The failure to get health care reform through the House of Representatives highlights the difficulty that this President is having in bringing his legislative agenda to reality; one would think that markets would have a significant negative reaction – but, that has not been the case. For sure, the Trump rally, itself, has stalled (except in the tech sector), as the closing level of the S&P 500 on Thursday, March 30, was 2368, just 4 points higher than its end of February level. But market negativity has been fleeting.
Trump Agenda – A Longer Runway
Back to the Trump agenda, besides health care, there is tax reform, trade policy and infrastructure. My readers know that it takes a significant length of time (sometimes years) to get public infrastructure projects approved. Now it appears that tax reform and trade policy will also take significantly longer to achieve than originally anticipated, and, perhaps, now not in the form originally contemplated. The markets priced in an almost immediate enactment of the President’s entire agenda. The failure of the healthcare bill appears to be an omen of how difficult it will be to get any of his agenda through, and, clearly it will not be in the timeframe that appears to be priced into the equity market.
The Deficit Issue
The next battle is tax reform. Without the $1 trillion “savings” over 10 years scored for the healthcare bill, the corporate tax rate isn’t going to be 15%-20% as Trump promised, as it doesn’t appear that House conservatives will allow a significant increase in the already large ($600 billion+) deficit. Perhaps the best corporate rate that can be hoped for will be a 25% rate. How is the market going to react to that?
There are other strategies Trump can follow to gain fiscal neutrality, like reducing loopholes in the current tax code. Interest deductibility is one that has been bandied about. But if that is the strategy, what would that do to his desired infrastructure spending, as much of that is financed via debt, and those fronting the money will likely require such interest deductibility
We now have the reappearance of the Border Adjustment Tax (BAT) as a way to pay for whatever tax reduction is proposed. Under certain conditions, a BAT could work and makes economic sense (see Leo Soong, “Common Sense About The Border Adjustment Tax,” Seeking Alpha, 3/17/17). Unfortunately, we don’t live in a world where political decisions are made based on what makes economic sense. Retaliation may be politically popular, and we run the risk of this leading to a significant slowdown in world trade, and/or perhaps, to a recession. Finally, if the BAT raises prices on Chinese imports, what will that do to the discount retailers, like Walmart (WMT) and Target (TGT), to retail in general, and to middle class pocketbooks?
The Economy Remains Sluggish
Given the difficulty the President faces in getting his agenda through Congress, one would think that we would see some significant adjustments in the sentiment indexes. The Conference Board’s Consumer Confidence Index for March hit its highest level (125.6) since December, 2000. The survey was taken prior to the healthcare bill fiasco, so maybe it will mark the high point of sentiment. We shall see. One thing is for sure, the underlying economy has done nothing but muddle along in Q1:
- The Atlanta Fed’s GDP growth forecast remains at a depressed 1.0% level; the average street forecast appears to be in the 1.5% range;
- Bank lending has significantly contracted over the past quarter;
- Delinquencies, especially in the sub-prime auto market are rising rapidly as revealed recently by Ally Financial;
- There is absolutely no evidence of inflationary pressures in wages or in the prices of goods; the price of oil remains below $50/bbl. due to overproduction and high inventories; and the prices of pharmaceuticals are clearly in the sights of this President;
- The Retail sector is in misery; Nike missed and guided lower; Lululemon’s share priced got smashed due to low sales and guidance; Sears has questioned its own viability in the fierce price competitive environment; Ford warned as production has slowed and auto prices are falling;
- China’s growth rate is declining and deflation there continues as they remain awash in overcapacity in their heavy manufacturing industries;
- The growth in restaurant sales, long a barometer of consumer spending, shows a 0% year over year growth rate.
If the economy were as strong as the sentiment indexes indicate, the 10 year Treasury yield would already have pierced 3%, as the Wall Street bond gurus forecast 3 months ago (but not yours truly!). The 10 year Treasury yield never got above 2.6%, and now it is hanging around 2.4%. Even the dollar has weakened; this should not be happening in the face of two (maybe three) more Fed rate hikes this year – unless the market is now re-evaluating its view of U.S. economic growth!
It is important now for investors to refocus on sales growth, profit margins, profits, and cash flows and away from “animal spirits” based on politics.