Weekly Update: Anticipating President (The?) Donald in La La Land

01-20-2017

My travel to Southern California this week started in Los Angeles, where I stayed at a hotel across from the Microsoft Theatre where the People’s Choice Awards was held. Checking out Wednesday morning, I missed my chance to spy my new heartthrob, Ryan Gosling (Brad Pitt’s getting too old, unfortunately) at the awards there that evening! At our first meeting, an advisor suggested “Trump is all about the candy.” Then off to Orange County, which I was told voted Democrat last November for the first time in 80 years. At a (wealthy) ladies event at the posh Pacific Club, we passed a Maserati, Bentley and limited edition Rolls Royce Ghost in the parking lot (Linda, you aren’t anywhere near Pittsburgh right now!) There, a most genteel lady worried aloud that Trump has an “unstable” personality. I fielded a number of questions about brick-and-mortar retail’s future, and “What will happen to the anchor stores and the boutiques!?” Shopping temptation was everywhere as we dined at the South Coast Plaza (where I was told more sales occur than in all of Beverly Hills) and stayed near Fashion Island. At a dinner with relaxed advisors, one of the more extroverted said in jest to the group, “Come on, let’s give him a chance. We can’t get Obama back, this ain’t Cuba!” At a meeting in Newport Beach, there was another Maserati sighting after a meeting for ultra-net-worth clients, in which the discussion revolved around “impact” and ESG (environmental, social, governance) investing. Later, in Irvine, again talking with advisors for wealthy clients, we were told they still “want a lot of cash.” Our final meeting was in Rancho Santa Fe, the wealthiest suburb of San Diego, where we counted our eighth Maserati for the week—with my 10-year old VW Jetta, I clearly don’t belong here.

Trump’s comments over the past week that the dollar is “too strong” (sparking a sell-off), the border adjustment tax (BAT) “too complicated” and repeal of the Affordable Care Act (ACA) should include immediate replacement reflect a president with little proclivity to equivocate. No surprise there. The question remains, what does he really want? For example, Cowen & Co.’s understanding is Trump’s BAT concerns are more semantic in nature than in concept, i.e., bad branding. BAT is bad name/branding. Sad! Taken in aggregate, Trump’s statements suggest incongruity at best between the new White House and congressional Republicans, not just on tax reform but health-care and entitlements (Trump’s chief of staff reiterated there are no plans to touch Medicare or Social Security). Of the Trump/Ryan “Big 3” (taxes, deregulation and infrastructure spending), taxes are by far the most critical in regards to political enthusiasm, but “fuzzy math” problems are beginning to weigh on sentiment, JPMorgan says. Without BAT revenue, for instance, it becomes very difficult to lower the corporate headline rate. A similar dilemma emerges with individual tax reform, ACA replacement and infrastructure spending—if entitlements aren’t touched, the government won’t likely have the fiscal capacity to achieve other pieces of the Trump agenda. At least, not from the perspective of many House Republicans. Trump may differ. Many sources proclaim he doesn't care about the deficit; he's remarkably comfortable with the concept of debt. He's also tone-deaf on race and many social issues, and has no reluctance to meddle in the private sector, intimidating companies that displease him. He’s a master troller, and Twitter is his bully pulpit.

Markets will have to get used to dealing with the cognitive dissonance of having a president who offers opinions on all sorts of things. Some, in fact, welcome it, seeing a method to the madness. They see a president who, by staking out aggressive positions against adversaries, will extract as many concessions as he can—a master negotiator whose ninja-like unpredictability keeps everyone on guard and off balance. Of course, Medley Global Advisors says the alternative—and equally plausible—explanation is that when you peel back the method, there is only madness. More broadly, history suggests presidents don’t really possess enormous power over the economy, even though they’re often judged on the performance of GDP and stocks during their tenures. Both, in fact, are functions of longer-term trends and cycles, not executive branch decisions. The enormous economic tailwinds in place up until the end of last century (higher birthrates, women entering the workforce, better productivity, etc.) are now exhausted or moving in reverse, and there’s not much any president can do about that. The reality is the laws of economic growth (labor supply and productivity) are immutable and anyone trying to violate them will only dramatically expand fiscal deficits and/or stoke inflation to damaging levels. Even some of the biggest doves, including Fed Governor Lael Brainard, don’t think an economy at or near full-employment requires fiscal stimulus. If the Trump administration does enact large unfunded spending/tax cut programs, it could result in an accelerated rising-rate cycle. Perhaps it’s this worry that has had the market in a holding pattern of late. Or maybe it’s due for a breather. It’s been nearly 70 days since a pullback of 1% or more, and sentiment is stretched (more below). Then again, stocks were rallying this Inauguration Day morning. Much is being discussed about celebrities avoiding the inauguration, but I don’t think it’s a reflection on Trump—all the beautiful people were in LA this week with Ryan.

Positives

Manufacturing momentum The Philly Fed index jumped in January to its highest level in more than 2 years on strengthening factory activity, rising new orders and the biggest backlog of unfilled orders in 6 years. The 6-month outlook also improved, with over 60% of firms planning to boost production. New York’s Empire gauge wasn’t as robust but still rose a third straight month as its expectations component held at a 5-year high. The reports built off a December that saw industrial production rise more than expected, though largely on weather-related utility demand.

This bodes well for capex & consumer spending The Equipment Leasing and Finance Industry Monthly Confidence Index jumped in January to its highest level since data started in May 2009, reflecting expectations that lower taxes, less regulation and rising interest rates will spur demand for capital expenditures (capex). Separately, the share of respondents who think the economy will do better in the near-term rose in the Bloomberg consumer expectations survey by the most since March 2002’s post-recession spike and the second most since March 1986.

Housing still on uptrend A jump in December starts lifted the 3-month average to its highest level since October 2007 and the 12-month average to near April 2008 highs. While the activity was driven by a surge in the volatile multi-family sector, single-family permits rose the most since September 2012 to their highest level since October 2007. The increase was accompanied by a high level of builder confidence, which despite falling back a bit in January, was still close to its highest level since October 2005.

Negatives

Inflation Watch Headline CPI rose 2.1% year-over-year (y/y) in December, its fastest pace since May 2014. While the pickup largely was an energy story, core CPI ticked up to 2.2% y/y, led by the biggest jump in shelter prices since 2007. This week’s Fed Beige Book, Philly Fed and New York Empire surveys reported price pressures intensifying on rising wages and tighter labor markets—pressures that are sure to weigh on Fed policymakers if they continue to build.

Have we seen the peak in auto sales? December’s surge surprised, lifting auto sales for the year to a 10-year cycle high. But December was highly promotional, and much of the increase in sales of late has been fueled by auto loans whose credit quality is now coming into question. Some banks have begun to tighten standards on auto loans, creating a significant headwind for future sales and prompting vehicle makers to plan production cuts.

Warning signs Insiders are the biggest net sellers since September 2014, suggesting that they are less optimistic about their companies’ prospects than investors are. Both Investors Intelligence and AAII sentiment are at bullish levels historically associated with pullbacks. Finally, whenever the Conference Board’s Consumer Confidence Index reaches historically high levels—it hit a 15-year high last month—it’s been problematic for the broad market and particularly for high-beta small-cap stocks.

What else

Where manufacturing is growing While it’s true the U.S. has lost 5 million low-skilled manufacturing jobs since 2000, the country’s advanced manufacturing sector—a computer-immersed industry that employs skilled and educated workers and adds significant value to the economy— has been expanding. About 500,000 jobs have been regained in high-value manufacturing, which includes robotics, 3D printing and 5-axis milling (in which numerically controlled tools that move in 5 or more ways are used to manufacture parts using water-jet or laser cutting).

A refreshing change on earnings For much of this cycle, earnings have surprised because analysts have revised down expectations over the course of the year as companies updated guidance. Since Trump’s election, 2017 estimates have actually risen modestly, helped by higher rates and increased business confidence. Historically, they would have fallen by over 2% during the post-election period leading up to the inauguration. 

Trump wants to go down as the greatest president ever And it’s not complicated. He wants to be remembered as the guy who got the jobs back, made us safe and remembered the forgotten man. Whatever you think of Trump, his mantra, “Never give up,’’ is inspirational. Godspeed and God bless America.