Dealmakers Are Sinking in the Swamp

US Economy: Animals Dispirited?

Following Election Day, there was a widespread jump in consumer and business confidence. It was widely deemed that this reflected the unleashing of “animal spirits” when Donald Trump won with majorities in both houses of Congress. Suddenly, his campaign promises, which included tax cuts for individuals and businesses, seemed quite doable.

So did his plan to repatriate $2.5 trillion of corporate cash stashed overseas, as well as his commitment to slash business regulations. Debbie and I argued that, perhaps most significantly, the election marked a remarkable regime change.

Over the past eight years, we’ve had government by community organizers, who were mostly lawyers with lots of government experience but almost no business experience. Trump and his Cabinet are dealmakers with lots of business experience but very little government experience.

A 1/5 FT article by Gillian Tett titled “Donald Trump unleashes business’s animal spirits” reported that Trump’s top eight officials (president, vice-president, chief of staff, attorney-general, and secretaries of State, Commerce, Defense, and Treasury) had 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 IN TOTAL.

Debbie and I argued that some of the aroused animal spirits might be reflecting the regime change, with many of the optimists excited about simply having a very pro-business administration. If so, then actually implementing the full Trump economic agenda might not be crucially important for sustaining animal spirits. After all, the economy is at full employment, and more economic stimulus is not an urgent priority. The stock market has been moving into record-high territory since July 11, 2016. The Fed started to normalize monetary policy by raising the federal funds rate in late 2015 at a gradual pace. Fiscal stimulus would most likely be offset by a more aggressive normalization of monetary policy.

So here we are with an administration full of dealmakers and very few deals to show for it so far. Perhaps some are in the works. Trump also promised to “drain the swamp.” So far, it looks like the swamp is deeper than he thought, and he seems to be sinking in it. In any event, animal spirits mostly remain elevated, as evidenced by the latest “soft data” that we continue to monitor in our Animal Spirits chart book. However, the hard economic data remain relatively soft.

Consider the following:

(1) Real GDP. After Trump’s election, Debbie and I raised our real GDP forecast for this year from 2.5% to 3.0%. That’s on a Q4-to-Q4 basis. Now we are lowering it to 2.1%. It’s been growing around 2.0% since Q2-2010 (Fig. 1). Even during Q1-2017, which was up just 1.2% (q/q saar), it rose 2.0% y/y! If it continues to do so, that would imply q/q growth rates for Q2-Q4 of 1.8%, 3.5%, and 2.1% (Fig. 2).

Previously, we’ve observed that from H2-2010 to H1-2015, real GDP was growing around 3.0% excluding spending by federal, state, and local governments (Fig. 3). Government spending in real GDP is on goods and services, not on entitlement programs, which redistribute income. These programs may now be so large that they are putting a lid on government spending on goods and services, which certainly explains the awful condition of infrastructure in the US. In any case, the weakness in government spending in real GDP has been an unusual drag on the current expansion (Fig. 4). The good news is that it turned positive on a y/y basis from Q4 2014 through Q4-2016, though it was down again during Q1-2017 by a modest 0.5%. The bad news is that excluding government, real GDP growth seems to have slowed from 3.0% closer to 2.0% since mid-2015.

By the way, on Friday, the Atlanta Fed’s GDPNow reported: “The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2017 is 2.9 percent on June 16, down from 3.2 percent on June 14. The forecast for second-quarter real residential investment growth decreased from 1.8 percent to 0.4 percent after this morning's housing starts release from the U.S. Census Bureau. The forecast of the contribution of net exports to second-quarter growth declined from -0.23 percentage points to -0.34 percentage points after yesterday's Import/Export Price Index release from the U.S. Bureau of Labor Statistics.”

(2) Economic surprise index. Among the softest of the hard data indicators is the Citibank Economic Surprise Index (Fig. 5). It continued to plunge last week, falling from a recent high of 57.9 on March 15, 2017 to -78.6 last Friday. That’s the lowest since August 19, 2011. The good news is that this is a highly cyclical series with lots of short-term swings. In the past, when it has dropped this much this fast, it has tended to rebound strongly.

For now, it is showing that expectations that the rebound in animal spirits would boost the actual economy haven’t been realized. As expectations turn more moderate, they are more likely to be realized or exceeded.

(3) Housing starts. As Debbie discusses below, housing permits and starts have been weaker than expected recently for both single-family and multi-family units (Fig. 6). Single-family housing starts remain on an upward trend. However, so far, they have recovered only to previous cyclical lows.

Contributing to the slow housing recovery is that fewer individuals than ever before are building their own homes. We can track the do-it-yourself trend by monitoring the difference between new single-family home completions and new single-family home sales (Fig. 7). The 12-month moving sum of this volatile series has remained below 200,000 since the start of the current recovery. That’s the lowest pace on the record, which starts in 1968!

(4) Retail sales & production. The good news is that the recent spate of bad news wasn’t so bad. While retail sales fell 0.3% m/m during May, the three-month change in the three-month average of inflation-adjusted retail sales was 3.9% (saar), the best pace since September 2016 (Fig. 8). Industrial production was unchanged during May, yet the three-month change in the three-month average was 3.8% (saar), the best since July 2014! This augurs well for a pickup in real GDP growth during the current quarter.

(5) Animated animal spirits. Meanwhile, animal spirits haven’t retreated much even though Trump seems to be thrashing about in Washington’s swamp waters. The latest reading we have on business conditions comes from the June district surveys conducted by the Federal Reserve Banks of NY and Philly. The average of their general business conditions indexes rose to 23.7 during June, up from 18.9 last month (Fig. 9).

The Business Round Table reports that the CEO Economic Outlook Index was 93.9 during Q2, exceeding Q1’s 93.3 reading, with both well above Q4’s 74.2 tally (Fig. 10). That augurs well for capital spending.

(6) Forward revenues & earnings. Debbie and I are big fans of the soft data that Thomson Reuters I/B/E/S compiles of forward revenues and forward earnings for the S&P 500 (Fig. 11). These series are time-weighted averages of industry analysts’ consensus forecasts for the current year and the coming year. Both tend to be very good leading indicators for S&P 500 revenues and earnings. They are highly correlated with numerous business-cycle indicators. Their only flaw is that they don’t see recessions coming. However, if there isn’t likely to be one over the next 52 weeks, then they are signaling that the economy continues to expand into record-high territory.

(7) Bonds & stocks. Finally, we need to consider the mixed message coming out of the bond and stock markets. The recent decline in bond yields and narrowing of the yield curve spread suggest weaker economic growth. That doesn’t seem to be fazing the stock market, which continues to make new record highs.

Our interpretation is that they are both consistent with our NBx2 scenario for the economy, i.e., No Boom, No Bust. In this scenario, inflation is likely to remain subdued. If so, there might be only three more 25bps hikes in the federal funds rate, to 2.0% by the end of next year, then that might be it for a while.