Weekly Update: In the Great Northwest, trying to get their arms around this new administration

01-27-2017

I spent this week in Seattle and Portland, where the audiences were subdued. There was a paucity of questions about the outlook I presented and it appeared people were avoiding uttering “Trump” as if it were a dirty word. Although during Q&A, one gentleman did raise his hand. He couldn’t remember when he was so bullish. He thinks Trump puts us in a position similar to where we were at the dawn of the Reagan era. (Sure, but Reagan arrived during the depths of a severe recession. Trump is starting with an economy in its 91st month of expansion and a debt-to-GDP ratio of 77%, the highest since Truman after World War II. A major fiscal stimulus here could easily be a recipe for inflation, leading to an aggressive Fed. Every recession since 1950 has been preceded by aggressive tightening. But this is a worry for later, so I kept my thoughts to myself.) Interestingly, there was much discussion in both venues about the millennial generation—are these people driven, or are they “smoking too much pot?” For sure, millennials are everywhere in Portland. More people moved here in 2015 than any other city in the U.S., according to my hosts. Why, I asked, for corporate growth of jobs? “No, because it’s cool.” At a client event, a millennial voiced his great concern about civil unrest, citing last Sunday’s women’s march. “I’ve never experienced this in my lifetime,” he worried. I suggested he read some history books.

There’s a gap between political reality and expectations for the new regime, but JPMorgan says the markets don’t really “care” right now and the tape may not really “need” material action from Washington anyway. Nominal GDP was accelerating prior to November’s election, and if present economic and earnings trends persist, the S&P 500 should be able to achieve earnings in the $127-130 range this year and $135-137 in 2018 without any of the new regime’s “Big 3” (tax reform, infrastructure spending, regulatory relief). Meanwhile, there’s growing anxiety about missing another major leg higher, which is helping drive the market further. Despite the federal balance sheet’s enormously limited capacity and the logistics of a Republican Congress built on fiscal discipline, investors are very enthused about the Trump/Ryan platform, in particular over the past week, infrastructure spending. Given how critical it is to Trump’s populist economic message, a potential $1 trillion plan is likely to be passed in one form or another over the next several months, just not in the way some think. It’s likely to lean heavily on public-private partnerships. House Speaker Ryan wants $40 of private-sector spending for each $1 of public spending, which means if $1 trillion is the number, it would only require $25 billion of direct government spending spread out over a number of years. In a similar vein, the narrative behind anticipated corporate tax reform driving market expectations doesn’t seem to comport with reality—the headline rate can’t move much lower without radical code changes. The average cash tax rate for S&P companies already is in the 23-25% range. More broadly, there’s a lot less incremental news than one may think by simply looking at the headlines. As is the case with most new presidents, Trump and his team are staging a series of public events with the intent of creating the illusion of action, but action shouldn’t be conflated with progress.

Now that Dow 20,000 has been crossed, history suggests it should outperform over the next year. It’s much better positioned from valuation and technical standpoints than when it crossed 10,000 in March 1999, Ned Davis Research says. The Dow P/E is 20.6 now vs. 25.1 then and market breadth is at 23-year high now but was deteriorating then. At the end of the day, it’s all about earnings and results so far have been encouraging. With 44% of S&P market cap having reported, earnings are beating by 3% and earnings-per-share (EPS) are on pace to rise 8.6% vs. an expected 6.9%. The global earnings picture also continues to improve, with consensus EPS accelerating to its highest level since 2011, Deutsche Bank says. While this morning’s first take on Q4 GDP disappointed (more below), a lot of it was centered on trade. More recent signs—leading indicators, manufacturing and services PMIs, sentiment and business investment—are suggestive of more robust growth coming into the new year. Clearly, the market is feeling this way, in part because of its hopes for Trump and a GOP Congress. But over in Portland, an advisor told me that his lady client is agonizing over the Trump win. When he asked if the growth in her portfolio made her feel better, she called it “blood money.’’

Positives

More good manufacturing news Markit’s flash PMI hit a nearly 2-year high this month as faster output and new-orders growth signaled a marked upturn in factory activity at the start of 2017. Respondents cited "strengthening client demand and improving underlying market conditions." Kansas City and Richmond Fed regional readings also were strong, while core capital goods orders (non-defense, ex-aircraft) jumped a second straight month in December, underscoring robust investment spending in this morning’s Q4 GDP report and suggesting capital spending is starting to ramp up.

Encouraging indicators Conference Board leading indicators rose again last month, with broad-based strength among individual indicators and rising growth momentum. Also, the Chicago Fed’s national gauge of activity reached its highest level since July 2015, while the advanced read on December’s trade gap unexpectedly narrowed, suggesting an offset to the deterioration witnessed in this morning’s first report on Q4 GDP that omitted December data.

Consumers are happier Michigan’s final read of January sentiment held at its post-election cycle highs. Prospects for future income were the highest in a decade, though the sample split between optimism among Republicans offsetting pessimism among Democrats. A fifth of the sample said it's a good idea to borrow in advance of possible rate increases, a 20-year high for this reading. The 52-week average of Bloomberg’s weekly consumer comfort index also was robust, reaching its highest level since February 2008.

Negatives

Flash GDP disappoints The first estimate of Q4 GDP put real growth at a below-consensus 1.9%, as solid private consumption and a rebound in residential investment were dragged down by net exports, which trimmed 1.9 percentage points off growth. Exports fell 4.3% while imports jumped 8.3%, a sign of robust household and business demand that couldn’t be met by domestic production alone. The narrative around this trade gap is sure to take center stage in coming months given Trump’s emphasis on the issue.

Are rising mortgage rates starting to bite? Both new and existing home sales fell more than expected last month—it was the biggest drop in new home sales since March 2015. Realtors attributed the drop-off to higher mortgage rates and tight supplies. Despite the drop-off, year-over-year (y/y) sales were still positive and trending higher, with new-home sales up 12% on the year and existing home sales up nearly 4%. Prices also were higher, with the y/y FHFA purchase-only index topping 6%.

Inflation Watch When an economy’s near full employment, fiscal stimulus tends to have a smaller effect on growth but a bigger effect on inflation and interest rates—a reason Goldman Sachs expects both short-term and long-term interest rates to rise faster than currently being discounted in the bond market. Recent inflation data has been trending up, and globally, consumer prices rose 2.1% y/y in December, up from 1.6% in June. Inflation is set to take a second step up in coming months as recent increases in oil and agricultural commodity prices kick in.

What else

Trade Watch Investors are likely to learn a lot more about the subtle ways countries restrict trade as tensions build. A major drop in global tariffs and quotas helped boost global trade after World War II, but in the past decade, non-tariff barriers are reversing some gains. Negotiating away these barriers will likely prove difficult. Easy-to-implement tariffs could serve as opening volleys in renegotiating deals—witness this week’s dust-up with Mexico over “the wall.’’ But there’s momentum within Congress for a more comprehensive plan using a border-adjustment tax that would allow for passage of a broader stimulus bill under the budget reconciliation process, avoiding a filibuster.

Get thee to the tailor! Unfortunately for Sean Spicer, Trump is obsessed with his press secretary's performance art. Axios reporter Jonathan Swan hears that Trump hasn't been impressed with how Spicer dresses, once asking an aide: "Doesn't the guy own a dark suit?" New York Time’s Maggie Haberman tweeted that at Spicer's Saturday press conference, Trump "wanted him to be in command/project strength [and] to be a derivative of himself—Trump almost always takes Q’s & slices it with humor."

Come visit and we’ll get dinner Personal finance website SmartAssets.com ranked Pittsburgh No. 4 among the 25 top U.S. cities for gourmands, just behind San Francisco, Seattle and No. 1 Miami. This comes a year after Zagat named Pittsburgh its best food city. This week also saw Pittsburgh International Airport named 2017 Airport of the Year by Air Transport World, which evaluated airports worldwide.