Politics aside (always a dangerous opening salvo), the current administration self classifies as pro-business. Agnostically, I classify it as pro-cyclical. Before its current obsession on “fair, free trade,” the accomplishments of lower taxes and less regulation had stimulated economic growth, stock prices, CEO optimism and consumer confidence. Earnings estimates have spiked higher, the unemployment rate has reached a level unseen in 20 years and wage growth is beginning to percolate. While client statements support applause for the administration’s attempt to keep the economy moving along at a higher rate, I think it’s unrealistic to reuse the same stimulative tricks over and over again. Politically, it’s difficult to cut taxes twice — and there’s the rub. While you can use fiscal or monetary policy to inflate the amplitude of growth or stretch the length of the recovery, you cannot eradicate the cycle. Time and Trump’s pro-business policies have transitioned U.S. economic growth from its post-crisis “new normal” of sluggish growth and low amplitude cyclicality to the more volatile “old normal.”
From Small and Slow to YUUUGE and Fast
Janet Yellen was blessed with excellent timing. As she began her chairmanship of the Fed, previous policy makers had initiated accommodative monetary policy and stricter lending regulation to responsibly lift the economy from the heavy debts of the great recession. Taken together, this cocktail of circumstances created the new normal of low volatility and slow, non-inflationary growth, allowing the Fed to stay accommodative for a longer than normal period. After the economy regained its footing and rising asset prices solidified bank balance sheets, Yellen initiated rate hikes at a slow annual tempo. As the cycle matured and resource utilization tightened, Yellen successfully passed the baton to Jerome Powell. Powell does not have below 2% economic growth, fiscal policy constraint and Amazonian price declines but rather enjoys expansionary tax policy and tight labor markets. While gradualism meant annual 0.25% Fed Fund moves off the zero lower bound under Yellen, Powell intends to quicken the pace of rate hikes driving short rates to 3.5% by 2020. Although we are nowhere near there yet, these projected YUUUGE fast moves are transitioning my classification of Fed policy from “normalization” to “restrictive.”
It Is Only Polite to Reciprocate
Just 24 hours after the U.S. announced a proposed $50b in tariffs against China for unfair trade policies, the Chinese responded with similar tariffs against the U.S. Per the Chinese Embassy: “As the Chinese saying goes, its only polite to reciprocate.” While trade wars are contrary to both the Trump White House’s stated policy for “fair, free trade” and economic growth, aggressive initial tactics are typical of this administration’s negotiating style. As we saw with both health and tax policy, Trump doesn’t begin negotiations where he wants to finish. Fortunately, the unsettling “tit for tat” with the Chinese appears to have ended just a week later as China’s Xi Jinping renewed his pledge to widen market access and reduce tariffs. With Chinese trade hostilities receding, equity investors should begin to refocus on declining valuation ratios, strong earnings and accelerating earnings estimates. Robust revenue growth and newly lowered tax rates have pushed first quarter estimated earnings growth to 17% which would be the fastest pace seen in eight years. Coupled with current P/E ratios that have declined to their lowest levels since yearend 2016, we believe investors should begin to reconsider the long term benefits of U.S. equities.
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