One Hundred Days Down, 1,360 to Go: How Economic Trends Trump Political
Much was made last weekend of the milestone of the first one hundred days of the Trump administration. Supporters found inspiration, critics found fault—this was the same thing voters were doing a hundred days ago.
What has changed is the perception of what will emerge from this administration. The president has charted a bold vision for America. He will need the assistance of the legislative branch to fulfill it. This is the rub; in private life, you can treat your employees as vassals or worse, and even fire them for public consumption. Political life does not work that way. Other elected officials are constantly doing the math of what can you do for them as you ask what they can do for you. The executive branch is no place for a Lone Ranger.
“Lone Ranger” is exactly the self-perception of the man who occupies the White House at present. As the result of Trump’s unilateral moves, non-consultation with the leaders of Congress, insulting and picking fights with allies, etc., Washington is now responding to him with the ultimate insult: they do not take the president seriously. Republicans have a majority but no unity. Democrats have unity but no majority. Both parties are acting as if the president does not exist. For public consumption, Republicans speak well of Trump, but there is no follow through. Democrats use Trump’s divisive rhetoric to recruit followers. What we have, in effect, is a divided government within the appearance of single party control. There is no precedent for this.
The founders of this country devised a system of three branches of federal government, with checks and balances on each provided by the other two branches. It is the president’s opinion that this setup is a hindrance. He has talked of dismantling the Federal Court of Appeals if they do not endorse his position on immigration including abolishing the sanctuary cities, declaring eminent domain so that the wall with Mexico can be constructed, etc. Just about any student with a semester of civics can tell you that is not how the government works.
In his efforts to enact his preferred methods, Trump joins the leaders of Turkey and Venezuela, who are also attempting to revoke their own constitutions to enlarge their power. Most leaders would be insulted by the association. Trump evidently revels in it.
The question for this publication is: how does the economy respond to this? Evidently pretty well. Talk of tax cuts buoys the stock market, since lower taxes means higher profits, all else being equal.
Just how well “all else” does in an environment of falling taxes, rising interest rates, and higher deficits is anyone’s guess. Then again, in the absence of detail, it is hard to say just how low taxes will be cut, how much the deficit will be increased, and thus how much interest rates will be impacted. The tax plan is so lacking in detail it may as well have been written on a cocktail napkin. As the failure of the repeal and replacement of Obamacare shows, such details matter. The details determine who will support which legislation. Trump seems to be incurious as to how passing laws is done.
In the meantime, his base stands by him resolutely. Only a smoking gun coming from the Russian investigations would seem to sway his core supporters. If it was shown that Trump somehow collaborated with the Russians to influence the election outcome in the U.S., public perception would turn on a dime against him. We are possibly months away from such revelations by the FBI, who, though a bit tarnished by the last election, still has more credibility than the investigations being launched in Congress.
In spite of all of these externalities, the economy seems to be doing well. The first quarter repeated a pattern at least seven years running, in which the first quarter is the weakest quarter in the year. The pace of corporate profits is slowing, sans tax cuts, but is still positive. Besides, with interest rates still so low, there is really not much competition from the bond market for investor funds.
Another area of market support is foreign acquisitions of American firms. Companies in both Europe and Asia are looking to buy American companies, given the relative stability of this country. As more companies are acquired, the proceeds of their sales are plowed back into the stocks that remain, making them rise in the process.
This scenario could unravel if the supply of stock surged due to the Initial Public Offering (IPO) market taking off, but that is not predicted until interest rates go far higher than they are today. Higher interest rates would also provide investment competition, but they would have to be 2-3 percent above inflation to begin to transfer wealth back to the bondholders as a group. With current inflation at two percent or so, it is obvious how far interest rates would need to climb to impact stocks.
Does this mean that it is smooth sailing for stocks? Not at all. In technology and some financial stocks in particular, valuations have reached a level not seen since 2000. The median valuation level for stocks overall is something like 22 times. The safe ports are those areas that sell for lower valuations, but at the same time have growth potential. Volatility no doubt will increase. Who bails and who sees it through will depend on the knowledge and conviction of investors; not all of them know what they own, or why they own it. A lack of such conviction is how panics begin. More knowledgeable investors then profit off the less knowledgeable ones.
Sort of like politics.
The propensity of the economy to start the year off slow, only to accelerate as the year comes to a close, has perplexed those who measure such activity.
Most economic data is seasonally adjusted, meaning that it is supposed to account for things like weather disruptions, etc. One problem is that the weather is more volatile than the seasonal adjustments anticipate, to say nothing of less consistent. How can an economic model that accounts for April being colder than December be built?
For whatever reason, seasonal adjustments become easier as the year goes on. It is thus risky to take at face value the data, which shows a slowing economy, when balanced against consumer optimism which is now at record highs for this cycle.
Inflation is showing up more in wages than any other area. The lid on immigration is resulting in a scramble for workers, especially in industries like truck farming, restaurants, construction, etc., that in recent years foreigners have come to dominate.
At present there seems to be no political will to take on the president and his zero approach to immigration. Whether cooler heads will find a compromise agreeable to everyone is problematic. The younger George Bush attempted as much years ago, to no real result.
Interest rates seems destined to continue an ascent so gradual it resembles boiling a frog by starting with cold water, to test how long the frog will tolerate the heat.
To encourage interest rate growth, the Federal Reserve has signaled two more interest rate increases, plus the unwinding of the $5 Trillion bond portfolio held by the Fed to pump money into the economy in 2008-2009.
On the other hand, the U.S. continues to attract funds for other countries, some of which have far higher interest rates than ours due to our “safe haven” status. Such funds will help to keep interest rates in check until such time as the rest of the world becomes less unpredictable.
The Stock Market
Stocks as a group have shown a rising pattern of prices year to date. This stems from the prospect of lower taxes increasing corporate profits, along with international trade and foreign firms acquiring domestic firms.
While parts of the market appear to be overvalued on a fundamental basis, there are also parts that are not. One example is the cruise ship sector; when a rumor recently made its rounds that a Chinese conglomerate wanted to buy an American cruise line, cruise ship stocks advanced significantly. Previously, cruise stocks sold as a group for low relative valuations due to the fear of terrorism, overcapacity, etc.
One observation is that, as more market participants use vehicles like index funds and Exchange Traded Funds (ETFs), the market has become more volatile. This would suggest that the next material downturn will come when investors try to get out of these new vehicles faster than can be accommodated.
Warren M. Barnett, CFA
May 3, 2017
Warren Barnett is the founder and President, and Portfolio Manager for Barnett & Company. He was associated with the investment banking firm of Kidder, Peabody & Company and the investment counseling firm of Davidge & Company in Washington before returning to Chattanooga to accept a position in the trust department of a local bank. Perceiving the local need for the type of firms with which he was associated in Washington, he established Barnett & Company in 1983. He obtained the Chartered Financial Analyst professional designation from the Institute of Chartered Financial Analysts, Charlottesville, Virginia in 1986. Mr. Barnett graduated from The McCallie School in Chattanooga. He received his Bachelor of Science degree in Accounting from the University of Tennessee at Knoxville and his Master of Business Administration degree in Finance from the Owen School of Management at Vanderbilt University.
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