In the first two years after a newly elected President takes office he enacts a major tax cut that primarily benefits the wealthy and significantly raises tariffs on imports.
His foreign policy is erratic but generally pulls the country back from foreign commitments. He also works to reduce immigration and roll back regulations enacted by his predecessor.
This President is widely rumored to have had numerous adulterous affairs and his administration is wracked by repeated scandals. He often seems overwhelmed by the job of President and confides to friends that he wasn’t prepared for the job.
President Trump? No, that describes the Presidency of Warren G. Harding. It only got worse after he died of a heart attack in the third year of his term and the Tea Pot Dome scandal came to light. He never faced impeachment himself but his attorney general survived several impeachment votes and two indictments before being forced to resign during the Coolidge administration. Harding is regularly rated as one of our worst presidents. His successor, Calvin Coolidge, is widely held to be the most boring president of all time, earning him the nickname Silent Cal. I would be remiss if I didn’t also point out that Coolidge bears more than a passing resemblance to Mike Pence, another man in no danger of being accused of verbosity.
Given the recent turmoil, I think we’d all be thankful for a little boring out of our government right now. But President Trump shows no sign of giving in on his border wall and the Democratic leadership appears to be following Napoleon’s maxim to never interfere with your opponent when he is in the process of destroying himself. But eventually we will achieve Harding’s campaign slogan and return to normal or at least what passes for that in the Trump era.
I often see comments about how something happening today is “unprecedented” but I rarely find that statement to be true. It is usually a case of the speaker (or writer) not knowing history which is replete with examples of just about any situation you can imagine. The examples may not be exact or as eerie as the Harding/Trump analog but to paraphrase Mark Twain, one can usually find examples that rhyme with the present.
And so, unlike most others in this business, I don’t see today’s economic environment as being all that special. Yes, we had a number of years of extraordinary monetary policy but that is hardly the first time and surely won’t be the last. The US used QE during and after WWII until the Fed/Treasury accord of 1951 and the Bank of Japan used it in 2001. Forward guidance? I think Paul Volcker was the first Fed Chairman to signal policy in advance but I bet there are earlier examples. Recent monetary policies may be ones rarely used but they are hardly unprecedented. We recovered from them in the past and we’ll recover this time too.
The Fed has raised rates steadily over the last two years and has now reached a level that many believe threatens to push the economy into recession. That is of course always possible but right now the market based indicators we monitor do not support the recession scenario. It appears to me, based on the available information, that what we’ve just witnessed is markets pricing in a return to normalcy – or at least the “new normal” that has prevailed in recent years. The spurt of growth we got from tax cuts and the anticipation of tariffs was not sustainable.
After a couple of quarters of above trend growth, the US economy is falling back to the previous trend. Will that slowing proceed to recession? I don’t know the answer to that but an economy growing around a 2% average is always going to be more vulnerable to a negative shock of some kind than one growing at 3% or 3.5%. If we get such a shock we could easily fall into recession. But that has been true for most of the period since 2009 and the economy keeps chugging along. We came close in 2015/16 when growth fell to nearly zero but the shale bust wasn’t enough to tip the scales.
Today’s weak spots are housing and once again shale but for now neither appears sufficient to pull the economy down into contraction. Housing just isn’t as large a part of the economy as it has been in the past. Residential investment spent most of the 80s and 90s between 4 and 5% of GDP before spiking to nearly 6% at the peak of the housing bubble. It fell to 2.5% in the aftermath and has only recovered to just over 3% today. If housing investment falls back to the lows it will certainly slow GDP growth but probably not enough to cause a recession.
As for the shale industry, drilling activity is slowing with crude prices in the low $50s. But it doesn’t appear to be causing the same level of stress it did when prices fell from over $100 to $35 from 2014 – 2016. A lot of the weaker companies failed during that bust and the ones that survived were better prepared this time with most of their production hedged at profitable levels. Of course, that only matters for oil they are already producing. The same level of drilling activity is unlikely at current prices and that has been a not insignificant part of investment – and growth – in recent years. So, again, a slowdown but probably not that severe. Credit markets support that view as you’ll see below.
Economic growth is a function of workforce growth and productivity. We can either put more people to work and raise output or we can raise output by making the existing workforce more productive. The latter – increasing productivity – is the key to raising living standards. With population growth stalling and the current administration hostile to immigration, raising productivity is critical to future growth. And that requires investment.
Investment in this cycle has been slow to recover and today Gross Private Domestic Investment stands at about 18% of GDP. That is still well below the peaks we’ve seen in previous cycles of around 20%. Could we get there before this cycle ends? Sure. Will we? I don’t know obviously but absent a shock of some kind I don’t see why not. A return to normalcy – if that is what we ultimately achieve – means this cycle may have quite a bit more to go.
One warning though. The negative impact of the administration’s trade policies may be the shock that puts an end to this expansion. I think a resolution of some kind of the trade war with China makes sense for both sides. But I have no idea – and I don’t think anyone does – what President Trump will do next. Forget monetary policy. It’s trade policy that matters the most and where the greatest risks lie.
Joe Calhoun is chief executive officer of Alhambra Investment Partners, a registered investment advisory based in Palmetto Bay, Florida. He has worked in the financial services industry since 1992. He studied engineering at the University of South Carolina and is a graduate of the U.S. Navy’s Nuclear Propulsion School.
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