The US Growth Inflection is About More Than Just Trump

Economic and sentiment data continue to come in, supporting the thesis of an ongoing positive turn. We’re headed away from the sluggish slow-growth path that the U.S. and global economies have been on since the financial crisis, and towards a pickup. The data are especially positive for manufacturing. We note that many of these trends were beginning to take shape months before the U.S. presidential election. Of course, economic cycles and political cycles are related but distinct. In this case, we had the arrival of a new administration proclaiming a pro-growth agenda including tax cuts, regulatory reform, and a more proactive and U.S.-centric trade policy; that didn’t create the turn in the economic cycle, but it helped accelerate it by causing an improvement in business and consumer sentiment.

Therefore, we also point out that if U.S. consumers and businesses begin to have less optimism about the new administration — maybe because legislative progress begins to look more difficult, maybe because they get fatigued by news about political battles — that likely won’t stop the turn in economic fundamentals. More probably it would simply slow it down.

Manufacturing

Where can we see the ongoing turn? First, in manufacturing data. The U.S. manufacturing purchasing managers’ index (PMI) surveys current and forward-looking sentiment among managers at U.S. manufacturing firms. It began rising off recent lows in early 2016, and has carried that through into January.

Further, when we break down the components of this index, virtually all of the underlying trends are positive and accelerating.

Employment

ADP’s private payroll report came in far above expectations: 246,000 jobs added against a consensus that only anticipated 168,000. We note that growth in manufacturing jobs was particularly strong and accelerating:

Capital Expenditures

The inflection for U.S. manufacturers, reflected in purchasing managers’ assessments and in employment trend, is also reflected in trends in capital expenditures. Morgan Stanley’s capital goods momentum index (CAPMI) is continuing an accelerating uptrend that began in early 2016:

And the Capex Plans Index reinforces the message, showing a strong uptick beginning halfway through 2016 and continuing into the new year. This index is now at levels not seen since 2011.

These manufacturing data and sentiment indicators are occurring in the context of many other positive signs for the U.S. and global economies. We’re seeing nascent inflation and rising inflation expectations, record improvement in business sentiment, and even — despite worries about renegotiation of trade deals — acceleration in global trade:

This Is Not a “Trump Rally”

In short, although the election has surely influenced U.S. stock markets, the markets’ breakout from the long sideways pattern they’d been in since mid-2015 is actually rooted in real positive economic and psychological developments that are independent of the political landscape. Thus, there is good reason to believe that the rally is more than just relief at the changing of the guard.

The Risk: Obstruction of Tax Reform There is one significant risk that we think may be increasing. Some Republicans in Congress have other priorities than tax and regulatory reform, which we view as the most significant planks in the new administration’s program. Rather than focus on taxes and regulatory relief, they may focus instead on more ideological issues, such as a repeal of Obamacare. If these dissenters squander the new administration’s political capital on such concerns, and the year progresses without a clear path becoming visible towards lower taxes, markets will become more volatile and liable to correction.

Investment implications: Markets reacted positively after the November election in the U.S. However, many indicators — both economic and sentiment — had already begun to trend up earlier in 2016, and those trends have continued in the new year. Inflation signs are abroad and inflation expectations are rising. We are particularly encouraged to see strength in a variety of U.S. manufacturing indicators, and signs suggest that an inflection in capital expenditures is imminent. Optimism is in the air, and there is a willingness to put capital to work to reap the benefits of real growth. Although there are risks, and many stocks are fully valued, we believe there are still bargains to be found where the market has not yet adequately priced in inflections due to growth and reform. If it begins to appear that progress on tax reform is stymied and that it may not happen this year, markets will not take the news kindly. Therefore we are adding to gold and gold shares on dips.