Will the Trump tax cuts (which are already priced into this rising market) keep markets safe and the economy strong?
In an environment where taking a political stance can feel like bringing a Red Sox flag to a Yankee’s game, we’ve probably learned it’s hard to talk politics or numbers without an awkward moment, and I hate awkward. To keep this clean, I’ll take a jab at both Republicans and Democrats in the oval office. Better yet, I’ll just take a jab at politicians in general.
The good (or bad) news is that history confirms economic ignorance has a fairly non-partisan consistency. The problem is not donkey or elephant: it’s human. Or worse, it’s political.
Right now, the buzz in DC is tax cuts, stimulus, infrastructure spending, repeal and replace and a general nod/hope that The Donald is a Reagan 2.0.
As for the Gipper and the 80’s, many share a nostalgia for those roaring good times. And as for Trump and America today, things look pretty good—at least on paper. Employment is high and the stock market is ripping. Nothing, not even a bomb blast in Manchester or a Special Prosecutor in Washington scares this tape.
Reagan is famous for tax cuts, lifting the GDP and looking good on horseback. Trump is promising more of the same, sans cheval. But are these romanticized memories and current headline promises supported by the numbers?
The Reagan Miracle of 81, I’d contend, was much less of a miracle of supply side growth than it was a few years of 4-6% inflation-adjusted GDP growth paid for by the then greatest deficit program in history. Reagan increased the US debt from $980B to $2.7T (or 30% of GDP), which was more debt accumulated in one administration than the prior 39 presidents before him—combined.
If I give my college green son a credit card with no spending limits, his already notorious frat-boy popularity would soar. I can only imagine the parties he’d throw… I’m sure his star would rise “miraculously” with each keg delivery, flat-screen TV purchase and pizza order.
But my checking account would suffer while he smiles through sorority invites. In short, debt works—but not really. Someone, after all, has to pay for the good times.
Would you give a teenager unlimited credit and call the party that follows “growth”?
Debt, of course, buys good times and hence a favorable Presidential (or campus) image, at least until…the bill arrives. Since the Gipper, America’s sovereign invoice has blown to levels beyond sustainability, which the Bush (Republican) and Obama (Democrat) administration only made worse.
Hero or villain, genius or buffoon, President Trump entered the executive mansion with zero to little balance sheet left to re-stimulate the economy or the markets.
Unlike Mr. Reagan, Mr. Trump has a much smaller national check book to fix things; he faces a US debt of $20T (106% of GDP)—and that’s not counting what it will cost to fund his tax cuts, infrastructure development, veterans benefits and border/immigration initiatives.
Furthermore, even if the legislature can pass a tax cut now or into 2018, no one, not even an “experienced business guru,” can be expected to whistle past this debt graveyard without facing a ghost or two.
And the US markets are particularly haunted by risk today. Depending on which accounting methods are used, the inflation of PE multiples in US equity markets has risen to 24X or 18.5X, with the truth lying somewhere in the GAAP middle.
Regardless, these are dangerously high PE ratios, and come to us despite the fact that the recent earnings euphoria came from Facebook, Apple, Amazon and Google—not the rest of the market.
Consider the following: the market cap of the S&P 500 gained almost $2T in the last 2 years, but almost 60% of that gain has been driven by just four stocks—the S&P 500 is essentially an S&P 4… And nearly 2/3 of their earnings growth was due to multiple inflation, not earnings growth. There’s a difference, a big difference.
Looking at this so called “earnings uptick” and pending tax stimulus, it’s hard to be optimistic as a risk manager when markets soar to nosebleed heights while actual earnings are dramatically distorted, PE multiples are near record levels, the Fed’s balance sheet is bloated by 5X since 08 and US debt is at historically unprecedented levels.
This is an open and obvious scenario where downside is far more likely than upside. GDP is stalled. The economy is nervous again, yet still the markets climb. Seen this before?
Can Trump save us the way Reagan “saved” us from Carter? Did Carter save us from LBJ? Can anyone save us?
Let’s look at the basic figures. In 81, Reagan slashed taxes and spurred what pundits call a “growth wave.” Empirically however, that’s just not true. During the Gipper’s two terms, real GDP averaged 3.58% per year, which is what the average GDP rate was for the prior 30 years before he came into office. Hardly a growth wave…
So why the hype? Because within that “Reagan” average were some memorable spikes —like in 1984-85, when GDP shot momentarily to 8.6% before regressing to 2% to 3% thereafter.
In short, the Reagan Miracle was more a steroid (or fiscal “keg party”) than an economic solution and the 80’s owe more of our nostalgia to Duran Duran and Boy George than to fiscal leadership.
But let’s not make this a Republican thing. Johnson (a favorite Texas Donkey) enjoyed a similar spike in 66—and all for the same reasons: he cut taxes (political gain) and increased deficits (kicked the can). Nixon (a less favorite Elephant) tried this in 72, and got the same momentary steroid effect then. Jimmy Carter (back to the Donkeys) was no different in 78, which saw GDP spike for a brief shining moment. Headlines were made.
But the numbers guys like me will remind you, then and now, that GDP spikes attributed to deficit spending are nothing to brag about. It’s like flying first class and sending the bill to your unborn grandchild.
But here’s something any one can admit, regardless of party: cutting taxes without simultaneously cutting spending, is not a stimulant. It’s not even a wash. It’s can-kicking as the national and global frat party rages on.
We are a country accustomed to can-kicking. Why? Because it’s the same as avoiding reality, which culturally—from Facebook to Monday Football—we humans like to do.
The argument today, as then, is that tax cuts trickle down to more economic activity. Yes and no. Tax cuts with spending cuts can lead to economic activity, but tax-cuts paid for by more debt leads to activity, and then pain.
Truman and Eisenhower, by the way, came from another generation that refused to pretend that debt was a good excuse for political popularity. They paid things with cash [i.e. tax revenues] rather than debt—like our grandfathers used to do.
We are not that generation—politically or fiscally. Since the 1960’s, we’ve essentially bought into the notion that tax cuts paid for by deficits work. But they don’t. Not really. They just give politico’s a poll boost and then hand us a hangover.
Democrats and Republicans are equally guilty of this short-sighted political trick—so let’s not make this a party thing. It’s an econ thing. It’s also a cultural thing.
In the 80’s, Gordon Gecko famously announced that “Greed is good.” Today, we’ve added an extra twist, namely: “Debt is Good.” Of course, there’s an irony intended here…
Neither is good.
So will debt work today?
Trump’s tax cuts face a much bigger reality check than anything Reagan, Carter, Johnson or Tricky Dick faced before him. When Reagan took office in 1980, the US Debt to GDP ratio was 31%. Today it’s 105%.
If this current administration wants to cut taxes and increase debt to cover Federal spending (now 20% of GDP), it will be lighting a debt fuse that can only lead to a market and economic “pop” down the road. Unless, of course, he cuts spending. Will Trump’s tax cut fly politically?
Will that happen? The GOP is split between populists and old timers; and the Democrats, well they rarely agree with either. In short: spending cuts are a matter of politics, and my faith in politicians is far weaker than my respect for market laws, which always punish debt bubbles.
In short, we need what JFK called a “profile in courage”—namely, a politician willing to sacrifice popularity and self-interest (i.e. re-election), for straight-talk, austerity, spending cuts and the kind of fiscal discipline our grandparents understood. Do you know many politicians like that?
So why are we even waiting for the White House to save us? Why so much faith in Trump’s Goldman alumni? Over-paid bankers like Gary Cohn—or Hank Paulson of old—are of the same banking stripe that confuses and prioritizes buy-side market stimulus with economics.
They will almost always chose Wall Street priorities over Main Street realities. Bankers who become cabinet members are still bankers, and bankers out of Wall Street are still Wall Street. They want steroids (i.e. more kegs) not fiscal restraint (or juice smoothies). In other words, “Greed and debt is good.”
The problem is we are running out of steroids in the nation’s capital. Our economy is like a college grad: debt soaked. And not just in one area, but across the board, from small businesses, families, governments and banks. The combined national tally is over $60T, which is just shy of 350% of our country’s GDP.
If the Fed keeps raising rates, this debt statistic can morph into a debt crisis.
At that point, the Fed (which is only raising rates now because it wants to have something to lower in a coming recession they damn well know is near) will find itself with its back to a wall of its own making. And sure enough, they’ll have one option left: print more money. In other words, more steroids.
As we know from Lance Armstrong, steroids work really, really well, until they don’t.
The trillion dollar question now is will Trump continue the same ol’ patterns of yesterday or can we find way to cut taxes and costs at the same time? This will require a lot of “profiles in courage” in Washington’s political circus. Do you see much courage there?