TBT Financial Services

Weekly Commentary by Dr. Scott Brown

The election and the economy
November 14 – November 18, 2016

Following the surprising election of Donald Trump and the news that Republicans had held on to the House and Senate, the stock market rallied. Optimism on near-term economic growth may be warranted, but investors should also be realistic. Growth over the next couple of years will be restrained by the demographics (slower labor force growth) and fiscal stimulus is more likely to fuel inflation and boost long-term interest rates.

Heading into Election Day, polls had suggested that Hillary Clinton would likely win enough Electoral College votes to gain the presidency. However, given the uncertainties in polling results and turnout, Donald Trump still had a path to victory. It boiled down to the key battleground states. He won Ohio, where polls had had him ahead. He won Florida and North Carolina, where the two candidates had been polling neck and neck. That left him with a good chance to win if he could flip one of Hillary’s “firewall” states, Pennsylvania, Michigan, or Wisconsin, where she had been polling ahead in each. He won Pennsylvania and Wisconsin (and likely Michigan), lifting him over the 270 Electoral College votes needed.

A couple of weeks before the election, Democrats appeared to have a strong chance of regaining control of the Senate. The Republicans were defending 24 seats this year. The Democrats were defending 10 and needed to pick up four seats (five if Trump won). They led in six of the Republican-held states, but that faded as the election neared. Instead, Democrats flipped just two seats, leaving control with the Republicans, who also retained control of the House of Representatives.

With Republicans controlling both chambers of Congress, President Trump should be able to achieve much of what he wants. And with Trump in the White House, congressional Republicans should be able to get most of what they’ve wanted, including the repeal of the Affordable Care Act.

Interestingly, we’re now hearing talk of fiscal stimulus (tax cuts or additional spending to spur growth). Trump, like Hillary, promised more infrastructure spending during the campaign. However, getting that through Congress may be tough. The House no longer has earmarks, which makes it difficult to reach a broad agreement on additional spending. Moreover, members of the Freedom Caucus, an extension of the Tea Party Republicans, are expected to resist more spending.

The one area on which all can agree is tax cuts. The nonpartisan Tax Policy Center estimates that Trump’s proposed tax cuts would reduce federal revenues by $6.2 trillion over the next 10 years, and with the added interest expense, would add $7.2 trillion to the national debt. However, it’s widely expected that tax cuts will be scaled back from what was promised. The economy is already close to full employment. Hence, large-scale tax cuts may be more likely to fuel bubbles.

The budget deficit and national debt (which is the accumulation of past deficits) received little mention during the election. It’s said that the federal debt only matters when the other party controls the White House, and it wasn’t clear who would win. Additional infrastructure spending and large-scale tax cuts, on top of increasing expenditures on Social Security and Medicare, will require the federal government to borrow more. Bond yields will be higher than they would be otherwise. The extra interest income should be helpful for retirees and other savers, but we’ll also see increases in mortgage rates and the cost of business borrowing.

Could lower tax rates speed up economic growth and boost revenues and offset themselves? Not likely. While there is still some slack remaining in the job market, labor force growth has slowed, limiting the upside potential for growth. That’s simply a reflection of the demographics (slower population growth) and expectations of moderate growth in labor productivity. Advances in robotics and artificial intelligence could lead to some significant labor savings in the years ahead, with displaced workers helping to relieve some of the impact of slower labor supply, but it’s hard to say with any certainty. We could increase immigration to offset the demographic shift, but that seems like a non-starter.

Trump campaigned on renegotiating or pulling out of NAFTA. Trade negotiations are extremely complex. They take a lot of time and manpower. Should Trump pull us out of NAFTA and other trade agreements, we could see a number of unfavorable developments. Higher tariffs will add to consumer price inflation. Retaliation or a full blown trade war would disrupt the global economy and hurt U.S. exporters.

The bottom line is that financial market participants face uncertainty in the near term. Tax cuts and infrastructure spending should support growth, but will boost the deficit and long-term interest rates. Trade disruptions are a genuine risk.

President Trump will appoint the next Fed chair. Janet Yellen’s four-year term ends in February 2018 and her presence should provide some near-term stability. Fed officials appear to be on track to raise short-term interest rates on December 14. Future policy moves will be data-dependent, but monetary policy expectations should adjust to the fiscal policy outlook, including the possibility of higher inflation.

Longer term, the population dynamics (the aging population) will restrain the economy’s potential growth rate, leading to a more challenging environment for investors. Market participants should be optimistic, but also realistic.

 


 

The October employment report
November 7 – November 11, 2016

The October job market data were not far from expectations, consistent with a further tightening in labor market conditions. While the average hourly earnings figures can be quirky (the data are often revised in the following month), wage growth appears to be picking up. That should keep Fed policymakers on track to raise short-term interest rates in December.

Nonfarm payrolls rose by 161,000 in the initial estimate for October, a bit lower than expected, but previous figures were revised higher. While there is a fair amount of noise from month to month, the pace appears to have slowed this year. However, job growth remains relatively strong given the demographics (slower growth in the working-age population). Remember, we need a bit less than 100,000 jobs per month to remain consistent with population growth.

Nonfarm payrolls have now risen for 72 consecutive months, the longest string ever (the previous record was 48 months). Private-sector payrolls have risen by 15.5 million.

The unemployment rate edged down, partly reflecting a drop in labor force participation. Do not read much into that – it is consistent with the usual noise in the Household Survey. The employment/population rate also edged down, but the trend for the key age cohort, those aged 25-54, has continued to improve. As this key cohort moves up to better jobs, space will be created for teenagers and young adults to get experience (the typical late-cycle pattern in a job market recovery).

As the job market tightens, one should see some upward pressure on wages. Average hourly earnings, as reported, are often quirky. Large gains may be revised away in the next month’s report or may be followed by more modest gains. Average hourly earnings rose 0.4% in October, up 2.8% y/y.

While nominal wage growth has picked up over the last year, real wage growth has slowed. That moderation reflects the stabilization and initial rise in gasoline prices. The recent increase in gasoline prices has come at a time of year when they usually fall – hence, the increase is magnified by the seasonal adjustment. The benefit to consumer spending growth of lower gasoline prices was expected to fade over time. The pickup in nominal wages helps to offset some of that impact.

Where does this leave the Fed? The Federal Open Market Committee’s November 2 policy statement made it clear that officials are getting closer to raising rates. However, the FOMC did not completely lock down a December 14 move. Policy action will remain data dependent, driven by the job market and the inflation outlook. We’ll get another employment report ahead of the mid-December FOMC meeting. While the Fed isn’t going to react to any one piece of data, the November job market figures should play a critical part in the Fed decision. At the same time, Fed officials are not expected to raise rates aggressively in 2017. However, that may depend on the pace of wage growth and the ability of firms to pass higher costs along.

 


 

Numbers and their meaning
October 31 – November 4, 2016

The U.S. economy is complex. Most people want to sum it up in one simple number: real GDP growth. However, that estimate has a number of flaws. Typically, there’s more going on under the surface in any government data report. The last several quarters of GDP growth are a good example.

Real GDP rose 1.3% over the four quarters ending in 2Q16, but that understated the economy’s strength. A slowdown in inventory growth subtracted 0.6 percentage point and a wider trade deficit subtracted 0.2 percentage point. Underlying domestic demand was more like 2.1% (+2.3% if you also subtract the government sector). This flipped in 3Q16. A faster pace of inventory growth added 0.6 percentage point, while a narrower trade deficit added 0.8 percentage point. Ex-foreign trade and inventories, domestic economic growth was more like 1.4%, about half of the headline GDP growth figure (+2.9%). In other words, the economy was not as strong as the 3Q16 GDP growth figure would suggest, nor was it as weak as the 2Q15-2Q16 GDP data would seem to imply.

The third quarter GDP numbers will be revised (and revised again), but the story is unlikely to change much. Note that there is a fair amount of choppiness quarter to quarter, which may reflect difficulties in the seasonal adjustment (and the possibility that the seasonal pattern is changing more rapidly over time).

Inflation-adjusted consumer spending growth was weaker than anticipated in 3Q16, and the quarterly data imply either a weak figure for September, or downward revisions to July and August. While slower than in 2Q16, the 3Q16 pace was moderately strong. Yet, there appears to have been some loss of momentum in consumer spending. Some of that may reflect caution amid election-year uncertainty. Consumer attitude surveys suggest some concern regarding the overall economy, but continued optimism in personal finances.

Consumers don’t spend confidence. Consumers may spend out of wealth or borrow, but most expenditures are fueled by personal income. Yet, consumer attitude measures can provide some indication of the overall consumer outlook, implicitly incorporating expectations for the job market and other broader economic drivers. The two major consumer surveys, the Conference Board’s Consumer Confidence and the University of Michigan’s Consumer Sentiment, have remained relatively range-bound over the last couple of years. The Conference Board’s survey includes labor market perceptions, which were less optimistic in the initial results for October, but still relatively optimistic, especially in comparison to recent years.

What does the advance 3Q16 GDP figure mean for monetary policy? Not much. The Fed’s staff is adept at slicing and dicing the data and officials should be made aware of the underlying strength beyond the headline GDP figures. More importantly, Fed policymakers are focused on the labor market and the inflation outlook. Job growth has slowed this year, but partly due to a tighter job market (although wage pressures haven’t picked up by much). The inflation outlook is mixed, but generally moderate. Oil and gasoline prices were never going to fall forever, and overall inflation should trend higher. Yet, recent figures have continued to suggest mild deflationary pressure in consumer goods, while inflation in services has been dominated by rising shelter and medical care costs.

A November 2 rate hike by the FOMC is not out of the question. The conventional wisdom about the Fed wanting to avoid action around elections is wrong. Similarly, there’s no hard rule that rates can only be raised when there is a press conference scheduled. However, the FOMC refrained from moving in September because it could afford to wait for more information. That argument is still valid, making a December move more likely – but that will remain data-dependent.

 


 

Numbers and their meaning
October 31 – November 4, 2016

The U.S. economy is complex. Most people want to sum it up in one simple number: real GDP growth. However, that estimate has a number of flaws. Typically, there’s more going on under the surface in any government data report. The last several quarters of GDP growth are a good example.

Real GDP rose 1.3% over the four quarters ending in 2Q16, but that understated the economy’s strength. A slowdown in inventory growth subtracted 0.6 percentage point and a wider trade deficit subtracted 0.2 percentage point. Underlying domestic demand was more like 2.1% (+2.3% if you also subtract the government sector). This flipped in 3Q16. A faster pace of inventory growth added 0.6 percentage point, while a narrower trade deficit added 0.8 percentage point. Ex-foreign trade and inventories, domestic economic growth was more like 1.4%, about half of the headline GDP growth figure (+2.9%). In other words, the economy was not as strong as the 3Q16 GDP growth figure would suggest, nor was it as weak as the 2Q15-2Q16 GDP data would seem to imply.

The third quarter GDP numbers will be revised (and revised again), but the story is unlikely to change much. Note that there is a fair amount of choppiness quarter to quarter, which may reflect difficulties in the seasonal adjustment (and the possibility that the seasonal pattern is changing more rapidly over time).

Inflation-adjusted consumer spending growth was weaker than anticipated in 3Q16, and the quarterly data imply either a weak figure for September, or downward revisions to July and August. While slower than in 2Q16, the 3Q16 pace was moderately strong. Yet, there appears to have been some loss of momentum in consumer spending. Some of that may reflect caution amid election-year uncertainty. Consumer attitude surveys suggest some concern regarding the overall economy, but continued optimism in personal finances.

Consumers don’t spend confidence. Consumers may spend out of wealth or borrow, but most expenditures are fueled by personal income. Yet, consumer attitude measures can provide some indication of the overall consumer outlook, implicitly incorporating expectations for the job market and other broader economic drivers. The two major consumer surveys, the Conference Board’s Consumer Confidence and the University of Michigan’s Consumer Sentiment, have remained relatively range-bound over the last couple of years. The Conference Board’s survey includes labor market perceptions, which were less optimistic in the initial results for October, but still relatively optimistic, especially in comparison to recent years.

What does the advance 3Q16 GDP figure mean for monetary policy? Not much. The Fed’s staff is adept at slicing and dicing the data and officials should be made aware of the underlying strength beyond the headline GDP figures. More importantly, Fed policymakers are focused on the labor market and the inflation outlook. Job growth has slowed this year, but partly due to a tighter job market (although wage pressures haven’t picked up by much). The inflation outlook is mixed, but generally moderate. Oil and gasoline prices were never going to fall forever, and overall inflation should trend higher. Yet, recent figures have continued to suggest mild deflationary pressure in consumer goods, while inflation in services has been dominated by rising shelter and medical care costs.

A November 2 rate hike by the FOMC is not out of the question. The conventional wisdom about the Fed wanting to avoid action around elections is wrong. Similarly, there’s no hard rule that rates can only be raised when there is a press conference scheduled. However, the FOMC refrained from moving in September because it could afford to wait for more information. That argument is still valid, making a December move more likely – but that will remain data-dependent.

 


 

The opinions offered by Dr. Brown should be considered a part of your overall decision-making process. For more information about this report – to discuss how this outlook may affect your personal situation and/or to learn how this insight may be incorporated into your investment strategy – please contact your financial advisor or use the convenient Office Locator to find our office(s) nearest you today.

All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates (RJA) at this date and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete. Other departments of RJA may have information which is not available to the Research Department about companies mentioned in this report. RJA or its affiliates may execute transactions in the securities mentioned in this report which may not be consistent with the report's conclusions. RJA may perform investment banking or other services for, or solicit investment banking business from, any company mentioned in this report. For institutional clients of the European Economic Area (EEA): This document (and any attachments or exhibits hereto) is intended only for EEA Institutional Clients or others to whom it may lawfully be submitted. There is no assurance that any of the trends mentioned will continue in the future. Past performance is not indicative of future results.

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