What If GDP Growth Is Not Improving?

Ever since the election, investors have been in a positive mood. Share prices took off on the day of the election results and did not look back. With election results in hand, people began to have some clarity of what the government was going to try to do. The big themes on the legislative agenda would be to reduce tax rates for individuals and corporates, reduce regulations that stop business from moving forward, eliminate the tax bias that encourages companies to move their manufacturing facilities out of the US, from help families with children and invest in the countries infrastructure (roads, bridges, airports, trains lines, telecom systems, etc.)

Ever since the election, companies, both foreign and domestic, have stated that they would build new manufacturing facilities in the US. Ford, for example, said they would build the plant originally planned for Mexico in the US. Softbank of Japan said they would invest as much as $50 billion in the US, creating 50, 000 jobs. Make no mistake, there is always a lag between when companies and government make an announcement to do something and when they actually do it. So if one is to expect faster economic growth in the future that is being predicted in the stock and markets, we might see it in the index of leading economic indicators.

Curiously, the LEI is not showing any uptick yet in the potential for faster economic growth. This is what the ISM is saying they hear in their latest survey.

  • “Business conditions continue to improve.” (Chemical Products)
  • “Business outlook is positive.” (Computer & Electronic Products)
  • “Regional business is strong. Hiring qualified team members has improved.” (Fabricated Metal Products)
  • “We had a lot of storm orders, so it really pushed our sales up this month.” (Miscellaneous Manufacturing)
  • “Starting to see some prices creeping up. We are raising our sales prices as well.” (Food, Beverage & Tobacco Products)
  • “Business up 10-15 percent.” (Machinery)
  • “Industry outlook is looking relatively flat currently, and the view for calendar-year 2017 looks to be flat as well. The jobs market has been very good in the region, and finding talent has been challenging.” (Transportation Equipment)
  • “Overall, material inflation is now clearly upon us.” (Paper Products)
  • “Business is strong and looking up.” (Furniture & Related Products)
  • “Opportunities for new business seem more abundant now. Orders and RFQs increasing.” (Nonmetallic Mineral Products)

We think the real clue that is taking place is found in the table above. PMI states that 57.2% of companies say the volume of orders is increasing, backlogs are rising and new export orders are rising and employment is rising. But strangely, the production component is falling. What could be causing this? Companies may be hiring people but, the focus may be on training and not production. That would come later. But the reason we are not seeing production growth in our opinion is that companies are waiting for the new tax and regulatory regime to reveal itself so that they know what the rules of the game are going forward. This is just a theory at this point. But many believe this phenomenon took place before the Reagan Tax cuts. It took a year before the legislation was completed and changes were phased in. As a result, there was a hesitation in economic growth before it accelerated. The one clear indicator that the economy is hesitating and not accelerating is the “GDP Now” estimate published by the Atlanta Fed.

The Atlanta Fed GDPNow model mimics the methods used by the BEA to estimate real GDP growth. The GDPNow forecast is constructed by aggregating statistical model forecasts of 13 subcomponents that comprise GDP. It is important to remember, the Bureau of Economic Analysis reports old data to report on what happened in the past. The Atlanta Fed uses statistical models are designed to tell us what is happening in real time. The chart above tells us that the GDPNow estimate is about 0.5% below the consensus estimate of economists at about 1.25%. This is much slower than the Q4-2016 estimate of GDP growth which was recently revised up to 2.1%.

If businesses are indeed waiting for health care, tax, and regulatory reform before expanding productive capacity and output at the margin, we might expect interest rates to fall or remain flat. In addition, we might expect share prices to give back some of their post-election gains. In short, we think business people and investors will adjust their timelines. But in time, compromises will be made and reforms that the new administration will move forward. Then the business community can move forward with more clarity. As this all plays out, we expect faster economic growth in the future. After we go through this corrective period in the bond and equity markets, we expect higher share prices and higher interest rates. With higher interest rates and economic growth vis-a-vis the rest of the world, we expect a higher US Dollar. We are bullish America and time will tell if we are right.

Share: