Time to Consider the Pros and Cons of ‘Trump Economics’
Goldman Sachs has put out the 10 market themes it is forecasting for 2017 and, unsurprisingly, they are heavy on Donald Trump. With each forecast, I’ll lay out my view as to whether they seem rational or hold fast to the Goldman Sachs culture of being very anti-Trump.
First, they don’t expect returns to be much higher, different from what some think Trump could bring. This is Goldman Chief Investment Strategist David Kostin’s position. As recently as Sept. 16, Kostin put out a note that the S&P would end that year no higher than 2,100. The S&P punched out a new all-time high yesterday of 2,193 and we haven’t even had any Santa Claus sightings yet. Not only will he eat crow this time next year, he will likely step down in favor of someone with a more ambitious view of the domestic economy and the stock market. After all, it’s better for business.
Second, Goldman expects growth in the United States on the back of a Trump stimulus. Gee, it seems the right hand at Goldman isn’t talking to the left. For a bunch of guys and gals that, as partners, bank about $3 to $6 million each per year, you'd think they could put out something a bit more creative than something Joe Six Pack is already acutely aware of. But again, this is the same company that sent an internal memo to employees forbidding them from displaying public support for Trump.
Third, it thinks the risk of new trade barriers from Trump is overstated. I agree with this position. Trump called the Chinese premier and held a high level, very diplomatic and productive dialogue that will dispel some of the overhyped fear about a massive trade war gripped by all manner of tariffs when a re-working of current trade agreements is more likely in the cards.
Fourth, it believes the pullback in Emerging Markets from Trump is only temporary, and that the asset class will gain as the economy grows. This is a toss-up as some forces are inherently bearish for emerging markets, namely a “king dollar” rally that has the Dollar Index (DXY) trading at a new all-time high against the other five major global currencies. The United States will be deemed the engine that pulls the global economic train out of the tunnel of global deflation, but foreign exchange currency headwinds can wreak havoc on profit margins.
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Fifth, the bank says China will continue to devalue the yuan, and hedging exposure to the currency is a good idea. I agree with this stated positon. The yuan was trading at 6.35 to the dollar a year ago and today it's 6.90 to the dollar. It benefits the Chinese economy greatly to export more goods to an improving U.S. economy where consumer spending accounts for two-thirds of Gross Domestic Product (GDP).
Sixth, Goldman officials expect a more targeted monetary policy focused on credit creation. I would expect the loosening of certain elements of Dodd-Frank will behoove the banks to take on more risk. This only is natural as long as it doesn't go to pre-2007 level “drunken sailor lending practices” that pushed the economy over the edge saddled with vast amounts of bad debt in the pursuit of quarterly profits.
Seventh, the bank's experts think earnings finally will start to grow in earnest, with S&P 500 operating earnings per share (EPS) rising 10% next year. Other research shops are rapidly modifying their earnings outlook for 2017 after the Trump win. Lower corporate taxes, repatriation of capital on attractive terms and the dialing back of deregulation for small business, energy and a push to actually implement large-scale infrastructure spending will create higher-paying jobs and generate more take-home pay. All these components support this assumption.
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Eighth, the bank sees higher U.S. inflation coming on the back of a number of Trump’s policies. Goldman must be making this statement after looking through the rear-view mirror. Costs for rents, health care, home repairs, college education, senior assisted living, taking your pet to the vet and travel and leisure have been going up all year. If you are buying rail cars that carry coal, inflation is barely budging. But if you are simply paying for household expenses, the inflation genie has been out of the bottle for a while.
Ninth, the bank does not think the credit cycle is going to come undone, with more of the same type of environment continuing. Nobody can possibly have a crystal ball on this issue. While home equity lines of credit have declined on a marginal basis, huge increases in auto loan and student loan balances could trigger some stress on markets, but it’s way too early to tell. If interest rates rise much further, the biggest credit bubble of concern is managing interest on the national debt, now at $19.8 trillion. As rates return to more normalized levels, the amount of interest that must be paid for the government to service its debt will rise substantially. The Congressional Budget Office (CBO) predicts the yield on the 10-year Treasury will rise to 4.0% by 2019. As a result, interest rates will more than triple from $250 billion in 2016 to more than $800 billion in 2026. By 2023, interest will represent more than 14% of the federal budget and continue to climb. A one-percentage-point increase costs the country $1.6 trillion over the next decade.
Finally, the “Yellen call” now has an upside cap on it, as Trump’s stimulus could make the Fed move faster to tighten conditions. That is the opposite of the so-called Greenspan or Bernanke put that investors once thought underpinned share prices. And while that was supportive of the Yellen call, it is being speculated that it is likely to keep stocks in check for some time. I wholly disagree with this position because as rates normalize, it’s indicative of an economy that is expanding with rising earnings prospects, hence a continuation of the bull market for stocks.
The “big picture” for the Trump administration is to bring long-term debt levels down, and that will require a comprehensive plan to addresses the major drivers of our debt. Reforming the tax code, slowing the growth of entitlement spending and reducing other spending and helping the economy through corporate incentives are all necessary to put debt on a downward path over the long term. These steps will define Trump’s presidency more than any other issue of the day because it is the elephant in the room that needs to be addressed much sooner than we expect.
In case you missed it, I encourage you to read my e-letter column from last week about how Trump's policies on taxes and income could affect you.