There has been an increase in stock prices since the election based on optimism about the Trump administration. Investors focused on the potential tax cuts, regulatory reform, healthcare reform, and infrastructure stimulus. The fact that investors were swooning over a politician’s rhetoric showed how far the hope trade had gotten in this cycle. The chart below shows the hope trade in action as soft survey data has spiked higher along with the market. Both stocks and surveys are based on sentiment. Usually they are rooted in reality, but hope reigns supreme when businesses and investors see a future catalyst to improve the economy. This vision of a future catalyst has been a mirage as hard data still hasn’t caught up. In fact, it has fallen recently.
The most blatant example of this hope was seen when investors bought stocks after Trump’s speech to Congress on the basis that there weren’t many specific details. In all my years of investing, uncertainty has been viewed negatively, but this time the logic changed. The reason uncertainty hurts stocks is because it hurts business’ ability to operate efficiently. Businesses may act more cautiously than necessary when uncertainty prevails.
The two scenarios which can cause businesses to act cautiously is when the economy enters a recession and when government policy is uncertain. Recessions hurt expansions because it’s tougher to get a loan during them and because demand is falling off so sharply that it’s tough to model it using sensitivity analysis. Investors reward the firms with the most solid balance sheets and the most conservative growth plans during recessions. It’s the exact opposite during expansions where investors reward the businesses taking the most risk. That’s why it’s best to have a happy medium between aggression and conservatism.
Recessions are usually a short period where growth turns negative. They end after a few quarters and then growth resumes. When governments put initiatives on hold, it can be worse than recessions because government acts slowly. It can take years for the government to make a decision. That was seen in the decision to allow the Keystone XL pipeline to break ground. By the time the pipeline was approved, it wasn’t even needed. The oil started getting shipped by rail. There’s also a glut in oil production as oil has fallen sharply in the past few years. If you can believe it, the plan was proposed in 2008 and Trump approved it in 2017.
The Keystone XL pipeline was an example where private industry was able to work around the government’s ineptitude. That’s not always the case. Although the Trump administration has prided itself on making decisions quickly and lowering regulations to help businesses, the Congress is preventing that goal from being fully achieved. Investors hoped the government would put forward pro-business measures, but with Congress stuck on healthcare reform and tax reform, investors are getting a toxic cocktail of uncertainty.
Small business optimism has risen since Trump’s election. This has correlated with increased hiring. The ADP report showed small businesses hired 118,000 new employees in March which shows small businesses expect increased demand. However, as you can see in the chart below, the small businesses surveyed aren’t showing capex aggression. This increase in capex would spur hard data. However, it’s a chicken and egg scenario. Which should come first, business expansion or increased demand? Small businesses won’t invest more capital into new projects if there’s no demand.
The weakness in this recovery is highlighted by the slower capex expansion compared to the prior two cycles. The lack of capex expansion is partially responsible for the decline in productivity. This weak trend is acting in congruence with the fact that there’s still slack in the labor market which is why wages haven’t exceeded CPI growth this cycle. To recap, GDP growth has been weak because of weak fixed investment growth which still hasn’t accelerated higher even with the latest spike in optimism. Firms must put their money where their mouth is or their optimism looks phony.
As I mentioned, one of the aspects which is corroborating with the optimistic surveys is the increased hiring. On Tuesday, the latest JOLTs (Job Openings and Labor Turnover) report was released which showed a greater level of detail on how the labor market looked in February. The JOLTs report showed mixed results which I consider bad news because the February BLS report had a strong headline number even after it was revised lower from showing 235,000 jobs created to 219,000 jobs created.
On the positive side, there were 118,000 new job openings which translates into a rate of 3.8% when looked at as a percent of total employment. The 118,000 increase in new jobs was the highest since September. On the negative side, there were only 110,000 Americans hired in February which is the weakest number since April. The chart below shows the 3.6% drop in year over year hiring which is the weakest growth since March 2013. There may be a further decline in the annual change in hiring when the March report comes out since it was sequentially weaker, but I’d refrain from calling this a trend until the May labor report is released. The last detail which the JOLTs report showed was the quits rate. The rate shows how confident workers are that they can find a better job. There were 102,000 fewer quits in February which signals workers are less confident about the labor market. This translates into a 2.1% rate which slowed from the 2.2% quits rate in January.
Conclusion
The small businesses may not be as optimistic as they say they are in general questions in the surveys as they say they haven’t beefed up capex spending. The JOLTs report makes the labor market for February look weaker than the 219,000 headline number suggests. The March JOLTs report, which comes out next month, should show more weakness in the labor market as the headline number was below February. However, even though I wouldn’t call the weakness a trend, if it does show weakness in hiring, the details provided may explain why the March number was so weak. The obvious explanation is it was weather related, but gaining more information can only help give more depth to this explanation.
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