Strategy: Exuberance Is in the Air. Now that the elections are over, we are starting to get readings on the post-election economy. First and foremost, consumer optimism jumped during November. That might be because the often-depressing election campaign is over. Fans of President-elect Donald Trump obviously would insist that consumers are exuberant about his economic policies, particularly the tax cuts. So far, there has been no mention at all of any painful policy prescriptions like how to rein in health care costs or fix the major entitlement programs including Medicaid, Medicare, and Social Security.
The stock market is also exuberant, with the S&P 500 up 2.9% since Election Day, November 8, to a new record high (Fig. 1). The election triggered a significant divergence among the S&P 500 sectors (Fig. 2). Since the November 8 close through Monday, November 28, their performance derby is as follows: Financials (10.6%), Telecommunication Services (7.0), Industrials (6.7), Consumer Discretionary (4.3), Materials (4.3), Energy (3.0), S&P 500 (2.9), Health Care (0.6), Information Technology (0.5), Real Estate (-1.8), Utilities (-2.6), and Consumer Staples (-2.8) (Table 1). Economically sensitive sectors have been very strong, while bond surrogates have underperformed as bond yields spiked from 1.88% on November 8 to 2.30% yesterday (Fig. 3). However, the steepening of the yield curve certainly boosted the Financials sector (Fig. 4).
Our Tuesday, 11/8 Morning Briefing was titled “Are Happy Days Here Again?” The answer is: “So far, so good.” In our commentary, we wrote: “Yesterday was a happy day, with the S&P 500 rising 2.2%, breaking the previous nine-day losing streak. … So yesterday’s happy day might be the beginning of yet another relief rally, which has been the modus operandi of the current bull market.” While the financial press speculated that investors were betting on Hillary Clinton to win the presidency after the FBI gave her a pass on their latest email investigation, we observed: “In any event, yesterday’s relief rally reflects lots of recent good economic news that hadn’t been discounted because of the political uncertainties hanging over the market as the elections approached.”
In other words, the economy was in reasonably good shape before the latest election. By comparison, when Ronald Reagan entered the White House on January 20, 1981, the country was still suffering from the after-effects of the 1979 oil shock and Iranian hostage crisis, and from a general feeling of malaise thanks to the bad luck and bad decisions of the Carter administration. Those were very unhappy days, and there was plenty of room for improvement, though there were still a severe recession and a bear market in stocks ahead.
Today, gasoline prices are down 41% from their 2014 highs (Fig. 5). Housing activity is increasing. Car sales are robust. The labor market is at full employment. Wages are rising at a faster pace. Retail sales and GDP are at record highs.
Now that the elections are over, we don’t have to listen to politicians telling us how badly the economy is performing. That might explain some of November’s jump in consumer optimism, which probably mostly reflects that the economy is in fact performing very well. Let’s review the pre-election and post-election economic indicators:
(1) Real GDP rose 3.2% (saar) during Q3 to a record high. That’s getting close to President-elect Trump’s goal of 4% growth. The Atlanta Fed’s GDPNow latest forecast for Q4 is 3.6%. Still, the y/y growth in real GDP was only 1.6% during Q3, and the quarterly rate was only 2.1% excluding exports of agricultural products, particularly soybeans.
The real question about real GDP is whether it can grow at 4% in a sustainable fashion without reviving inflation. That’s possible if productivity growth improves significantly. But that might be hard to do given our discussion yesterday showing that the problem has been a flattening of manufacturing capacity in the US ever since China joined the World Trade Organization in 2001.
(2) Home sales of new and existing single-family units combined rose in October to the highest since March 2007 (Fig. 6). November’s jump in mortgages rates is likely to spur more home buying in coming months.
(3) Confidence measures rose sharply this month. Debbie and I calculate our Consumer Optimism Index (COI) by averaging the Consumer Sentiment Index and the Consumer Confidence Index (Fig. 7). When Reagan was elected during November 1980, the COI was 82.0. This month it was 100.5, nearly matching the previous cyclical high during July 2007. The current conditions component of the COI rose to a new cyclical high this month, and the highest since summer 2007. The expectations component also rose sharply this month, but remains below its cyclical peak. Interestingly, the COI and its component didn’t soar until early 1983.
(4) Corporate profits, on an after-tax basis and as reported on tax returns, rebounded this year after falling from Q1-2015 through Q4-2015 (Fig. 8). It rose 19.0% over the past three quarters, approaching the record high recorded during Q4-2014. After-tax profits from current production is also rebounding, reflecting that most of the previous weakness was concentrated in the Energy sector as a result of the plunge in the price of oil, which has recovered some of its losses this year.
The corporate profit margin in the GDP accounts rose from a recent low of 7.8% during Q4-2015 to 9.1% during Q3. It remains below its record high of 10.8% during Q1-2012. The profit margin of the S&P 500 also rebounded recently, but it returned to its record high of 10.7% during Q3 (Fig. 9)!
(5) Forward earnings of the S&P 500/400/600 continue to trend higher in record territory, confirming that the depressing impact of the Energy sector’s recession is over (Fig. 10). With the Q3 earnings season behind us, the quarter is showing a 4.0% y/y growth rate, also confirming that the Energy-led earnings recession is over (Fig. 11).
So what could go wrong? Never before has a new administration proposed to provide so much fiscal stimulus to an economy that is already at full employment. Don’t get me wrong, personally I would love to see my top income tax rate cut significantly. I wouldn’t mind giving up all the tax deductions and exemptions that might be necessary to pay for the tax cuts. However, given our political process, it will be easy to cut tax rates and not so easy to pay for those cuts in a way that doesn’t boost the federal deficit and maybe provide too much stimulus to an economy facing a combination of labor shortages and protectionism.
The Bond Vigilantes have already made it clear since Election Day that they have saddled up and are forming a posse to ambush inflation before it makes a significant comeback.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
© 2022 Newsmax Finance. All rights reserved.