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Not So Fast: The Path to Faster Growth Won't Be Easy
Originally published Nov. 21 at 7:40 a.m. EDT" Dougie, there is many a slip 'twixt the cup and the lip."
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 as described in Friday's opening missive 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.
The Debt and Deficits Are Now Out of Control
"Deficits don't matter."
--Vice President Dick Cheney
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.
As mentioned late last week, 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 feat the gap between lower taxes and offsetting revenue increases will be wider than many now believe.
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.
- The U.S. dollar is flat today.
- The price of crude oil rallied smartly -- by nearly $2/barrel to $47.60.
- The price of gold was listless, up a beaner.
- Agricultural commodities: wheat up $0.02, corn up $0.03, soybeans up $0.24 (!!), oats down $0.04.
- Lumber is flat.
- For a change, bonds are quiet. The yield on both the 10-year note and long bonds showed little price change. As mentioned earlier the 2w/10s narrowed by 3 basis points.
- Municipals were a bit lower.
- Junk bonds found a bid, however, and Blackstone/GSO Strategic Credit Fund (BGB - Get Report) was up $0.06.
- Banks continued to trade well, small gains on top of large gains over the last month.
- Insurance very strong, though brokerages had some modest profit taking.
- Retail was mixed -- Home Depot (HD - Get Report) and Nordstrom (JWN - Get Report) lower while Foot Locker (FL - Get Report) and Best Buy (BBY - Get Report) were higher. JCPenney (JCP - Get Report) weaker.
- Oil stocks were the world's fair--with broad-based gains. Schlumberger (SLB - Get Report) and Exxon Mobil (XOM - Get Report) ++.
- Autos lackluster, still underperforming ... down to tagends in General Motors (GM - Get Report) and Ford (F - Get Report) .
- Biotech was modestly higher with Allergan (AGN - Get Report) down but Celgene (CELG - Get Report) better. I have no exposure in biotech.
- Big pharma mixed. No exposure here, either.
- REITs a bit lower. Still short iShares Dow Jones US Real Estate ETF (IYR - Get Report) (but covered quite a lot after the big drop over the last month).
- Old media strong with IBM (IBM - Get Report) a league leader. Trading short Cisco Systems (CSCO - Get Report) is down on the day.
- Consumer staples strong with Campbell Soup (CPB - Get Report) leading the bunch.
- Fertilizers pick up a bid -- though there is no apparent fundamental reason that I see! Ag commodities higher (led by a $0.24 gain in soybeans), but besides that nothing material in terms of price rises.
- Ag equipment mixed but well off day's highs. Still short small Caterpillar (CAT - Get Report) and I probably should be adding at these prices.
- Media is noticeably weak. Disney (DIS - Get Report) down half a beaner (but neither in shorting nor covering territory). Comcast (CMCSA - Get Report) being sold.
- Consumer discretionary mixed. Short, Starbucks (SBUX - Get Report) , up small. Nothing to there at these prices, either.
- (T)FANG exploding higher, with Facebook (FB - Get Report) and Amazon (AMZN - Get Report) leading. Netflix (NFLX - Get Report) still a small short (big push from a brokerage today).
- In individual holdings, my Apple (AAPL - Get Report) short is painful today (despite battery issues and an Oppenheimer downgrade) but DuPont (DD - Get Report) moving back to $70. Radian (RDN - Get Report) , trading well again and approaching a four-month gain of 50% for the period.
1. Jim "El Capitan" Cramer characterized the rally.
2. Ben "Goldfinger" Cross on, what else (?), gold!
3. Bobby Lang dismisses the concept of the bull market in bonds being over.
4, Chris "Not the Designer" Versace flattens up his good Trump trades before Thanksgiving.
5. Rev Shark writes: Market Rally - No Trader Left Behind?
LONG: SDS large, bonds, HIG large, JCP large, DD, CPB
Bottom line, not much to say here. On the non-event auction, Treasuries are about where they were just prior to the release of the auction details. The Treasury market over the past three days has been digesting the violent move higher, which of course begs the question of whether it's just a short-term pause before the next leg up or a short-term top.
Looking towards 2017-2018, I would preliminarily expect the 10-year yield to shift to about 0.8x where nominal GDP is (about 3.5% higher before any implementation of fiscal policy) and that means a continued (but slowing) move higher in bond yields. The economic slowdown this would inevitably create would then in turn slow and/or reverse the rise in yields -- but not back to anywhere near where they were in July 2016.
I would emphasize, again, that we have seen a Generational Bottom in Bond Yields.