The optimism in the market is unwarranted and unfounded. It’s amazing how the mainstream media concluded Trump would bad for the economy and then investors changed their minds and bought stocks after he won. The Fed’s bubble stock market hasn’t dealt with reality this entire recovery, so it’s not a big shock. In fact, Trump’s election won’t necessarily be bad at all. In my opinion, Trump’s policy initiatives are mainly good. In his recent statement to the American people he stated he would do an executive action where for every new regulation put in place, two regulations would have to be rescinded. This is a great policy. The problem is a massive crash is going to occur under his watch, not because of his policies, but because of reckless central bank action.
It’s clear that optimism reigns supreme as the Russell 2000 is now up 13 straight days. I don’t think much of streaks usually because they can be the equivalent of a coin flip, but this rally since November 3rd has been impressive. It’s up almost 15%. It could be a blow off top from what I hear from my friends involved in technical analysis, but I don’t have any insight into such topics. Excessive optimism isn’t always bad, but at market tops it is unwarranted. Investors are acting like gamblers because the facts no longer warrant positivity.
The most positive fact the bulls have on their side is the earnings streak of quarterly declines has ended. While the streak is over, one low single digit quarter of growth does not make up for the declines. The bulls need the analysts’ average growth estimates for 2017, which is 11%, to be accurate to justify this rally in stocks. The past few years have also seen negative revisions to initial estimates, so the trend would need to reverse. What usually happens is growth rates start out very high. Then they are cut below what is expected, so stocks can beat estimates. While stocks traditionally beat estimates, it has become a fraud because when estimate beats are still showing weak growth and stocks rally based off this, it is irrational.
The average S&P 500 earnings beat is 3%, so I was expecting to see 1% growth as the estimate was for a 2.2% decline. As you can see below, the growth rate will be about 3% if the current estimates (estimates are blended with actual results) are accurate. A large part of the reason estimates are high for 2017 is because of energy. We will see what type of agreement OPEC comes to on November 30th. That will determine where oil prices and energy earnings for 2017 go. This type of uncertainty in estimates would usually lead the market to fall, but optimism is blinding investors.
The chart below shows Gallup’s economic confidence poll. It shows the same optimism we’ve seen in the stock market. Investors and the general public think Trump will bring the economy out of the malaise of the past 8 years, but they don’t realize the disaster which is coming. It’s the equivalent of a train which is moving slowly. Optimists hope Trump will speed the train up, but it is headed straight for a wall. Optimism that the nasty campaign is over may not translate into spending this holiday shopping season. No matter how optimistic the consumer is, it doesn’t matter if they don’t have money in their pockets or a bank willing to lend them money.
I have previously spoken about the 2016 budget deficit being about $600 billion. As bad as that stat is, it is generous towards what is really happening under the surface. The first obvious point is if interest rates were normalized, the deficit would be $612 billion higher. Trump doesn’t even have to spend more money to welcome back $1 trillion plus deficits.
Accounting gimmicks suppress the growth in the deficit. This is how the total debt increased $1.2 trillion even though the deficit in the fiscal year ending June 30th, 2016 was $524 billion. Some of the reason why the debt is larger is because some spending is considered an investment which means it doesn’t count towards the deficit. For example, $93 billion to make student loans doesn’t count against the deficit. It would be great it would be counted since this lending is causing the student loan bubble. The government spending money on loans is making things worse for the average student. $75 billion was spent on Social Security, Medicare, and the Affordable Care Act. This was extra money not paid for by tax revenues. These expenditures will get worse as government spending creates bubbles in industries it is involved with. The aging population also plays a part in the costs increasing.
Trump plans to repeal the Affordable Care Act, but plans to keep the provision that lets kids stay on their parents plan until 26 and the part where the sick cannot be denied coverage because of pre-existing conditions. The best part of Trump’s plan is getting rid of state lines when buying insurance. We will see how much government spending declines as a result of this. As you can see from the chart above, the debt increased more than the deficit in 27 of the last 30 years. It will take a miracle for Trump to turn the budget deficit around without big cuts to spending.
Conclusion
Trump is the type of Republican who believes if the economy grows, then the debt problem becomes less of a factor. While this is true, government spending is a negative multiplier, so the economy can grow even faster if spending was cut. Spending is a drag on the economy because it crowds out private investment and takes money from the private sector through taxes. The taxes have to go up to pay for the debt. While tax cuts can happen temporarily, if interest rates do normalize, revenue will need to be raised to offset this problem. We’ve seen the policy of cutting spending and raising taxes tried in Europe as austerity measures. So far we’ve seen their economies stagger. Part of that is because the creation of EU has hurt some nations. I will review that in a future article.
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