Executive Summary
The detailed explanation for each of the following Current Economic Impediments to Growth and Proposed Polices can be found at the end of this article.
Current Economic Impediments to Growth – Which are all bad for the economy and the markets.
- US Debt is High
- Weak Growth
- Aging Population
- Slowing/Stagnant Productivity Growth
- Lack of Demand after a Long Economic Expansion (albeit tepid)
- Disposable Incomes Continue to Remain Low
- Low Unemployment Can Equate to Inflation
Proposed Policies – Which have negative and positives for the economy and markets. The problem is that the proposals which are pro-economic expansion / pro-market could give rise to higher growth. This could result in increased inflation which is bad for the markets.
- Lowering Corporate Taxes
- Lowering Personal Taxes
- Tax Credits for Infrastructure Spending
- Repatriation of US Multinational Corporation Profits
- Regulatory Reform
- Trade Policies
I have been an investor and a fee-only financial advisor for multiple decades. From everything I know and have read a 4% economic growth rate in the current economic environment is wishful thinking. I am not disparaging this or the previous administration in Washington or comparing them, I am just communicating the current reality.
Presidents, like coaches of sports teams, are sometimes given too much credit and blame. We have been in a deflationary cycle for a long time. This is what is driving our economic malaise. We can debate the poor economic policies of the past several administrations until we are blue in the face. It won’t change the fact of where we are, which has as much or more to do with demographics as poor fiscal responsibility. Please note that this is a multi-decade issue.
Despite the overreaching efforts of the Federal Reserve over the last several years, its policies have done nothing to increase economic activity. By keeping interest rates low, it has increased the bubble in stock market valuations and hurt savers.
The reality is that whatever Trump or Congress do, they will probably end up with not much to show for it short-term, and quite possibly a recession at some point in the next few years. This is based on the current tepid economic expansion, which is very long in the tooth by historical measures. It may die of old age.
If Washington politicians finally work together and put together a long-range plan, they could build a better foundation for future economic growth. The politicians may not keep their jobs in this fast-paced, “what have you done for me lately” world we live in, but they could positively impact the long-term future. We can only hope that they can find some common ground and that calmer heads prevail.
What does this mean for the markets?
As always, no one has a clue as to what the markets will do short-term. Long-term the markets will be most impacted by overvaluation and sustained trends in interest rates and inflation. Either scenario – higher inflation and higher interest rates or deflation and lower interest rates – will require that investors continue to be proactive and diligent to take advantage of mini stock market booms and avoid large stock market busts. This is especially true given such an overvalued market. Investment management is not for the faint of heart!
Conclusion
The knee jerk reaction by Wall Street and financial pundits is that pro-growth, economic stimulus policies will lead to a growing economy which equates to a stock market rally. Don’t we all wish it were that simple! As we know from the last decade plus, the economic system is much more complex than that; however, innovation is the hallmark of human nature and of the U.S. We could see some very nice surprises in various industries. There continue to be many technological advances from healthcare to productivity software to automobiles that drive themselves. It is impossible to know exactly how this all plays out. Based on the current economic realities, the odds are certainly stacked against sustained strong economic growth of 4% or more.
Currently the good short-term news is that the economic numbers are positive for the first part of the year, hopefully this can be sustained for this year and beyond.
We will continue to be very proactive with portfolio management as this plays out. Being an independent financial advisor for business owners, medical professionals and individuals who understand calculated risks and appreciate diligence always inspires and motivates me. While we have all enjoyed the nice rally post-election, the rally had slowed. We did experience a nice little uptick this past week. The markets appear to be at an inflection point with a lack of clear direction. Will we see a continuation of this rally, a correction, or more sideways movement? We are watching closely, ready to react either way. The reality is that a post-election rally may fizzle when investors move from hope based on potential pro-economic and pro-business policies to the reality that these things take a long-time to play out in the largest economy in the world.
See below DETAILS of Economic Impediments to Growth and Specific Trump Proposals and their impact on the Financial Markets
“If everyone is thinking alike, then no one is thinking.” – Benjamin Franklin
The Details
Please note that the details below are from an economic view only. The social/societal impacts pros and cons are not addressed.
Current Economic Impediments to Growth
Let’s review why the current Administration’s economic policies have a low probability of creating 4% economic growth. These same economic issues existed for the prior Administration. I have included stock and bond market implications as well. As you will read, it is “damned if we succeed” and “damned if we don’t”. Even if the current Administration is successful with increasing economic growth it does not easily equate to investment gains.
- US Debt is VERY high – If interest rates increase, the burden to service the debt will increase thus choking off economic growth. With more dollars needed to pay-down debt there will be less available for spending on goods or productive investment. Debt effectively pushes consumption and economic growth into the current period and robs future economic growth. The same is true across the globe – more money is needed to service debt and less is available to purchase goods and services or invest.
- Impact on the Markets – High Debt is not good for the markets. If the low inflation/deflationary cycle continues then interest rates will decrease, not rise. This helps bonds, but there is not much more room for bonds to appreciate.
- Weak Growth – Global Growth continues to slow; however, there have been signs of some life.
- Impact on the Markets – Global growth slowing is obviously not good for corporate profits and the stock market. If economic growth starts to increase this would be good for corporate profits; however, if economic profits are very good this would be inflationary which would be bad for stocks and bonds.
- Demographic Challenges – Birth rates and population growth continue to slow. The population in the U.S. and across the globe is aging. These two factors significantly slow productivity which is a major factor in economic growth. A young, growing population tends to fuel higher economic growth. Lower economic growth exacerbates the population growth problem. Lower per capita income tends to lower the birth rate and immigration and therefore population and economic growth.
- Impact on the Markets – Aging/slow population growth equates to slower economic growth and lower corporate profits which are bad for the stock market. Low inflation/deflation will favor bonds at these low interest rates – ughhh! More of the same.
- Productivity Growth – It is difficult to see how we reverse the multi-decade decline in productivity growth. One of the reasons for high productivity growth from the mid 1990’s to the mid 2000’s was the accelerated increase in hardware technology. That pace has slowed considerably; however, we are seeing tremendous productivity growth from software advances. I am curious if that will substantially increase productivity growth? Possibly not where we need to look at the economy as a whole. Often-times a job is not lost from software advances but redistributed. For example, advances in technology such as mobile bank depositing may decrease the number of tellers but increase technology jobs to create and service the software. Unfortunately, these redistributions are not always a one-for-one exchange of jobs.
- Impact on the Markets – Stagnant or slower productivity growth equates to slower economic growth and lower corporate profits which are bad for the stock market. Low inflation/deflation will favor bonds at these low interest rates – ughhh! More of the same.
- Lack of Demand – This Economic Expansion is Long in the Tooth – Despite the tepid economy, we are in the midst of one of the longest economic expansions in history. Usually at this stage of an economic expansion (based on time) most pent-up demand has been exhausted.
- Impact on the Markets – Lack of demand equates to slower economic growth and lower corporate profits which are bad for the stock market. Low inflation/deflation will favor bonds at these low interest rates – ughhh! More of the same.
- Disposable Income Continues to Be Very Low – This could change if we have strong economic growth which should equate to higher wages.
- Impact on the Markets – Stronger economic growth should create higher wages and higher disposable incomes which is net-net not favorable for stocks. Higher disposable income to spend in the economy is short-term pro-business and markets (if this money is spent on goods and service and not debt pay-down). Corporate profitability, currently at all-time highs, will decrease due to higher wages. This will lower corporate profits which is bad for the stock market. Higher inflation from higher wages is also bad for bonds. The silver lining is that this will create better values in the stock and bond markets – Finally!
- Low Unemployment Equates to Inflation if the Economy Heats Up – More money will have to be paid to workers if the economy heats up. 70% of Gross Domestic Product (GDP) is consumption. More money in worker’s hands is pro-economic growth; however, corporate profits are at an all-time high which is not sustainable. Higher wages will equate to lower corporate profits and lower stock prices due to lower corporate earnings. Bonds will not do well if inflation ticks up.
- Impact on the Markets – Stronger economic growth will create higher wages due to low unemployment. This is not favorable for stocks. Corporate profitability, currently at all-time highs, will decrease due to higher wages. This will lower corporate profits which is bad for the stock market. Higher inflation from higher wages is also bad for bonds. The silver lining is that this will create better values in the stock and bond markets – Finally!
Specific Trump Proposals – Pro and Con Financial/Market Impact
- Lowering of Corporate Taxes – This will be positive long-term for job creation due to the attraction of more businesses to the U.S. Short term, however, it will not have a significant impact on the economy. Interestingly enough, lower corporate taxes have not historically increased corporate profits.
- Impact on the Markets – Stronger economic growth from tax cuts is favorable for stocks; however, as noted above, corporate profitability generally doesn’t rise with corporate tax cuts, therefore, stocks may not benefit. Bonds will not be impacted unless inflation or interest rates rise.
- Lowering of Personal Taxes – Tax reduction works slowly. Tax reduction means more debt in the short term which is already choking the system. The U.S. debt has spiraled out of control over the last few decades. We are starting at a significantly higher debt level then when taxes were lowered in the Reagan and Bush II administrations. Lowering taxes can work if there is a commensurate cut in spending. Although this does negatively impact economic growth short term, it would be good for economic growth long-term.
- Impact on the Markets – Stronger economic growth from increased consumer spending — not based on consumer debt, but based on lower taxes — is favorable for stocks. If the tax cut is not offset with spending cuts, however, the benefits will be a short-lived. Bonds will not be impacted unless inflation or interest rates rise.
- Tax Credits to Private Sector for Infrastructure Spending – This could be very effective, BUT the tax credits and commensurate tax revenue losses must be offset with spending decreases. We know this from history. Japan tried increasing infrastructure spending by increasing government debt and it failed miserably. It is one of the major reasons why Japan is now in debt to the tune of 200% of GDP. There is no easy/quick way of digging out of that level of debt which slows economic growth to a crawl because productive investment is choked off by the money needed to service the massive debt. It is the same as a family that has excessive debt, any extra money goes to servicing the debt. Eventually there is an event such as job loss (recession for a country) that brings the crisis to a head.
- Impact on the Markets – Stronger economic growth from infrastructure spending is favorable for stocks, however, if the tax revenue losses are not offset with spending cuts the benefits will be a short-lived. Bonds will not be impacted unless inflation or interest rates rise.
- Tax on Repatriation of Corporate Money – When this was done in 2005-2006, most of the repatriated money was spent on investment (e.g. share buybacks, mergers, debt repayment, bonuses…) and not invested in productive capital. In fact, the bulk of the money to be repatriated is in the hands of three industries whose corporations are already cash rich; technology, pharmaceutical and energy. They don’t need the cash to invest in growing their businesses. Repatriation will also increase the value of the dollar as it did in 2005-2006. This will hurt sales and profits of corporations selling their goods in foreign countries.
- Impact on the Markets – Probably minimal where the repatriated money will most likely not be used for productive investment/significant long-term growth in corporate profits. There may be a small bump in corporate earnings for a few corporations from stock buy-backs and debt repayment. Bonds will not be impacted unless inflation or interest rates rise.
- Regulatory Reform – This policy would not require government debt to implement, therefore, it could have the best impact without a significant downside. The impact does take time to be realized.
- Impact on the Markets – Stronger economic growth from less cost to comply with regulations will be pro-stocks. Bonds will not be impacted unless inflation or interest rates rise.
- Trade Policies – This for me is the most concerning. If we get into trading wars, everyone loses. We need to be engaged globally. A high percentage of our corporate output is consumed by foreign countries. If the cost of our goods and services are increased due to retaliatory tariffs then our corporations make less money and workers make less money or are laid off. This is also a double-edged sword because foreign goods will cost us more. Over time this decreases the quality of American goods and services, due to lack of competition.
- Impact on the Markets – Lower economic growth and corporate profits are bad for stocks. Bonds could do well if interest rates remain low.