver on a tightly coordinated schedule. Once safely on the ground, the group would be whisked to a staging area, where members would share rations and receive final orders. The next morning they would rendezvous with their commander and attack their objective in groups of four. I’m not certain what would be comparable for Trump and his tight circle, many of them family.

The recent slowing in the market’s upward momentum may reflect a growing realization that getting things done even in an all-GOP Washington may prove more difficult than the markets have appreciated. As Mike Tyson once said, "everybody has a plan, until they get punched in the mouth." The World Bank estimates Trump's policies of tax cuts, regulatory reforms and infrastructure spending could add up to 0.3% to U.S. GDP this year and 0.8% in 2018, boosting global growth by 0.3% in 2018. Such numbers mostly reflect aspirations for some kind of certainty about what lies ahead, says Medley Global Advisors, which thinks it’s a laughable proposition to attach any kind of precision to the end-game impact of a long and messy political process in its infancy. Anticipated tax cuts aren’t likely to happen until 2018, the Affordable Care Act’s repeal and replacement will be complicated and contentious, and a possible border tax (more below) aimed at supporting domestic manufacturers could trigger a disruptive rise in the dollar, protectionism, etc. Combined with such late-cycle headwinds as rising rates, higher oil prices and a stronger dollar, extremely high business and consumer expectations could retrace, dampening animal spirits. The key will be whether the recent spike in confidence actually does lead to the stronger economic activity the market has been pricing in. Over the long term, the success of Trump’s agenda will be whether it drives real GDP growth from 1.5-2% currently to 3%+. Near term, widening session ranges hint at the potential for deleterious volatility, FBN Securities says, with both the earnings reporting season and the transfer of power in the White House having the potential to augment skittishness. When there is a change of political parties in Washington, the market historically has fallen back, forming a buyable low around mid-February.

The question remains, where are we in the business cycle? The U.S. and global outlooks already were improving before the election, and the data have picked up since. Ned Davis Research’s proprietary model puts the probability of recession at a 2-year low. One reason: there are few signs of credit problems ahead. It took 9 years for the real earnings of the bottom 80% to regain their 2007 level, with much of the recovery coming in the last 2 years when that group’s wage gains shot higher. That has helped lift big-ticket spending (auto sales hit a record high again last year, more below)—and has prompted consumers to start using their credit cards again (revolving credit jumped to a cycle high in December). The demand cycle still looks to be a drawn-out affair, as consumers and businesses remain focused on managing debt. Since 2014, the consumer has taken out 44 cents of new debt per dollar of new disposable income, a third the average from 1980 through 2007. This suggests it will take significant tightening to derail the consumer cycle, likely prolonging a recovery that’s already 7½-years-old and about to become the third-longest of the post-war era. High-powered stimulus that comes from lending money to the people who need it most, a la trickle-down economics, may be just starting to occur. Trumped-up trickle-down economics or the real thing? What do you think?

Positives

Small businesses ecstatic The NFIB optimism index surged a record 7.4 points in December to a 12-year high and on a year-over-year (y/y) basis rose at its fastest pace since October 1983. The report indicates strengthening upward momentum on expectations for pro-growth, business-friendly policies from the new administration, sparking a jump in plans for expansion (nearly triple levels 3 months ago) and capital expenditures.

Fed is in no rush While this week’s report on producer and import prices suggested rising pipeline pressures, core prices still remained relatively subdued albeit on an upward track. This would indicate the Fed’s unlikely to act quickly this year despite signaling 3 potential rate hikes in 2017—a view supported by the recent price action in Treasuries. The 10-year yield’s move to below 2.5% indicates markets aren’t expecting robust growth soon.

Global Recession Watch Global PMIs finished 2016 on a solid note, prices are reflating and sentiment indicators are hitting multiyear highs. As a result, leading indicators for the OECD, U.K., Japan, U.S., Canada, Europe, Spain, Germany, Italy, France, China, Brazil, S. Africa, Mexico and Russia are trending up, supportive of expectations for stronger growth in the new year.

Negatives

Santa didn’t shop in the usual places December retail sales ex-autos and gas were modest and November was revised down. General merchandise sales were weak, down 0.5% on the month and 1.7% y/y. Electronics, food & beverages, and eating & drinking also were drags. Online sales, by comparison, were robust as was spending on big-ticket items (autos) and recreation, signs of consumer confidence.

Inventories could undermine Q1 growth Data on Q4 inventories are looking heavy, Bloomberg News reports, with retailers and wholesalers showing large 1% builds in November and manufacturers also up 0.2%. Given weakness in total sales, the increase in the stock-to-sales ratio could foretell production slowdowns in coming months.

Where are we in the economic cycle? The Employment Trends Index declined for the first time in 4 months in December, led by "jobs hard to get" responses. The SHRM/LINE Survey reported recruiting difficulty, while November’s JOLTS survey put the number of unemployed per job opening at its second lowest level since April 2001, a sign of a tightening labor market. Finally, the Fed’s Labor Market Conditions Index has been declining steadily since early 2015 on a 12-month average basis—job gains averaged 180K last year vs. 229K in 2015. Decelerating job growth is the first sign of an economic slowdown.

What Else

BAT-ter up? A border adjustment tax (BAT) that would tax imports and credit exports is being considered to help offset some of the expensive stimulus plans, kind of a potential U.S.-style value-added tax (VAT). Beyond its similarity to a de facto tariff and putting aside problems it might cause with the World Trade Organization and our trade partners, a BAT could penalize a lot more of the economy than it would reward since the U.S. runs persistent, large trade deficits, Medley Global says. Barclays estimates a 20% BAT could increase y/y core inflation rates by 0.5-1% and pare GDP growth 1% or more. But the Cowen Group thinks a BAT won’t happen without significant adjustments, including carve-outs/exemptions and an extended transition. Republicans could use the upfront projected revenue to fund tax cuts, 100% expensing, etc., but never fully utilize BAT. As with Obamacare’s “Cadillac Tax” that was widely expected to never be implemented, this could be great politics.

Ike & event risk It was a crisp Saturday afternoon in September 1955. The economy was booming, there were no major crises in the world and the president, enjoying an approval rating of 79%, was on vacation. Then, on the eighth hole of his beloved Cherry Hills golf course, a 64-year-old Eisenhower started complaining of indigestion, which he attributed to the hamburger with Bermuda onions he had wolfed down between his morning and afternoon holes. Just 24 hours later, the American people were informed their war-hero president was in an oxygen tent at Fitzsimons Army Hospital. Another 24 hours later, the bull market that had seen stocks triple the previous 7 years went into a tailspin, with markets suffering one of their worst days since the start of World War II. Eisenhower recovered and was playing golf in 6 months, but his doctors forbade him any more golf in Denver’s high altitude. His summer vacations would be moved to Newport, R.I., and the Newport Country Club.

A ‘spirited’ group A recent Financial Times article entitled “Donald Trump unleashes business’ animal spirits’’ notes Trump and his executive team have only 55 years of government experience but 83 years in business. Obama’s comparable team had 117 years in government but only five years in business. BTW, the term “animal spirits” was popularized by the economist John Maynard Keynes in his tome, “The General Theory of Employment, Interest and Money.’’ “There is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations … Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits—a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”