December 5, 2016

Donald Trump and Ronald Reagan economic policies


A surprising amount of spontaneous optimism has spread over the markets following the Trump election victory. Specifically, interest rates have climbed swiftly and economic and profit forecasts have been lifted based on the expectation of successful pro-growth policies to be implemented by the Trump administration.

However, one of the most pressing headwinds will be those higher interest rates. It is a headwind that will be compounded by the size of the federal government's debt, which will be close to $20 trillion in January 2017. And that does not include another $3.5 trillion of local and state debt.

Back in the Reagan administration, tax cuts increased the deficit, but when combined with the Clinton/Gingrich budget controls, debt was falling and economic growth accelerated. Debt as a percentage of GDP fell. But the abandonment of budgetary controls (tax cuts rose at the same time spending programs grew) in the Bush administration put us back into deficits The Great Recession led to an explosion in the deficit, growing by nearly $10 trillion in eight years.

The total federal debt has risen by more than $1.3 trillion in the last year (+7%); this includes off-budget debt.

The larger our debt, the harder it is to grow--just look at Japan and Europe. 

The U.S. debt to GDP ratio is more than 120% (it was only about 30% when Reagan was elected). Today, total U.S. debt--which includes private and business debt--totals $68 trillion, or under 400% of GDP. But nearly 95 million individuals are not in the labor force. As my pal John Mauldin writes, there are 43 million living in poverty, 2 million prison inmates, 43 million on food stamps, 57 million Medicare recipients and 73 million Medicaid recipients.

There also are more than $100 trillion of unfunded municipal liabilities that ultimately must be paid off.

Over the last 10 to 15 years, the U.S. economy has been growing at about 2% in real terms. More recently the rate of growth has slowed to only 1.5%. Add in inflation and nominal GDP growth is approximately 3.25%, compared to 7% growth in total debt.

The Heavy Lifting Lies Ahead

The Republicans' economic growth policy is founded on the notion that their initiatives will produce enough GDP growth to negate the growing deficit.

However, history indicates over the last 110 years that the U.S. economy has entered recession within one year of the end of every two-term presidency. If this occurs again, the lifting will be next to impossible.

Practically speaking, the implementation of Trump policy will take time and will require much more than just eliminating waste. Moreover, despite the stated goal of reducing health care costs, demographics (the aging Baby Boomers) will cause ever-more spending of a Social Security kind.

Finally, with a stated objective of reducing individual and corporate taxes, revenues and growth will occur with a lag, producing a rise in the deficit and worsening debt problems, particularly if interest rates rise.

I fear the gap between lower taxes and offsetting revenue increases will be wider than many now believe.

Bottom Line

Conditions today are materially different than they were 50 years ago, or even 35 years ago when Ronald Reagan became president.

When Reagan assumed the presidency, stocks were inexpensive. Back then, the stock market's capitalization as a percent of GDP was 40%; it's close to 200% now. Arguably, stocks are now expensive.

When Reagan became president, interest rates were falling; now they are rising. When Reagan won election, there was large pent-up demand. In 2016, zero interest rates for seven years have borrowed from future growth. When Reagan entered office, baby boomers were entering the work force; today they are retiring.

The heavy lifting of coherent tax and spending policies aimed at producing a smooth path of economic growth will be a meaningful challenge to the Trump administration, especially considering the length of the current expansion and with the historic precedent of recessions soon following two-term presidents.

Balancing the U.S. budget with an already swollen deficit in order to create a clear path to growth is easier said in a campaign promise than executed over the next few years.


November 30, 2016

Retail investors have come back in the markets

The Trump rally has carried the small-cap index and Dow Jones Industrial Average to new highs and the Nasdaq Composite and S&P 500 close to new highs.

However, looking under the hood discloses a change of leadership and more of a mixed picture. Indeed, conflicting group performance is as great as the last time we observed it--back in the first quarter of 2000, when tech screamed higher as consumer and industrial stocks faltered.

By March 2000, at the near end of that year's first quarter, there was an inflection point in which tech cracked and many of the out-of-favor groups began to recover.

March 2000 marked a major change in leadership and market direction.

To me, the extended tech bull market that came to an end in the first quarter of 2000 compares to the extended bond market run, which seemingly came to its conclusion four months ago. Recently the crack in bonds has accelerated, signaling a major shift in the three-decade bull market in bonds--something I have described as a Generational Bottom in Bond Yields.

The Trump victory has produced selling in bond-equivalent stocks and buying in financial and industrial stocks.

The questions at hand are (1) whether the new leadership is simply an election-related bump or something bigger, and (2) whether this leadership change is occurring (as is typical historically) to a bear market.

Much will depend, in my view, on whether the rise in yields is sustained and whether the rise in interest rates becomes a threat.

We do know that retail investors have returned in size. The total amount flowing into equities and ETFs of $45 billion was only exceeded in mid-2007--a poor time to buy stocks. The AAII (American Association of Individual Investors) bullish reading is the highest in 23 months.

The contrarian would be concerned about the sudden public affinity with the equity markets in such a brief period of time.

I do have a view that the magnitude of the gains in the market-leading groups may be too quick to be sustained. To make the Brexit analog, that rally lasted a total of three weeks (a week beyond Wednesday's two-week celebration of a Trump victory).

Bottom Line

Momentum is strong and the excitement is palpable, but I don't see a runaway leg of the 7-year-old Bull Market as the prospective fundamentals and elevated valuations do not support such an advance.

Position: Long SDS large; short SPY, IWM small 

via thestreet





November 23, 2016

Bought shares in Trevena


I bought some shares in biotech Trevena as insiders have made some recent purchases and company has a Prescription Drug User Fee Act date in the first quarter.

Those looking for a contrarian investment play might want to look at Mexico. The iShares MSCI Mexico Capped ETF (EWW) is down some 15% since the election.

Personally, I don't think anything major will change between countries despite the campaign bluster.

Position: Long CARA, TRVN.

November 21, 2016

Importance of contrary thinking

Let's begin this morning by considering and examining some possible contraries--some that I embrace, some that I don't embrace--and how markets may be impacted. Many of these contraries are obviously emanating from political uncertainties.

Some of the following outliers and non-consensus developments should be used as food for thought:

Interest Rates: 
Back in July, I called for a Generational Bottom in Bond Yields. I received a consistent Bronx cheer from the stands for this forecast, as many that previously had seen a spike in rates over the last few years now saw rates low forever. At that time back in early July, the 10-year U.S. note yield bottomed at 1.32%. This week the 10-year U.S. note yield hit 2.30% and, after an increase in yields of 100 basis points, the consensus is firmly now in the higher interest rate camp. (As an example, some vocal observers such as Mark Grant, who had been looking for a 1% 10-year yield weeks ago, is now assuming rates will climb higher). Should the new Trump administration's promised goal of more rapid economic growth be delayed or fail, rates will head right back down and yield spreads would flatten anew. (This morning the 10-year note yield is slightly below 2.2%, down by two basis points). Note: I believe that, at least over the short term, a long trade in bonds might be ahead.

Sector Strength: 
Lower rates would have broad sector implications. As an example, everyone's new favorite--bank stocks--would turn back down after a rip-roaring post-election move. Industrial stocks also would fall back to earth.

The Economy: 
How about the impact on the consumer of a $1 trillion bond market loss in the last month? Or an adverse impact of climbing rates on the refinancing market? How about the Trump transition? Again, should this transition be less smooth or meet opposition, any assumed economic benefits also would be delayed. So, what if the economy slows down further in the months ahead and we have seen a top in yields for months to come? What if it becomes clearer that the consensus 2017 S&P earnings forecast is way too optimistic for what would be the fifth year in a row?

Secular Growth Threats: 
Neither the Democrats nor Republicans are addressing the intermediate-term structural issues that are a threat to growth and create disruptions in the jobs market. Maybe the Republican policy implemented provides only a temporary relief to longer-term problems and the markets could see right through this, and falter.

The Trump Presidency (Part One): 
Suppose as the economy is weakening, growth-encouraging policy and tax policies are slow to be introduced? At best there will be a hiatus, as implementation of these policies becomes a late 2017/early 2018 event.

The Trump Presidency (Part Two): 
Is a brief presidential honeymoon ahead? Though a minority, some critics are more concerned with a disorganized Trump administration, characterized by authoritarian impulses, cronyism and incompetence. After all, the office's power is immense and the president is the most powerful person in the world. For now there is some expected in-fighting within the Republican Party. As yet there have been no roadblocks placed by the Democratic Party (even opposition to Steve Bannon has been limited) amid an incoherent process, but this, too, could change more quickly as the Democrats conceivably could get their act together.

The Trump Presidency (Part Three): 
Suppose Trump's tax cuts, if implemented, are a failure and don't trickle down, but, once again trickle up? Suppose his policy does Make America Great Again, but is restricted to the One Percenters? Then what happens to Trump's popularity when the middle class he wants to be elevated is demoted and not restored, again?

The Trump Presidency (Part Four): 
Finally, in a broader sense, there is still a legitimate question about Trump leadership and his ability to govern coherently. The President-elect's ability to govern is totally untested--even his defendants recognize it requires a leap of faith. Trump may be determined but, with little background in government, the new administration's governing philosophy is not yet recognizable. As I have previously expressed, we don't yet know how Trump will govern; this makes things of a market-kind uncertain.

The Democratic Party's Opposition: 
The Democrats, like the Republicans, have their own set of problems as they are caught in their own cul-de-sac. Facing a bleak few years, the Democratic leadership is old and there is a lot of tension. It is uncertain where the next leadership comes from, but should the Dems get their act together while there is some Trump administration delays, the opposition could have more impact and a more forceful policy influence on the Republicans. In other words, the Democrats may be down but not out, and how much of the Republican policies ultimately will be implemented is a big question mark.

Facebook and FANG: 
Facing its second significant issue in a month, the consensus favorite stock could disappoint in the months ahead. Maybe Facebook is a better short than long. FANG stocks may continue to be weighed down by fears of trade wars, a stronger currency and other threats to world trade.

Gold: 
The yellow metal is a hated asset. What if gold is the buy of the decade and breaks out under the aforementioned U.S. political issues?
The U.S. Dollar: 

Buoyed by confidence in pro-growth Trump initiatives and a Fed rate hike, our currency is strengthening. If economic growth slows and the U.S. dollar's strength continues, might we again have to ratchet down forecast global and corporate profit growth for 2017-2018?

Inflation: 
Consensus is for a slow increase in inflation. Suppose the pattern is quicker? Are the markets (bond and stocks) prepared for this?

The Year-End Rally: 
Everyone every year expects a year-end rally, and 2016 is no exception. But suppose that large hedge fund redemptions are much greater than expected. Who is left to buy to offset that selling?

Fraud: 
We haven't had a giant company fraud, a meaningful hedge fund fraud or any other fraud for some time. Suppose something comes up? I have a hunch about one big one. Stay tuned!

I have some more contraries, but I will wait for my 15 Surprises for 2017 next month.


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