Last week, the S&P 500 inched up by only 0.25% while 20,000 on the Dow Industrials continues to look like a temporary ceiling. Fortunately, the expected quarter-ending window dressing season – when institutional managers realign their portfolios – sets up what could be a new rally during fourth-quarter earnings announcement season, beginning in mid-January. If selected earnings come in as positively as I expect, The Dow at 20,000 may become a new floor following the next (and inevitable) overall stock market correction.
Confidence has risen since the election. Going into the New Year, Gallup reported (on December 20th) that its U.S. Economic Confidence Index hit its highest level in nine years, as the election of Donald Trump as President-elect pushed the U.S. Economic Confidence Index into positive territory for the first time since March 2015.
Clearly, expectations are high for President-elect Trump, but I pointed out on CNBC last Wednesday that we have been in the midst of a short squeeze in low-quality stocks, as stocks with weaker earnings and sales have outpaced top-quality, fundamentally strong stocks, which should re-emerge as market leaders during the upcoming earnings announcement season. I also said that small-cap domestic stocks are poised to lead the next surge, since a strong U.S. dollar is likely to hinder earnings of large multinational stocks.
After a strong post-election rally, a bit of reality is settling in as investors realize that President-elect Trump may not be able to push much of his agenda forward without running up huge budget deficits. The Democrats are asking how he intends to pay for massive infrastructure programs with “revenue-neutral” financing. On Tuesday, outgoing Treasury Secretary Jacob Lew warned the Republican Congress that they should not ignore how their proposed tax cuts would impact the federal budget deficit.
Perhaps Treasury Secretary Lew should look at his own record first, as the U.S. budget deficit widened 34% to $587 billion in fiscal 2016, under his watch, after declining for five straight years. The budget grew last year particularly due to rising costs of Obamacare, Medicare, and Medicaid. Treasury Secretary Lew diverted attention from these Obama-era deficits to warn that popular programs like Social Security, Medicare, and Medicaid would limit the ability of the incoming Trump administration to cut tax rates.
Fortunately, we know from the record of historical tax cuts in the 1920s, 1960s, 1980s, and the 2003 tax cut that rate cuts can generate rising economic growth which can generate even more tax revenues, which could give the incoming Trump Administration more room to implement their economic growth plans.
The Latest GDP Projections
Last Thursday, the Commerce Department announced that third-quarter GDP growth was revised up to a 3.5% annual rate (from a previous estimate of 3.2%) due largely to higher consumer and business spending than previously estimated. Specifically, consumer spending was revised up to a 3% annual rate (from 2.8%) and business spending was revised dramatically higher to a 1.4% annual rate (from 0.1%).
The bad news is that since record soybean exports significantly boosted third-quarter GDP growth, economists are estimating that fourth quarter GDP may grow at a much slower annual rate of 2.4%.
As we end the year, there are some storm clouds emerging that may cause economists to revise their fourth-quarter GDP estimates lower. On Thursday, the Conference Board announced that the Leading Economic Indicators (LEI) were unchanged in November. Ataman Ozyildirim, director of business cycles and growth research at The Conference Board, said that “the underlying trends in the LEI suggest that the economy will continue expanding into the first half of 2017, but it’s unlikely to considerably accelerate.”
Turning to the details of the LEI report, Bespoke said last Thursday (in “Leading vs. Coincident Indicator Ratio Drifts Lower,” December 22, 2016) that the November Leading Indicators “came in slightly weaker” while ratio of leading vs. coincident indicators is a warning sign: “prior to just about every recession since 1959 this ratio was in free-fall right ahead of the onset of recessions.” However, the recent decline “has been slight to say the least.” Bespoke had to expand it to four decimal places to demonstrate the decline.
In conclusion, Bespoke said, “what we have seen with this ratio over the last year is more characteristic of a mid-cycle economy (like we have seen in several other prior expansions) than the type of decline that has been common leading up to a recession,” so you can file this dip under “much ado about very little.”
There was also plenty of other evidence last week that economic growth may be slowing a bit. On Thursday, the Commerce Department announced that Personal Income rose only 0.2% in November. The Commerce Department also reported on Thursday that Durable Goods orders declined 4.6% in November for the first time in five months due largely to a 73.5% decline in civilian aircraft orders! Excluding transportation orders, however, Durable Goods rose 0.5% for the fifth straight monthly increase. Also encouraging is that “core” orders for Durable Goods rose 0.9% in November, which is the largest monthly increase since August. Overall, our GDP appears to be still growing, but at a slightly slower place.
The best economic news last week was that National Association of Realtors on Thursday announced that existing home sales rose to an annual rate of 5.61 million in November, up 0.7% from October’s revised number and the highest level since February of 2007. In the past 12 months, existing home sales have risen by 15.4%. Median home prices have risen 6.8% to $234,900 in the past 12 months. Overall, the housing market does not appear to be adversely impacted by the significant increase in mortgage rates.
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