At the end of 2017, tax reform was passed to great fanfare. Media pundits, administration officials, and market predictors assured us that this would lead to massive economic growth in the neighborhood of 4-5%. We were assured that corporations were standing by and just waiting to invest in America and a boom awaited us.
Capital Expenditures Remain Weak
Yet the economic data has thus far not corroborated that prediction. In fact the opposite is proving itself to be true. Instead of seeing a rise in capex spending, we are seeing a decline and a worsening trend developing. This is of course nothing new, as capex spending levels have remained below their pre-financial crisis levels for some time. Corporations remain unwilling to invest in the future of their businesses, and instead have been using cheap debt to finance corporate share buybacks and dividend increases, while sitting on trillions of dollars in cash. Corporations have had this cash for some time and yet chose not to invest it. As a business owner myself, it is hard to believe that lowering marginal tax rates on corporations would have a meaningful effect on their capital investment when they were already sitting on trillions of dollars of cash.
It is very early, and I understand that major capital expenditures take time to plan and price, but the trends we are seeing so far in 2018 demonstrate a slowing in capex, not an increase as was projected. As you can see at the tail end of this graph, a lower trend seems to be developing from already low levels, as the chart above demonstrates.
U.S. Consumer Debt Soaring
Consumers are throwing caution to the wind and spending on credit. Consumer debt is rising, which is contrary to the thesis of cutting taxes so consumers have the money to spend. Instead, many consumers will need to use any additional cash they see from the tax reform bill to pay down debt. Household debt is soaring, driven by auto and credit card spending, and student loan borrowing, leaving many consumers maxed out.
GDP Expectations for First Quarter Are Cratering
Economic data continues to show a slowing economy, even in the face of fiscal stimulus from tax cuts. GDP estimates for the first quarter have fallen from 5%, as the optimists told us the tax cut would lead to growth, down to 1.8% as reality is setting in. I expect the economy to continue to slow as we move through 2018.
As the Fed continues to insist that they will get multiple rate hikes in for 2018, the data continues to point to an economy that is slowing. Investors seem to be willing to ignore the facts and bask in the glow of euphoria left by last year's enormous gains, assuming they will last forever.
So far in the first quarter we have seen record inflows into stock funds, even as volatility has picked up and political and economic uncertainty have risen. Investors would be wise to ignore the cheerleaders who insist growth is around the corner, and follow the data. The reality remains that GDP is determined by the money supply multiplied by the velocity of money. The money supply is now in decline as the Fed reduces its quantitative easing policies and engages in quantitative tightening. Velocity is currently sitting at the lowest level since 1949 and continues to decelerate. Combined, these two variables point to lower inflation, and lower economic growth in the future. Fears of runaway inflation are nothing but fear mongering, the data does not support such a conclusion.
To the contrary, the world continues to tread water, with central bankers trying desperately to keep us from sinking into deflation. UK inflation continues to slow at a greater pace than the BOE expected. Eurozone inflation continues to move lower, posting 1.3% in January. U.S. inflation has remained anchored at a 1.5% yearly rate. Yet central bankers remain steadfast in the belief that they need to get rates up. I do not believe that central bankers do not see the same data we all see, but I do believe they are acting contrary to this evidence, because they need the room necessary to be able to have appropriate accommodation tools when a recession does hit. If the data continues to move in the direction it has been, they may run out of time before policy accommodation needs to be engaged.
We are in a very serious period of time and it is not being taken very seriously by most market participants. The world is drowning in debt, and this will continue to put a very serious drag on GDP growth. Let's leave the rest of the world alone for a moment, as I have dealt with the global debt challenges in previous articles, and I want to focus on the U.S. debt situation for a moment.
U.S. National Debt Skyrocketing
We are now at a point where we have the national debt at $21 trillion, and it has grown by 2,043% since 1980, and is up over $1.2 trillion in just 6 months. As if this wasn't bad enough, we have growing budget deficits, which will only be made worse if the growth projections from the tax bill are not met, not to mention the trillions of dollars in off balance sheet liabilities that we have. The U.S. sits at over 370% aggregate debt to GDP and yet consumers and their representatives in Washington keep spending money they don't have.
I believe, in this time of uncertainty, investors would be wise to be very cautious here with their hard earned money.
Conclusion: Be Conservative, Maintain Discipline
This is a challenging time in the market cycle. The uncertainty about where we are going and where to put your money seems ever present. I believe the proper course of action is the opposite of what most people are doing these days, which is over allocating to the equity markets. Benjamin Graham, the father of value investing was very clear on delineating the differences between investment and pure speculation.
"People who invest make money for themselves; people who speculate make money for their brokers. And that, in turn, is why Wall Street perennially downplays the durable virtues of investing and hypes the gaudy appeal of speculation."
There is a great level of uncertainty in the markets today, with the greatest uncertainty being the direction of monetary policy, in relation to the data coming in from the economy. While the Chairman certainly would like to maintain a gradual pace of tightening, if the data continues on its current trend as we move through 2018, this will prove to be an impossible task. I would not be surprised to then see QE 4 in short order.
As always I do believe equities should continue to make up a portion of your portfolio, and in my opinion, investors should favor small cap stocks, and value stocks with growing dividend streams which trade at much lower valuations than their growth stock counterparts. This is all the more true in international markets, which continue to trade at a discount to the U.S.
However, an equally important component, which is being neglected today by many market participants, is to hold sufficient holdings in U.S. Treasury securities. Principled conservative asset allocation is most difficult at times of maximum pessimism and euphoria. While investors may be averse to holding Treasury securities with their low yields, it is important to maintain discipline in asset allocation precisely because you cannot predict the future.
I urge investors to be conservative with their money, and stick to their principled investment strategy. There have been multiple episodes in American history when stocks entered uncharted territory, as we are now, and they have all ended miserably. Have the discipline here to stick to your long term plan and maintain or establish your positions in U.S. Treasury securities appropriate for your situation. There will come a time in the future where you may be happy you did. I end with an excellent quote from Benjamin Graham, on the importance of maintaining discipline. In my next piece I will begin a multi-part series looking into the economic data and why I believe U.S. Treasury securities offer investors great value here.
"The best way to measure your investing success is not by whether you're beating the market but by whether you've put in place a financial plan and a behavioral discipline that are likely to get you where you want to go."
Disclosure: I am/we are long US TREASURY BONDS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article is for informational purposes only and is not an offer to buy or sell any security. It is not intended to be financial advice, and it is not financial advice. Before acting on any information contained herein, be sure to consult your own financial advisor. This article does not constitute tax advice. Every investor should consult their tax advisor or CPA before acting on any information contained herein.