Tuesday, 26 of September of 2017

Economics. Explained.  

Economics and Politics

May 19, 2017

The firing of FBI Director James Comey and subsequent appointment of former FBI Director Robert Muller as a Special Prosecutor to investigate the Trump campaign’s ties to Russia clouds the economic outlook.  At the end of last year we specifically added 0.1% to GDP growth this year and 0.2% to growth in 2018 with an expectation that Trump’s tax cut proposals, repatriation of corporate earnings, and regulatory relief would boost investment spending and stimulate growth slightly in the near-term, and boost potential GDP growth from 2.0% today to 2.8% by the end of the decade.  Recent developments delay the possible implementation date of these hoped for policy changes, and it is easy to envision a scenario in which they do not happen at all.  Having said that the U.S. and global economic outlook appears to be strengthening.  Thus, we are not yet prepared to alter our GDP forecast despite Trump’s political woes.

The stock market selloff on May 17 was certainly justified.  The S&P had risen 15% since the election last November and a correction is long overdue.  However, the nearly 2% drop on May 17 appears to be nothing more than a single-day event.

 

The market had also become extraordinarily complacent.  As measured by the VIX index, market volatility fell in early May to its lowest level since 1993.  Following the favorable election outcome in France in early May the markets seemed to believe that they had nothing to worry about.

But President Trump’s firing of FBI Director James Comey and the subsequent hiring of Muller as a Special Prosecutor re-inserted risk into the equation for both the stock market and the economic outlook.  As we see it, it will be far more challenging for President Trump to enact the legislation noted above any time soon.  It is hard to envision any support from Democrats, and many Republicans could abandon ship.

But we do not want to impose judgment on President Trump.  Only two people were in that room and nobody knows exactly what was said.  We are supporters of the Trump policy initiatives — tax cuts, repatriation of earnings, and deregulation.  We are not supporters of the man himself.  He says, and we agree, that the mainstream press has not been particularly fair in their reporting.  It could be that there is less going on than we are being led to believe.  But we also recognize that things could be far worse.  We simply do not know.

One does not have to be a political analyst to recognize that the mid-year election campaign will begin early next year and the election itself is only 18 months away.  If Republicans lose control of the House of Representatives, Democrats will almost certainly initiate impeachment proceedings.  The Senate probably would not convict, but under those circumstances Trump’s agenda would never be enacted and he would be a one-term President.

But what if Muller does not find evidence of any significant wrongdoing by the president or his administration?  A lot of the current uncertainty disappears and a significant portion of his agenda could actually be implemented (although later than we had envisioned).

Certainly Republicans are aware that the midyear election is not far off and will double their effort to pass some of his proposed legislative changes.  If that happens our economic outlook would be largely unaffected.

In short, we believe it is premature to make significant revisions to our economic forecast at this point.  We continue to expect 2.2% GDP growth this year and 2.7% growth in 2018.  A couple of things to consider:

1.  The nearly 2% drop in the S&P 500 index on May 17 is not even remotely close to a stock market “correction” which is usually regarded as a decline of about 10%. A correction is long overdue and would be considered healthy if it were to occur.

2.  One reason the stock market is so strong is that corporate earnings were very robust in the first quarter and are on track for an easy double-digit increase this year.

3.  The strength in corporate earnings reflects in part a rebound in earnings from companies in the oil industry that were crushed as oil prices plunged in late 2014 and 2015. The rebound in oil prices has restored profitability to those companies.  It also reflects the continuation of extremely low interest rates.  While the Fed is gradually raising rates, the process will occur very slowly and gradually.  These two events are not going to change any time soon.  Thus, any stock market drop may be muted.

4.  The labor market continues to improve and is beyond the full employment threshold. The official rate is at 4.4%.  Even the broader measure that Yellen prefers is at 8.6%.  This labor market strength generates income which allows consumers to spend freely and keeps the economy expanding at a respectable clip.

5.  The global economy is gathering momentum.  Faster growth is evident in many countries to Europe – Spain, Germany, and the U.K. in particular.  Now that the French election uncertainty has passed, labor market reforms may actually occur in that country.  In Asia, GDP growth in China is holding steady at about 6.5%, but in India growth is rebounding to 7.5% which is the fastest GDP growth rate in the world.  Emerging Asian economies are benefiting from the rebound in commodity prices.  The IMF believes global GDP growth rate will accelerate from 3.1% last year to 3.5% in 2017.

Politics matter and we will follow developments in Washington closely.  But, for now, it appears that economic fundamentals “Trump” political events.

Stephen Slifer

NumberNomics

Charleston, S.C.


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