The New Year -- Return of the "R" Word
2019 looks to be a Jerry Maguire year where Wall Street goes from telling Donald Trump “you complete me” to “show me the money.” (Yeah, we know it’s cheesy, but it fits.) Wall Street doesn’t care about talk. It cares about earnings. And Main Street cares about wages and jobs. It's time to get back to the "R" word: "reality."
Return of the R word: The day after Donald Trump was elected, the stock market expressed its surprise and elation by shooting up 257 points. It continued to rise, reflecting a widespread belief on Wall Street that a pro-business president with an America-first agenda would be good for the economy as well as anybody who put their hard-earned money into stocks. After all, what more could they have asked for? The incoming president wanted to cut taxes, get rid of hundreds of regulations on businesses, and assert a strong American presence in international trade. (And he’s done much of it.) Between election day and inauguration day the Dow surged 1,400 points. The only president to have a better performance (percentage wise) on Wall Street during that period was Herbert Hoover. That, my friends, could be a foreshadowing, but the return of the R word may or may not be a “recession,” but it most certainly is a return to “reality.”
• Stock market reality: Over the short term the financial markets can move on psychology – and optimism can help fuel an economy -- but eventually fundamentals return. Any financial professional worth his or her quarterly fee knew this bull market was getting long in the tooth after starting its run in 2009, the longest on record in the post-war years. But 2019 looks to be a Jerry Maguire year where Wall Street goes from telling Donald Trump “you complete me” to “show me the money.” (Yeah, it’s cheesy, but it fits.) Wall Street doesn’t care about talk. It cares about earnings.
Bullish argument:The stock market was due for a pullback and is getting back to more modest valuations. Money will move into more promising areas for growth – as it always does. And the economy still looks good if the cable networks don’t talk us into something worse.
Bearish argument: Much of the growth in 2018 was due to tax cuts and increases in government spending, which led to stock buybacks. But that won’t increase earnings, and Trump’s trade policies are putting a damper on growth, with the Damocles sword of rising interest rates looming over any hint – or hallucination -- of inflation.
** Shutdown -- The return of opposing party government: As of this writing, the border wall shutdown was still going on. It could be settled quickly, or -- without a path for both sides to save face -- drag on for a record period (exceeding 21 days). Leaving aside the symbolism and politics of the shutdown – and legitimate arguments on both sides regarding immigration policy -- we’ve learned an important number from this process: 33%. That’s the percentage of people who believe that the Democrats – not Trump -- are responsible for the government shutdown, even after Trump famously said to “Chuck and Nancy” in the Oval Office that he would proudly claim the shutdown. Let’s do the math. Trump said the shutdown would be his. A shutdown begins. 33% don’t blame him, they blame the Democrats. I think it’s safe to say: 33% is Trump’s base.
• Wall Street reality:Donald Trump might like to think he has a magic elixir or tweet to remedy every economic or stock market malady, but other recent presidents have outdone him after 24 months, and he’ll have a tough measuring stick when he faces reelection.
Stock Market Performance (S&P 500):
After 24 Months After 48 Months
• Obama + 55.7% Obama + 81.4%
• Reagan + 12.2% Clinton + 79.2%
• Trump + 10% (until 1/1/19) Reagan + 38.7%
• Clinton + 7.2% Bush 43 - 13.5%
• Bush 43 - 37.4%
• Party reality:If you’ll notice, the Democrats have outperformed Republicans after four years in the numbers above. That’s a trend. Democratic presidents tend to outperform Republican presidents in the stock market AND economic performance. I know what you’re thinking: What about the party in Congress? Same result, according the Princeton Professors Alan Binder and Mark Watson. I mention that not to favor one party over another but to make the point, Wall Street doesn’t care what tribe you’re in.
Bullish argument: If the new Democratic majority in the House does more than investigate Trump, good things may develop. President Bill Clinton presided over a government that actually balanced the budget for the first time in decades. And while he deserves credit for it – he took the hit by initiating a take hike in 1993 -- a Republican Congress also forced his hand in cutting spending. In other words, the opposing party helped put a check on the president, aiding the economy and the stock market. Given that the projected deficit is $1 trillion this fiscal year, it might be a positive step for Democrats to put a hold on unfunded programs, which Nancy Pelosi and company have done in the past. (By the way, the last Republican president with a budget surplus was Dwight Eisenhauer, back in the 50s.)
Bearish argument: Who are we kidding? The border wall shutdown (still going on at this writing) is all the evidence you need that Trump and the Democrats are like oil and water. Add to that never-ending investigations and an unpredictable executive and the financial markets will stay on-edge.
• Tariff reality: Has the Trump pro-business premium been replaced by a Trump pro-tariff penalty? The interesting twist in this market is that at least part of it has been driven by a president who tweets, “Tariffs are the greatest!” (July 24, 2018). Then he backs off the tariffs. Then he returns to them. Then he cuts them. Then he threatens to impose higher ones. The he says a China deal is imminent. Wall Street doesn’t like the uncertainty, or the reality of tariffs. As the Tax Foundation put it: “Tariffs raise prices and reduce economic growth.”
The reality of a bear market
Fact: The NASDAQ and S&P 500 recently hit bear market territory. (As of this writing, the DOW Industrials had not.)
Fact: Bear markets usually last 15 months and drop 41%. The last bear market, October 2007 – March 2009, lasted 17 months and the Dow Industrials fell 51%. (First Trust Portfolios, using Morningstar data.)
Fact: A bear market has occurred 13 times in the post-War era. A recession followed seven times within a year (in other words, about half the time). (CNBC.com)
Economic reality: The Trump economy has very likely peaked. The Trump tax cut gave it a quick but short-lived sugar high. Second-quarter growth was impressive, a 4.2% annual pace. But this slowed to 3.5% in the third quarter, and the Federal Reserve says the fourth quarter pace will be about 2.9%. This will slow to about 2.4% next year according to the bipartisan CBO, and even slower going into 2020. (Not good timing for a reelection campaign.) Some economists think even this is too optimistic: A CNBC survey of economists said there’s a 23% chance of an outright recession within the next 12 months.
• Fed reality: Trump has tweeted his anger at Fed Chief Jerome Powell over rising interest rates and their negative effects on the financial markets. Trump is not alone in blaming the Fed. There are many Fed critics who feel that conditions have changed and don’t warrant raising rates at the pace the Fed has been following to reach “normalization.” But Trump has also reportedly hinted at firing Powell. Leaving aside whether the president can actually fire the Fed chief, it remains a question as to whether it would make much difference. There’s no question the Fed chief can influence other members of the FOMC, but there are 12 members that vote on the direction of interest rates. The most relevant way of looking at it might be the way a basketball coach complains to the referee about calls during the game. It won’t affect the last call, but it might affect the next one. It remains to be seen whether Jay Powell has rabbit ears. (This might explain why the Fed traditionally didn’t hold post-meeting press conferences. The Fed was set up by Congress to remain at a distance from the executive branch so that it wouldn’t be used as a puppet for a president’s political agenda.)
• Bullish argument: Paul Volcker, as Fed watchers recall, pushed Fed funds up to 20% during the early 1980s to quash inflation. It did. And it led to a recession. More than one. And Ronald Reagan didn’t like it, although he didn’t have Twitter in which to express his frustration. But when Volcker – appointed by Carter, not Reagan -- reasserted control over inflation, it also set the stage for the Reagan Recovery and historic bull market that started in 1982. Conditions are completely different right now, but if earnings continue to grow and unemployment is low, inflation may be the gremlin that needs to be kept under control. If it is, corporate earnings – the fundamental driver of stock prices – can continue to grow.
• Bearish argument: The Fed may misjudge where we are and raise rates too fast. Or it could become too reactive to a whining president and fail to follow its responsibility “to promote maximum employment, stable prices and moderate long-term interest rates in the U.S. economy.”One scenario stymies growth, the other creates bubbles.
• Reality in Congress:The Democrats are back in the majority in the House. And they are not the damaged group still in shock over their candidate losing the 2016 presidential election. This is a group empowered by picking up 40 seats and eyeing a president whose armors appears to be showing some cracks. Democrats are chomping at the bit to investigate Trump every which way, starting with his tax returns—which the president continues to stonewall on. Republicans—who said it was vital to investigate Hillary Clinton’s emails, Benghazi, uranium and all the rest—call this partisan harassment and a waste of taxpayer dollars. But that is hypocritical to anybody who looks at the political process from a distance (as we try to do). A good reminder comes from Mark Rozell, professor of public policy at George Mason University: “In our constitutional system, the burden is on the executive to prove that it has the right to withhold information and not on Congress to prove that it has the right to investigate.” Even the first president was investigated.
George Washington was asked by the first Congress to turn over documents related to a failed military expedition. Washington met with his Cabinet to discuss whether he could deny the information to Congress in the first assertion of executive privilege (even though it wasn’t called that then). He decided to cooperate with Congress because they had such authority when it was in the public interest. That’s not a bad yardstick even today.
Indictment:Can a sitting president be indicted? Brett Kavanaugh, in his hearings, said it was “debatable.” And he could end up debating it! The arguments are coming. Criminal v. civil. Federal v. state. Within the statute of limitations or outside of them. Guidance from the DOJ or the Constitution. The definitive answer is one of Trump’s favorite sayings: “We’ll see.”
Virtually everyone agrees that if Congress impeached and removed the president from office, he could be indicted at that point. Until then, the Oval Office is home base.
• While legal scholars debate to process or appropriateness of indicting a sitting U.S. president, the American public is fairly clear on it: 71% favor the ability to charge a president while in office. A Quinnipiac University Poll asked the question, “Do you think that the President of the United States should be able to be charged with a crime while they are in office, or should presidents only be charged with crimes once they have left office?”
Quinnipiac Poll (Dec. 2018) Tot Rep Dem Ind
Able to be charged 71% 49% 90% 70%
Charged after leaving office 21 38 6 23
Don’t Know 8 13 4 6
• We know how this will unfold. Trump will fight the investigations politically and legally and tweetfully (yeah, we made it up) and Congress will fight Trump, and the courts will play a role at some point. The media outlets on the left will run specials on impeachment and the ones on the right will talk about overreach and Hillary’s emails and how taxpayer money is being spent. Wall Street and Main Street will hold their breath and hope that the damage is minimal, or at least constructive. Let’s face the reality, this isn’t going to be pretty. But it’s going to happen. Investors need to ignore the noise and remember this is part of our political system, even though nowadays it’s a loud and polarized one. There is no glut in statesmanship these days.
• Return of Mueller’s report/findings: This brings us to the legal vise that, like a boa constrictor, is ever so slowly squeezing the president. He has giant problems here and only one of them is Robert Mueller. Let’s discuss him first. Everyone keeps asking, when is the former FBI director (and lifelong Republican) going to issue his report? Actually, with all the indictments, guilty pleas, convictions and prison sentences that have already been handed down, we already know a lot—and like a fireworks show on the 4th of July, there could be a grand finale that makes the nation go “wow.” Remember: Mueller’s jurisdiction is not limited to Russia; he can take his probe in any direction necessary, and he has done just that. Trump supporters say there’s no collusion, and they may or may not be right. But they don’t know what other cards the wily lawman is holding so close to his chest.
Mueller’s revelations, released in a manner and time of his choosing, have the added effect of stealing news cycles away from Trump and keeping him on the defensive. The president is in reactive mode, tweet-ranting and waiting like the rest of us for the next shoe to drop. He is not in charge — due process is.
There is also this: The impeachment of Bill Clinton was 20 years ago. It should trouble Trump that the independent counsel investigating Clinton, Kenneth Starr, was able to force a sitting president to testify before a grand jury. All this is in addition to Trump being implicated by federal prosecutors for paying off mistresses—a felony crime.
• Bullish argument:The financial markets may not care whether Trump is investigated, indicted, or impeached. Wall Street may actually like a Congress and President squared off against each other in the courts and on the cable networks and not passing bills they can’t pay for. The Bill Clinton stock market was booming with dot.com money in 1998 even as Clinton himself was answering for deeds that actually led to the only impeachment of a U.S. president in the 20th century.
• Bearish argument:Wall Street – and Main Street -- might care if Trump and the Democrats can’t find answers on health care, prescription drug costs and immigration – or continue to fight over funding the government. To Bill Clinton’s credit, he was able to “compartmentalize” his impeachment troubles and still conduct business with the majority Republicans. If the coming Trump vs. Democrats vs. Mueller conflicts paralyze the government, that won’t be good for the economy.
• Return to elections: Yes, 2019 is the year that the 2020 election campaigns begin. Democrats need to narrow their presidential field down from the 20, 30, or 40 (really) candidates who look like they’re “exploring” whether to throw their hat in the ring. And then there’s the President. Consider this: the unemployment rate is currently 3.7%. This is a fabulous number—the best in half a century. And yet Trump's not exactly Mr. Popularity. He just lost 40 House seats, and the House itself, in a blue wave election – Beto notwithstanding -- and his Real Clear Politics average approval remains stuck in the low 40s.
So here’s the question: If Trump’s numbers are that low with the growth we’ve had this year and a 3.7% jobless rate, where do you imagine they’ll be if things get worse like the Fed predicts? Good timing is everything in politics, and a slowdown heading into a presidential cycle isn't exactly good news for the incumbent. Of course Trump, the anti-Truman, the man for whom the buck always stops somewhere else, will just point the finger at others—but voters won’t. For better or worse, the guy at the top always gets the blame. Especially one who has stuck his neck out bragging every day about how great things are and all the winning we were about to enjoy. His supporters see many wins, but in 2020 it might be “what have you done for me lately?”
Washington Bullet Points Outlook
• U.S. economy to slow. After expanding at a 4.2% annual pace in 2q 2018, 3q growth slowed to 3.5%. The Fed says it will slow further to about 2.5% in 2019 and heading into 2020, 1.95%. The beginning of a recession is also possible, with economists surveyed by CNBC expecting a 23% chance of one.
• Oil prices to remain low. Crude markets will remain under pressure in 2019, amid signs of a slowing global economy and a production glut. A Wall Street Journalforecast of investment banks predicts that Brent crude, the global benchmark, should average $69 next year, while West Texas Intermediate, the U.S. standard, should average about $63. Just a month ago both forecasts were $77 and $70 respectively.
• Inflation hawks will continue to rule the Fed.Four new voters join the central bank’s rate-setting committee in January. Three of them—Esther George from the Kansas City Fed, Eric Rosengren from the Boston Fed and Charles Evans from the Chicago Fed—have signaled support for further hikes. Only one—the St. Louis Fed’s James Bullard, is a rate dove. Each year, the rate-setting Federal Open Market Committee rotates four voting seats among 11 of the 12 regional Fed bank presidents.
• Investigations of Trump will intensify—and multiply. Special counsel Robert Mueller is only one of his problems. New York investigators are looking into numerous things—earlier this month Trump agreed to shut down a charity after Attorney General Barbara Underwood found “a shocking pattern of illegality involving the Trump Foundation — including unlawful coordination with the Trump presidential campaign, repeated and willful self-dealing, and much more.” And Democrats, who take over the House of Representatives, will launch numerous probes themselves. Federal prosecutors have already implicated the president—in Nixon era parlance, an “unindicted co-conspirator” — in two felony crimes.
• Trump will NOT be removed from office. House Democrats may try to impeach Trump—a simple majority vote is all they need. But absent some sort of major bombshell, Trump would easily survive a trial in the Senate, where a 2/3 vote—67 votes—is needed to remove a president from office. That would require 20 Republicans to turn against him. That’s unlikely.
• The tariff war with China may drag on. Trump has hinted at a pending breakthrough, but as of this writing neither Trump nor China’s Xi shows any sign of giving in on their spat. Meantime, a hot-selling book in China in the last few weeks—fanned by communist party propaganda—tells of Mao’s long-term focus, the famed “long march” and his emphasis on perseverance. And yet like America’s, China’s economy is slowing—and has been for the last few years. And that’s assuming they’re even telling the truth about their numbers. They do, as we’ve mentioned in prior issues, cheat.
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