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Does 2.3 percent economic growth justify Dow 20,000?

A survey of 53 economists by Blue Chip Economic Indicators forecast 2.3 percent economic growth for 2017, up from an estimated 1.6 percent in 2016. While better, 2.3 percent is still low by post-World War II standards. Consensus found that inflation would tick up to 2.4 percent, industrial production would begin to grow again (+1.6 percent) after stagnating in 2016, business investment (+2.7 percent) would finally be positive (after several years of disinvestment), and corporate profits would grow by 4.2 percent. Remember, these are just forecasts. In any other year, these would be downbeat, as a 2.3 percent economic growth rate is at the low end of post-WWII history. Yet today it actually looks upbeat given the last eight years of growth anemia.

Based on these expectations, and frankly on more rapid growth in corporate profits than this consensus forecast, the equity markets have soared with the Dow Jones Industrial Average within whiskers of 20,000, briefly reaching 19,999.63 at one point Friday. Note that the consensus of 53 economists forecast profit growth to be just north of 4 percent. However, at the historically normal forward price-earnings ratio, the market is pricing in 30-plus percent for 2017!

This tells me that the current equity market is priced for perfection. As such, it is vulnerable to any sort of disappointment – even good news that simply isn’t “good enough.”

This is reinforced by the current spate of economic data which are quite mixed, and it appears likely that the first quarter of 2017, and possibly the second quarter, could easily be a repeat of 2016 — i.e., anemic.

  • Holiday retail sales are softer than originally expected at retail stores, with Macy’s announcing the closing of 100 stores and the layoffs of up to 10,000 employees. This could be channel issues, as internet sales were strong, so let’s keep an open mind.
  • The Conference Board’s leading economic indicator composite was +0.7 percent in November, the softest it has been since December 2009. A year ago, this indicator was at a +3.2 percent level.
  • Industrial production remains flat, and evidence for Q1 production is mixed.
  • The price of gasoline is now rising, not falling as it was this time a year ago. According to Wall Street economist David Rosenberg, this is equivalent to a $50 billion tax hike.
  • As for inflation, maybe rising gasoline prices will have an impact, but it is really hard to see a 2.4 percent rate for 2017 when the world is still in deflation with excess capacity in almost all goods producing industries — and most of President-elect Trump’s policies portend deflation, not inflation, including regulatory rollbacks, energy independence, and a repeal of Obamacare.
  • The November trade deficit was at a 15-month high, and that was prior to the impact of a stronger post-election dollar.
  • November’s pending home sales fell 2.5 percent from their October level due to rising interest rates, and they rose further in December.

Still there is some positive news, so it doesn’t appear that a recession is yet in sight:

  • Auto sales for 2016 set a record at 17.55 million units, just eclipsing 2015’s level. However, the industry currently has a glut of inventory on dealer lots, and there was record discounting in November and December; so production is likely to be weak in Q1
  • The ISM Manufacturing Index, at 54.7, was significantly above consensus estimates, and the very large differential (three-year high) between the new orders and inventory sub-indexes in the survey suggests that factory activity could pick up early in 2017. Nevertheless, despite the positive sentiment displayed in the ISM, it is hard to overlook the fact that core capital goods orders (non-defense capital goods orders, less aircraft) are down 3.2 percent from year ago levels.
  • Construction spending in both the private and public sectors was strong in November, up 0.9 percent from its October level (when we were expecting 0.5 percent), indicating that 2016 ended on a positive note — and perhaps Q4 of 2016 has a shot at a 2.5 percent GDP growth rate.

Let’s assume that the new president is able to deliver on all of the positive economic growth factors he has promised (deregulation, tax cuts, profit repatriation, repeal of Obamacare, and increased military and infrastructure spending) and none of the negative factors (tariffs, trade wars, etc.). None of these can possibly have an impact on economic growth until at least the second half of 2017, if not later, because a) it takes time to get Congress to act, and b) there is a fairly long lead time between enactment and economic stimulation. The markets are impatient, and they are going to get tired of waiting and even fearful if the economy shows weakness early in the year, as I believe it could.

In 2009, when President Obama first took office, the market was just finishing its bottoming process and the recession’s end was imminent. The Fed was dramatically easing. The equity market tripled during President Obama’s tenure despite the anemic economy. As 2017 begins and President-elect Trump is about to assume office, the equity markets are at or near all-time highs; the expansion, anemic as it has been, is quite long in the tooth; and the Fed is now in tightening mode. In ’09 when Obama took office, the forward PE ratio was 8; today, it is 19.


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