Article / 13 January 2017 at 10:00 GMT

Perplexed over presidential policy

Managing Partner / Spotlight Group
United Kingdom
  • Small businesses hoping president Trump will address their needs. 
  • Scarcely a shred of detail has been offered as to economic policy
  • Theoretical model shows Trump will rely on the Fed

By Stephen Pope

There is just one week until Donald Trump is inaugurated as the 45th US president and there is a sense in the markets that some of the gains booked since the November election are evaporating amid a lack of policy detail.

(Index close on November 8, 2016 / post-election peak / close January 12, 2017)

  • Dow Jones: 18332.74 / 19974.62 (December 20, 2016) / 19891.00
  • S&P 500: 2139.56 / 2276.98 (January 6, 2017) / 2270.44
  • NASDAQ: 5193.49 / 5563.65 /January 11, 2017) / 5547.49

Why should this be?

Trump's whole campaign was based on one key message: “make America great again”. For all the initial euphoria that saw equity markets rise so aggressively, however, there are mounting questions as to how will this achieved.

Erecting trade barriers against nations that the new president believes have taken advantage of America will simply result in reciprocal action, leading to a net loss of consumer choice and welfare. Policy conducted by Twitter that threatens and bullies corporates into revising their strategic plans is also far from statesmanlike. 

However, that was part of Trump's wide appeal. It was not going to be "business as usual" with a politician that just loves to talk. Trump was perceived as a businessman who wanted to make deals.

Donald Trump
"Just the best deals. Big, beautiful deals." Photo: iStock 

That said, business cannot flourish if there is no clear economic strategy and so far all we have are words and vague aspirations wrapped up within a loosely worded 100-day plan.

In a recent survey of 31 leading academic economists – the University of Chicago’s IGM Economic Experts Panel – 90% of the respondents disagreed with the effectiveness of the actions listed within the plan intended to protect American workers. 

That left just two economists; one was uncertain, and one expressed no opinion.

Why would the academic profession be so dismissive of this critical element of the Trump strategy?

This is because the key appointments made so far to the president-elect's cabinet or as advisers regarding the economy appear to have little rigorous economics education.

In fact, only one appointee could be classified as an economist, Dr. Peter Navarro. He earned his Ph.D. in economics at Harvard and is to lead the newly formed National Trade Council. What is worrying is that his opinions are quite radical and well away from the mainstream of economic thought. 

Perhaps that is why Trump likes him so much...

Navarro is known for his book “Death by China: Confronting the Dragon – A Global Call to Action” which assesses currency manipulation and abusive trade policies, the sale of deadly consumer products, and the potential threat to American economic dominance in the 21st century posed by China's Communist Party.

It was made into a documentary film described by The New York Times as "alarming and alarmist" and the progressive/liberal website Salon.com commented that it was full of "...dramatic overkill that is both unfortunate and unnecessary...”

Economics at odds with business

Looking at the latest survey from the National Federation of Independent Businesses, or NFIB, the numbers of their membership expecting general business conditions to improve has moved drastically.

Before the election, when Hillary Clinton was still holding a satisfactory lead, pessimists who saw business conditions as likely to worsen outnumbered the optimists by 7%. In December, after the result was known, the optimists outnumbered the pessimists by 40%. 

This is an extraordinary shift.

One reason for this shift in the perception of small businesses is that too many smaller firms are used by major corporations as subcontractors. Many of these firms have been complaining since 2010 that any money they owe a bigger firm has a maximum of 30 days' credit, whereas when the situation is reversed, payments that were once "net-30" – i.e. 30 days after an invoice date – are creeping towards toward net-60, net-90 and longer as larger clients try to keep their cash for longer.

Major corporations
"Let 'em wait." Photo: iStock 

Nearly 40% of firms surveyed by the NIFB said receivables, or funds owed by larger corporates, are coming in at a slower pace, just as new NFIB data show. Private businesses in the manufacturing, retail, and wholesale industries are really feeling the pinch, says financial data firm Sageworks.

Sara Horowitz, executive director at Freelancers Union, a non-profit group that includes self-employed workers such as consultants and contractors said:

 "This is a huge issue... I am getting e-mails from members who have a hard time [...] because their clients aren't paying on time."

Nearly 45% of the group's members struggled to get paid last year, according to a national Freelancers Union survey. The average amount per larger corporation they were paid late during the first nine months of 2016 was $17,000, up from $10,000 in 2013. 

For a small business, that is a significant sum of money. 

The result is that such lags in payments from larger to smaller firms has caused a vicious cycle; firms that don't get paid in a timely manner in turn can't pay their own debts. The banks have been less tolerant or accommodating to smaller firms. It is hoped that president Trump will also be “businessman Trump” and stand up for the little guy.

The dilemma for economists

Trump certainly is an unknown when it comes to how he will steer the economy. Varying groups are adopting different opinions, but isn’t this just a form of "filling in the gaps" in a patchy policy framework?  What’s perhaps worse is that each group is filling in the blanks differently...

Small businesses are pleased to see a businessman in the White House who might be on their side, but what of big business? Will they draw the same conclusions or consider the trade barrier rhetoric harmful to their export drive?

In contrast, economists across the world have learned to harbour reservations against all politicians whatever their ideology.

Perhaps one of the troubles with Trump is that the lack of detail has created too large a lacuna for economists to theorise within. It is as though we can mark out the ground with our theoretical mason's skirret, but we have no real idea where we are to plant the centre pin.

A simple conceptual model that appears to hold

When in the US recently I took several soundings from auto retailers, large and small businesses as well as consumers. These were sketched into a hypothesis linking, in crude linear form, the relationships of the following:

  • Real GDP growth rates
  • 30-year mortgage rates
  • Consumer confidence
  • Equity values from the S&P 500

Model
Sources:  Federal Reserve, NYSE, Bureau of Economic Analysis, University of Michigan 

The chart above shows the usual (x, y) space mapped out so that each directional arrow marks a positive direction. The theory is drawn so that the mappings of...

  • Real GDP growth and equity valuations
  • Real GDP growth and 30-Year home loan rates
  • Consumer confidence and 30-year home loan rates
  • Consumer confidence and equity valuations

... can be drawn in theory, all have positive correlations.

Now, I know that the chart has Consumer Confidence drawn on the x-axis, however the Independent and Dependent (I and D) pairs and their associate correlations or R-Squared values over the past 57 months are:

A: I =Real GDP Growth, D = Equity Valuations, R-Squared = 0.3212
B: I = Real GDP Growth, D = 30-Year Home Loan Rates, R-Squared = 0.6023
C: I = 30-Year Home Loan Rates, D = Consumer Confidence, R-Squared = 0.3667
D: I = Equity Valuations, D = Consumer Confidence, R-Squared = 0.8209

I accept that R-Squared values in the A and C space are not extraordinarily high, but there is enough there to suggest a reason for deeper analysis. When married to the relationships in the B and D space, then I certainly think one could allow the general direction of the model to be given consideration.

The crux of the matter concerns real GDP growth and the level of the equities and consumer sentiment, hence consumption is driven by the interest rate. So, in the early days of the Trump administration the role of the Federal Reserve is essential. 

We must hope that the next president does not try to steer the Fed or do anything that would leave Fed chair Janet Yellen feeling that the institution's longstanding independence is being compromised.

Budget
 
Source: Spotlight Ideas

There will be a lag between the new policies' implementation and the pickup of business activity in reaction to them. Business strategy takes longer to react than do equity prices. Therefore, as the chart above suggests, there will be a tendency for the US fiscal budget run a larger deficit for longer unless the lag between Trump’s policy and industrial pickup is minimised.

The borrowing binge that the new President has proposed will require a higher level of growth to be sustained over a longer period even if the US is to maintain its current budget position (let alone be in balance or surplus).

In fact, it is my view that the policies he introduces in the first six months will shape the economic legacy of his entire first term.

Given we know so little about how his policies regarding spending, tax, trade etc. are to be crafted (even if the new president will be loath to admit it), he, the US and maybe the global economy will depend ever more on the economic skills of the Federal Reserve.

Equities at first loved the election result, but there are increasing worries that we could be headed for another period of boom and bust. At Spotlight Indices, we monitor 11 sectors. Since the election, only two have lost ground. They are utilities and consumer staples.

The irony, however, is that if there is a sign of any economic underperformance under the new administration, those defensive sectors that so far no one has selected will suddenly become the darlings of the street.

Buckle up tight as from 1200 EST next Friday it is going to be a “bumpy, Trumpy ride”

Bumpy road
Destination unclear. Photo: iStock 

— Edited by Michael McKenna

Stephen Pope is managing partner at Spotlight Ideas

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