Reaganomics v Trumponomics

Reaganomics v Trumponomics

The market has been giddy as all get out over the fiscal policies that it expects the Trump administration will push through in a relatively short period. We’ve discussed at length how the timeliness of legislation is likely to be less timely than the market is hoping for, so we’ll leave that alone for now. Instead, let’s just look at the potential impact of these moves, taking into account the impact of similar legislation in the past.

The popular refrain we keep hearing bandied about is a reference to the post-Carter economic boom of the 1980s under President Ronald Reagan. Team Tematica would love nothing more than to get back to that type of rip-roaring growth — not to be self-serving, but such an environment makes the job of an investment professional a heck of a lot less stressful when everything is going up!

Here’s the thing, there are more than a few material differences in the state of the nation and global economy that no mere mortal inhabitant of the White House could resolve in a matter of months or years. President Trump is indeed a mortal… granted an unusually orange one, but a mortal nonetheless. Sorry, that was too easy of a shot not to take, but let’s look at some of those differences…

First, when Reagan took office, the total debt to GDP of the United States was just over 30 percent. Can you imagine? The headlines back then were also all about getting debt spending under control that the nation needed to work towards a balanced budget. When President George W. Bush took office the debt to GDP ratio was 57 percent. Today debt to GDP ratio is around 105 percent, 75 percent higher than when Reagan began, and around the levels at which warnings bells were going off concerning Greece a few years ago.

Many studies, most famously the one by Carmen Reinhart and Kenneth Rogoff entitled This Time is Different: Eight Centuries of Financial Folly, have shown that as sovereign debt levels get above a threshold level, growth becomes increasingly hampered.

In other words, Reagan had a lot more wiggle room for fiscal stimulus.

We can see the impact of this debt burden in the fiscal spending multiplier. According to an analysis by Lacy Hunt, Ph.D. of Hoisington Management, from 1952 to 1999 $1.70 of government debt spending generated an additional $1 of GDP. From 2000 to 2015, each additional $3.30 of government debt spending generated an additional $1 of GDP. By 2015, it took $5 of government debt spending to generate $1 of GDP. Ah yes, the law of diminishing marginal returns we heard too much about in economics classes.

Speaking of fiscal stimulus, the markets are ecstatic over expected tax cuts both at the personal and corporate level. Back when Reagan took office, the top marginal income tax rate was 70 percent, which was cut during his two terms to 28 percent. Today the top marginal tax rate is 39.6 percent, giving Trump a lot less room for reductions.

The workforce also looked a lot different under Reagan than it does today, as is reflected in our Aging of the Population investing theme. During Reagan’s term the working age population growing much faster than it is today.

 

 

The participation rate was also rising significantly and was at a materially higher rate than today. Today the United States has both the oldest population and the weakest population growth in its history. In 2016 population growth was 0.7 percent, which is the lowest since the 1935-1936 period with the fertility rate for women aged 15-44 tied for the lowest on record in 2013. For a bunch that looks heavily at thematic tailwinds, that is a major demographic headwind to growth.

 

With a lot more room to drop the top marginal tax rate and a much faster-growing workforce, Reagan was able to get a lot more bang for his buck. Today the current household formation rate is a painful 0.7 percent versus the average from 1960 to today of 1.6 percent.

Back when Reagan took office, the savings rate was around 10 percent, whereas today it is about 5.4 percent. From 1900 to the present, the average savings rate has been much higher, at 8.5 percent, which means we are likely in the later stage of the expansion when pent-up demand has been exhausted with savings for many negative when we look at savings rate by income/wealth levels. With many living paycheck-to-paycheck, as we regularly discuss in our Cash Strapped Consumer theme, the economy is increasingly vulnerable to shocks. This low savings rate also has repercussions inside our Aging of the Population investing theme, especially since roughly half of all baby boomers have little to no retirement savings.

Disposable personal income per capital growth over the past ten years has been less than 50 percent of the norm since World War II. Higher income allowed for a higher savings rate that also generated higher returns which translated into greater spending capacity, as interest rates were much higher.

During Reagan’s term, the 10-year Treasury rate dropped from a peak of nearly 16 percent to a low of 7 percent – talk about stimulative! Today interest rates remain near record lows with the Fed in the midst of a rate hike cycle. On top of that, we are seeing the beginnings of tightening loan standards and declining demand for credit, which is part of our Economic Acceleration/Deceleration theme.

From the Federal Reserve’s January 2017 Senior Loan Officer Opinion Survey on Bank Lending Practices, the most recent data available:

Regarding loans to businesses, the January survey results indicated that over the fourth quarter of 2016, on balance, banks left their standards on commercial and industrial (C&I) loans basically unchanged while tightening standards on commercial real estate (CRE) loans. Furthermore, banks reported that demand for C&I loans from large and middle-market firms, alongside small firms, was little changed, on balance, while a moderate net fraction of banks reported that inquiries for C&I lines of credit had increased. Regarding the demand for CRE loans, a modest net fraction of banks reported weaker demand for construction and land development loans and loans secured by multifamily residential properties, while demand for loans secured by nonfarm nonresidential properties reportedly remained basically unchanged on net.

 

Regarding loans to households, banks reported that standards on all categories of residential real estate (RRE) mortgage loans were little changed on balance. Banks also reported that demand for most types of home-purchase loans weakened over the fourth quarter on net. In addition, banks indicated mixed changes in standards and demand for consumer loans over the fourth quarter on balance.

 

Most domestic banks that reportedly tightened either standards or terms on C&I loans over the past three months cited as an important reason a less favorable or more uncertain economic outlook. Significant fractions of such respondents also cited deterioration in their current or expected capital positions; worsening of industry-specific problems; reduced tolerance for risk; decreased liquidity in the secondary market for these loans; deterioration in their current or expected liquidity positions; and increased concerns about the effects of legislative changes, supervisory actions, or changes in accounting standards.

 

This is typical of the later stages of the business cycle and regardless of what the Trump administration does, is a headwind to growth. In addition to the survey, we can see that since peaking around January 2015, the loan growth has been declining significantly, again one of the headwinds of our Economic Acceleration/Deceleration theme.

 

We can also see rising rates reflected in LIBOR rates, to which many mortgages are tied, which helps explain the declining demand for mortgages.

Finally, for investors, there was a lot more room for stock prices to go up in the 1980s compared to today’s market.

 

When Reagan took office, the Shiller Cyclically Adjusted Price-Earnings ratio was under 9, dropping to less than seven as Paul Volker hiked interest rates dramatically to crush inflation. By the end of his term, it had risen to just over 17 then continued to increase during the 1990s, peaking in 1999 at over 43. Today this measure stands just shy of 30, nearly four times what it was shortly after Reagan took office.

To put it all together, Reagan benefited from a labor pool that was growing much more rapidly than today, a higher starting point for the marginal tax rate, the stimulative effects of falling interest rates and a higher starting savings rate. During Reagan’s term investors benefited from much lower starting stock valuations.

The bottom line is that while many of the policies suggested by the Trump administration would likely have a stimulative effect, they must be assessed within the context of today’s economic reality.

Want Growth? Hello Immigrant!

Want Growth? Hello Immigrant!

One of our investing themes here at Tematica is the Aging of the Population. The first baby boomers are turning seventy this year, with another 1.5 million joining the 70+ crowd every year for the next 15 years. That means that we will be seeing record numbers of workers leaving the labor pool, which has a big impact on the economic growth potential.

The growth of GDP is a function of total hours worked in an economy, (which is itself a function of how many people are in the labor pool) and productivity.

This week the fourth quarter 2016 productivity numbers were released and they revealed that worker productivity increased last year at the slowest pace since 2011. With hours worked rising just under 2 percent combined with productivity rising about 0.5 percent per year, the best the economy can muster is roughly 2.5 percent growth. In order to get that much higher, we need people to work more hours, which is unlikely given the aging demographics or productivity needs to rise.

Increasing productivity isn’t something that can be done all that quickly, regardless of who is in the White House or which party dominates in DC, which we’ve talked about earlier in this post. We also discuss in that post how fertility rates in the U.S., and in much of the developed world, are declining to levels well below replacement rates, which means that were the nation to be left in isolation, the population of the country would decline over time. A declining population means fewer workers which leads to weaker growth prospects, not to mention a shrinking taxable base.

So what’s an economy to do? Pew Research just answered that question.

“Without immigrants, Pew projects the total U.S. workforce population — those ages 25 to 64 — would fall from 173.2 million in 2015 to 165.6 million in 2035. But if the current rate of both legal and unauthorized immigration remains steady, Pew projects that the number of working-age adults will rise to 183.2 million in 2035.”

 

They further found that,

“…the largest portion of the working population, people born in the U.S. to parents who were also born here, is shrinking. According to Pew, this segment of the workforce is expected to fall from 128.3 million people in 2015 to 120.1 million by 2035. U.S.-born workers will go from accounting for 74% of the workforce to just 66% of it.”

While concerns over terrorism are completely valid, the basics of economics tell us that to get this economy back to more historically typical rates of growth, the nation needs to augment its workforce, particularly as the largest generation in American history moves into retirement. This shift is a double-whammy in that not only is the economy losing large numbers from the workforce, but those retirees tend to spend a lot less in their sunset years, where they are more likely to shed assets than acquire more: grandpa and grandma are more likely to be downsizing their homes and less likely to be buying new cars today than they were 20 years ago! While our Aging of the Population investment theme is a tailwind for many companies serving that older cohort, companies that are tied to consumer spending are likely to feel the headwind.

Bottom Line – all the growth-positive legislation that could possibly be issued out of D.C. cannot get around the simple math that the more the pool of labor grows, the greater the potential for the economy.

Source: Without immigrants, U.S. workforce would shrink dramatically over next 20 years – Mar. 8, 2017

JOLTS Jars with Mainstream View of Jobs

JOLTS Jars with Mainstream View of Jobs

Yesterday the Bureau of Labor Statistics released its monthly JOLTS report (Job Openings and Labor Turnover Summary), revealing further details on labor market conditions in December. Despite all the post-election euphoria, the number of job openings actually declined by 4k and has dropped 130k since September.

While the number of new hires rose 40k, the level of hiring is 16k below the level in August and firings increased 16k in December, the third consecutive monthly increase for a cumulative 122k. That’s the highest level we’ve seen over a three-month period in more than three years. On the other hand, voluntary quits, which are viewed as an indication of confidence in the job market, fell by almost 100k in December.

We continue to see a historically very high skew between the average duration of employment versus the median duration of employment. (The average takes all the numbers together and divides them by number data points so a few large outliers can affect it, while the median is just the middle data point when all the numbers are sorted in ascending value, this not affected in the same way by those outliers.) This means that there is a large group that continues to not find employment up until, (and likely beyond) the period for which they are eligible for unemployment.

 

This is yet another manifestation of how the labor pool in the United States is structurally not functioning the way it has for decades. Having an unusually high percent of the population that would under more normal conditions be gainfully employed, contributing to the nation’s economic health, means that our potential growth is materially hampered. Just what is causing this structural alteration is the subject of much debate. Some argue it is caused by more generous policies around disability pay or other public assistance programs. Others have argued it is related to the percent of the population that has been incarcerated as the U.S. has the highest incarceration rate in the world: America is responsible for approximately twenty-two percent of the world’s prison population with only 4.4 percent of total population. Just look at the revenue trend for CoreCivic (CXW) which manages correctional and residential reentry faciliites.

 

We suspect that it is likely a combination of many of these factors and is also a result of the hangover from the last boom-bust cycle, in which many people became highly skilled in areas that are unlikely to regain their pre-bust employment levels. Someone who was a well-paid mortgage loan officer in 2007, is going to find a lot fewer openings in that field today, which means developing new skills and even more painful, likely taking a pay cut. Some may have found they cannot stomach the cut and so are staying on the sideline, nursing their understandably bruised ego. That means opportunity for those firms that can develop ways to take advantage of these unemployed and help them because productive again.

With a lower percent of the overall population employed it means that those with a job are shouldering a bigger portion of their family’s expenses. Adding to that, recall that Friday’s employment report showed that nominal annual wage growth was rather weak for 2016 at just 2.5 percent. Compare that rate to the 4 percent increase in rents and the over 5 percent increase in home prices and you get an image of households getting squeezed – something very much in tune with Tematica’s Cash-strapped Consumer investing theme.

Inflationistas ought to consider that and after having had near zero policy rates since 2008, with considerable rounds of quantitative easing on top of a record-breaking stock market and a recovery that is historically exceptionally long in the tooth, this is the best we can muster?

  • CPI Inflation 2.1 percent
  • PCE Inflation 1.6 percent
  • Core PCE Inflation 1.7 percent
  • Nonfarm Business Price Deflator 1.5 percent
  • Unit Labor Cost 1.9 percent
  • Employment Cost Index 2.2 percent

Add into that a strong dollar that is likely to continue to strengthen with oil looking to have topped out, (more on that later) and the inflation trade is not an obvious bet.

Where are the Jobs?

Where are the Jobs?

Friday the Dow Jones opened down, falling as much as 258 points, to only then completely reverse direction and ended the day up 200 points for a more than 450-point swing!  This was the biggest one-day percentage reversal in about four years. What drove the crazy move? This wild move was based on the very disappointing jobs report released Friday morning. Yes, you read that right.  A market rally on a weak jobs report as we return to bad news is good news and wonder, where are the jobs?  Whoop whoop!

2015-10-05 Job Growth Slowing

 

  • Consensus estimate for new jobs was 201,000 but the actual was 142,000 – 30% below expectations.
  • On top of that grim number, about 60,000 jobs were removed from the prior two month’s estimates, making August’s not-so-bad 173,00 look pretty sad at a revised 136,000 new jobs.
  • This is also the sixth of the past eight reports to have had a downward revision – not a good trend.
  • To rub salt into that wound, the workweek also dropped from 34.6 to 34.5, which doesn’t at first glance look like that big of a deal, but when you put that number across the nation in aggregate… it means effectively an additional 348,000 in job losses!
  • No improvement in wages either, so don’t be waiting to see consumer spending to help out the economy here.
  • The steady unemployment rate is only because more and more people are leaving the workforce, such that the labor force participation rate has fallen to its lowest level since the grim days of 1977 at 62.4% from 62.7%.

2015-10-05 Labor Participation

 

I’ve been saying for most of this year that I think a rate hike is highly unlikely in 2015 and this market rally shows the market is coming around to my way of thinking.  After Friday’s report, I’d say not only is a rate hike unlikely, but another round of quantitative easing is becoming a real possibility if things continue on this trajectory.  That isn’t to say I think QE is useful, as a matter of fact I think it is quite harmful, but it is the only tune that central bankers seem to know how to sing when times get tough and the rest of the government has basically shrugged off any responsibility for providing a fertile environment for economic growth. Most seem to be more interested in tossing snappy sound bites at each other.  Good times.

How-Sibling-Rivalry-Helps-Kids-Prepare-Life

 

I will also be watching very closely how the dollar is going to react as the strengthening we’ve seen could very well be affected by a belief that yet another round of QE is on the way, with the Fed once again joining the ranks of central bankers around the world trying to print their way into prosperity.

Looks like the refrain we’ve been singing for years of “Where are the jobs…. there ought to be jobs,” isn’t going to wrap up anytime soon. This cover is from over 4 1/2 years ago!   Oh and that Afghanistan thing… it’s sorted out right?

2015-10-05 Where are jobs

 

Unemployment Problems Persist

Unemployment Problems Persist

Perhaps the reason so few are saving is because the job situation isn’t exactly rosy, nor are income levels. According to the most recent report from the Bureau of Labor Statistic, the unemployment rate has dropped to 6.7% which looks on the surface to be good news. However, if you look a bit deeper, the source of that improvement is troubling. The labor force participation rate, meaning the proportion of the population either employed or looking for employment has continued to drop, see chart at right, and is now at mid-1970s levels. Without the drop in the participation rate, the unemployment rate would be around 13%, rather than just under 7%. Additionally, according to data from the Minneapolis Federal Reserve (see chart at right), the American economy is experiencing the worst performance for labor markets since the Great Depression.

 

Some argue that the decline in the labor force participation rate is primarily driven by the inevitable retirement waves of the baby boomers. However, the chart below illustrates that baby boomers are in fact participating in the work force at a higher rate than in decades.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Along with the grim jobs recovery, household income levels continue to struggle, with income levels close to those 20 years ago, see chart above. Bottom Line: The fiscal and monetary stimulus has been unable to get employment or income levels back to anywhere near the levels enjoyed during the start of the 21st century. So far the impact appears to be more visible in rising prices in the stock markets and more recently rising home prices.