One of the principal puzzles for investors since Donald Trump’s election has been the divergence between ‘soft’ economic data such as consumer sentiment or business investment intentions and ‘hard’ data – the realisation of those intentions in, for example, retail sales or capital expenditure.
Some sentiment indicators have risen sharply since November. In March, the Conference Board’s Consumer Confidence Expectations Index hit its highest point since 2000. The National Federation of Independent Business’ Small Business Optimism Index in January was the highest since 2004 and the change in the index level from November to December 2016 was the biggest since 1980 (see exhibit 1).
Exhibit 1: Soft data indicators for the US economy have risen
Data as at 1 May 2017. July 2016 = 100
Sources: Conference Board, National Federation of Independent Business, BNP Paribas Asset Management
Valuations of equities have rallied….
This optimism appears to stem from the belief that the Republican Party will be able to implement its pro-growth agenda — from tax reform and infrastructure spending to deregulation and reduction in red tape — now that there is a president of the same party to sign the legislation. It’s an optimism that has lifted US equity prices, with the large cap S&P 500 index up almost 13% since 8 November 2016, and the small cap Russell 2000 index up nearly 20% (Exhibit 2).
Exhibit 2: Valuations of US equity markets reflect optimism
Data as at 3 May 2017. 8 November 2016 = 100
Sources: S&P, FTSE Russell, BNP Paribas Asset Management
… but consumer spending hasn’t risen…
So far, however, there has been little evidence of a surge in consumer spending commensurate with the surveys. Retail sales (excluding vehicles and vehicle fuel) are growing no faster than they were before the election. The last reading in March showed a 3.6% year-on-year expansion compared to a 3.8% average in the preceding six months.
This weakness in consumer spending became most apparent with the recent release of the estimated GDP growth rate for the first quarter of 2017. The disappointing overall growth rate of just 0.7% (SAAR) appears to have been due to a drawdown in inventories, which in our view will likely reverse in the next quarter or so, and, more worryingly, a contribution of just 0.2% from consumer demand. This is an extremely low reading for the US outside of a recession – the average non-recessionary value being 2.4% – and highly surprising given the consumer confidence surveys.
Even so, we are not unduly concerned as we anticipate that consumer demand will recover in the second quarter as job openings remain plentiful, wages are rising and aggregate consumer debt burdens remain manageable.
Business investment: promises need to be delivered, first
The corporate spending outlook is more ambiguous. CEOs would tend to want to see more than mere election promises before deciding to increase capital expenditure and in any event, it takes time before business plans result in actual spending. The Duke CFO Global Business Outlook (see exhibit 3) suggests that we should expect to see capital expenditure growth rise from 1.9% — the most recent figure from Q3 2016 — to closer to 6% by the time the data for Q1 2017 becomes available.
Exhibit 3: US capital expenditure growth took an upward turn in the wake of President Trump’s election
Data as at 4 May 2017
Sources: Duke Fuqua School of Business, US Federal Reserve, BNP Paribas Asset Management.
Exhibit 3 shows that the outlook of chief financial officers (CFO) for capex growth inflected positively after the election. However, these heightened expectations were premised on pro-growth policies that have yet to materialise, so it remains to be seen whether the capital spending will follow.
Besides the improvement in business confidence, there was yet another reason to think that investment might increase. One encouraging part of the latest GDP release was that business investment rose significantly, contributing 1.1% to GDP growth for the quarter, more than double the average over the last several years. Unfortunately, this increase is not as encouraging as it first appears. The dramatic swings in oil prices over the last 15 years have had a commensurately large impact on energy-sector investment. As oil prices have risen and fallen, so has investment in the sector. Investment in the other parts of the economy has been steadier, however (see Exhibit 4).
Exhibit 4: Business investment by sector
Data as at 1 May 2017. December 2002 = 100
Sources: BEA, BNP Paribas Asset Management.
Regional bank CFO commentary and corporate lending trends provide additional fodder for this ‘soft-hard’ data divergence debate. Bank CFOs have unique insights into the borrowing and spending plans of a wide range of businesses, given their role as capital providers. Our conversations (the ‘soft’ data) with bank CFOs have drawn a relatively uniform picture since the election: that corporate customers are optimistic; management teams are drawing up plans to increase capital expenditure and expand the workforce; and that healthcare reform, tax reform and/or deregulation should trigger an acceleration in spending. Unfortunately, this early optimism has not been justified given the lack of concrete wins to date on the pro-growth policy front. As a result, corporate and industrial loan growth (the ‘hard’ data) slowed in the first quarter.
Table 1: Commercial and industrial loan growth
Source: Federal Reserve, 28 April 2017; commercial banks in the US
US equity markets rallied strongly after the election on high hopes for pro-growth policies and tax reform from the new administration. So far, the ‘hard data’ to support this rally has failed to emerge as the path to successful enactment of these policies has been more difficult than expected. As a result, investors are slowly ratcheting down expectations for the new administration and enthusiasm for US stocks has eased. Furthermore, recent investor surveys indicate a clear preference for European and emerging-market equities over US equities. Despite this, corporate spending plans are primed and the consumer is relatively healthy. The Trump administration needs a pro-growth policy win to accelerate spending and turn good intentions into action.
This text was written by Geoffry Dailey and Daniel Morris on 4 May 2017