Infamous Trump Tweet

President-Elect Trump made a peculiar tweet which marks the excessive optimism in the market. In third person, he thanked himself for the optimism which led to the increase in consumer confidence. It increased 4 points to 113.7 which is the highest rating in over 13 years. It’s amusing to see the Dow continually fail to reach 20,000. There is no reason why anyone should care about this. The most enjoyable thing watch are the CNBC commentators who do care about this metric.

While the market had a relatively rough tumble today considering this is a holiday week and many traders aren’t at their desks, the optimism remains excessive. I think that tweet by the future president will live in infamy. It will represent to hype before reality sets in sometime in the next few quarters.

President-Elect Trump has a near perfect ability to pick out the statistics which favor him. It’s like he’s been a politician his whole life. It’s not difficult to manipulate statistics to fit your agenda. Consumer confidence is at the highest level since August 2001. Consumer expectations for the next 6 months increased to the highest rating since December 2003. Americans’ expectations for improving business conditions increased to 23.6% which is the highest amount since February 2011. I don’t consider this optimism to be a positive. A positive would be real change that drives the economy forward by embracing capitalism. There’s not much higher the optimism can go. It doesn’t mean a turn is coming soon, but does mean almost everyone who can be positive already is.

confidence

The positivity has a bit of cognitive dissonance attached to it. The optimism is the sort which doesn’t deal in reality. Everything is expected to work out, but the people aren’t sure how it will. “Why trifle over such details?” they think. The chart below shows corporate profits and employee compensation as a percentage of GDP. The decline in employee compensation as a percentage of GDP partially explains stagnant median wages which have been a byproduct of globalization. The only way for both to improve is if there is a spike in productivity. The chance Trump will be able to get productivity to increase over the next 6 months is almost impossible. It will slowly improve after regulations are removed. Therefore, over the next 6 months either corporate profits will spike or wages will spike. However, the optimists think both will occur which is unlikely.

employeecomp

The chart below shows the optimism about the stock market. 44.7% believe stocks will be higher in the next 12 months. As you can see, optimism had the biggest monthly increase since November 1998 which explains the recent Trump rally. It is a chicken and egg scenario because either optimism caused the market to rally or the rally caused the optimism to increase. I think it’s a little of both. Either way investors are implying they are expecting great corporate profit growth in the next 6 months if they are buying stocks. Maybe some are only buying because of momentum, but stocks are supposed to represent the value of future earnings.

expectation

As I said, the people in these surveys have cognitive dissonance by being positive on labor market and corporate profits. Those expecting to see more job availability over the next 6 months reached 21% which is the highest since February 2011. Citizens surveyed expecting their incomes to increase in the next 6 months rose to 21% from 17.4%. The difference between those expecting incomes to increase and decrease reached 12.4% which is the highest since 2007.

On an interesting note, there’s a bifurcation of who is optimistic about the economy. People over 55 are the most optimistic since 2007, while confidence dropped among heads of households under the age of 35. This may have more to do with politics than results objectively shown to be occurring. The excitement over a person’s favorite candidate may wane quickly. We’ll see in the next few weeks how this translated into holiday shopping sales. It seems some optimistic older Americans plowed money into equities based on their political preferences. This can lead to a dangerous amount of selling if Trump doesn’t deliver quickly.

oldvsyoung

One place where the level of excitement about the market has reached record highs is the Russell 2000. Since the election, the IWM (Russell 2000 mini-index) has gotten $5.6 billion in funds. Non-commercial net longs reached 92,433 contracts or 65.2% which is the highest ever. Eventually this optimism will reverse and small caps will sell off. I expect this reversal to happen in the beginning of Trump’s presidency as the optimism over decreased regulations meets reality which is that eliminating regulations won’t be as easy as expected.

russell

The chart below shows the forward S&P 500 multiple which has reached the highest level since May 2002. It’s one thing to justify these valuations by saying interest rates are low. This isn’t what’s happening. When bulls buy stocks, they are expecting this market to get even more expensive. What is the catalyst for stocks to go higher if they are expensive and optimism is high?

valuation

The chart below shows historical earnings growth rates. 2016 earnings are expected to increase 0.1% with Q4 earnings still outstanding. Q4 earnings are expected to grow 3.2%. With the decline in 2015 considered, earnings peaked in 2014. There needs to be an acceleration in earnings in 2017 to meet the market’s expectations. Oil’s increase to $54 will help corporate earnings because energy earnings will have a bounce back year. The big question is if financials and industrials are able to realize the optimism Trump has brought.

earningsgrowth

Conclusion

            Earnings expectations haven’t been met in years, so I’m skeptical of 2017 being the year where earnings exceed expectations. Buybacks have started to decline with interest rates rising, so this means revenue growth will need to drive earnings more than it has in the recent past. Since we are headed into the 8th year of this recovery, I find it doubtful that a magical second leg of earnings growth will appear.

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2 Comments

  • Calvin

    December 29, 2016

    Taking the marginal tax rate for business from 35% to 15% equates to a 30.8% profit improvement. While this form a basis for the market optimism?

  • Mark Hoffman

    December 30, 2016

    Calvin, your analysis is inaccurate. With the proposed tax rate cuts comes the elimination of a substantial number of deductions and credits. You are probably over-estimating the gains by more than 50%.