Tuesday, December 20, 2016

Votes of Confidence

Once again, the election results demonstrate that “It’s the economy, stupid!” Stock investors are certainly giving the President-elect not only the benefit of the doubt but a big tailwind for his economic program, as the market capitalization of the S&P 500 has increased by $1.0 trillion since Election Day to a record high. In fact, the votes of confidence since that day have been overwhelmingly positive, suggesting that Trump may have unleashed some animal spirits that might very well boost economic growth. Consider the following:

(1) Financial stocks. Leading the way among the S&P 500 sectors has been the Financials sector. In the past, leadership by this sector tended to be bullish for the overall market. REITs were removed from this sector on September 19, so it hasn’t been weighed down by their relative weakness. Instead, the sector has soared as the yield curve has steepened and credit spreads have narrowed. Financial stocks have also been buoyed by the prospect of less government regulation.

Here is the S&P 500 sector performance derby since Election Day through Friday of last week: Financials (17.2%), Telecom Services (10.8), Energy (10.3), Industrials (7.7), Materials (7.0), S&P 500 (5.5), Consumer Discretionary (5.3), Health Care (2.0), IT (2.0), Real Estate (0.5), Consumer Staples (-0.9). and Utilities (-1.2). (See table.)

(2) Credit markets. In my meetings with our accounts in Toronto and Chicago last week, I opined that November 8 might have marked the end of the New Normal, or secular stagnation, and comeback of the Old Normal. That’s certainly reflected in the 10-year US Treasury bond yield, which jumped to 2.60% on Friday, up from 1.88% on Election Day.

So far, the credit markets aren’t signaling that the backup in bond yields might cause a recession. On the contrary, the yield curve has steepened by 42bps since Election Day, based on the spread between the 10-year US Treasury bond and the federal funds rate. The yield curve spread is one of the 10 components of the index of leading indicators, and it usually turns negative before a recession. It had been narrowing prior to the election, but has turned more positive since then.

Another upbeat signal from the credit markets is that the spread between corporate bond yields and the 10-year Treasury yield continues to narrow after peaking during February. The spread widened significantly during the second half of 2014 and during 2015 on fears that the plunge in oil prices might trigger a financial contagion. Instead, it caused a recession that was contained within the energy sector, which has been recovering since early this year along with the price of oil. Most encouraging is that the corporate high-yield credit spread has narrowed from a peak of 844bps on February 11 to 363bps last Wednesday, the lowest reading since October 6, 2014.

(3) Business surveys. Among the most spectacular votes of confidence for a “New Morning” scenario for the US economy are December’s business surveys for the Fed’s Philadelphia and New York districts. The average of their two composite indexes jumped from 4.6 during October to 15.3 this month, the highest reading since November 2014.

The NFIB Small Business Optimism Index jumped from 94.9 during October to 98.4 last month, the biggest one-month increase since April 2009. The NAHB Housing Market Index rose this month to the highest reading since July 2005 thanks to a sharp increase in traffic of prospective home buyers. This is happening either despite the jump in mortgage rates or because of it as potential buyers scramble to purchase before rates go still higher.

(4) Consumer sentiment. As we noted last week, the Consumer Sentiment Index has increased from a 14-month low of 87.2 during October to 98.0 during the first half of December. At the end of the month, the final number will be reported in addition to the readings for December’s Consumer Confidence Index. November’s results for the latter showed that confidence was especially strong among survey respondents who are under 35 years old. If Trump can make young adults happier, maybe we will see an increase in household formation, marriages, babies, and home buying.

(5) Still ahead. There are still plenty of post-election surveys ahead, including those of the other three Fed districts that will be reporting their December business surveys. Business Roundtable conducts a survey of corporate CEOs. The quarterly index that is compiled from the survey is a leading indicator for capital spending.

The Q4 survey was taken between October 26 and November 16. However, CEOs remained cautious, as their Economic Outlook Index didn’t change much from Q3. “America’s business leaders are encouraged by President-elect Trump’s pledge to boost economic growth,” said Doug Oberhelman, chairman and CEO of Caterpillar Inc. and chairman of Business Roundtable. “We will work with the incoming Administration and Congress to enact pro-growth policies such as modernizing the U.S. tax system, adopting a smarter approach to regulation, investing in infrastructure and focusing on the education and training people need to thrive in the 21st century economy.”

He added, “It’s telling that for the fifth year in a row CEOs name regulation as their greatest cost pressure. We are encouraged by the promise of a renewed focus to usher in a smarter regulatory environment that promotes job creation and economic growth and also protects safety, health and the environment.”

Our sources among our institutional accounts tell us that many CEOs are becoming increasingly exuberant about the prospects for Trump’s policies. That should show up in the Q1 reading of Business Roundtable’s CEO survey and in better capital spending next year.

(6) Commodities & currencies. Remarkable votes of confidence since Election Day are also visible in the CRB raw industrials spot price index and the JP Morgan trade-weighted dollar. The former is up 3.3%, while the latter is up 4.7% since the election. The nearby futures price of copper is up 7.7% over this same period. In the past, a strong dollar tended to depress commodity prices.

So far, Donald’s Trumpland seems a bit like Alice’s Wonderland. In any event, financial and survey indicators suggest that while Clinton’s supporters may remain in mourning, it may very well be a new morning for the economy.

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