A Message from Baron The U.S. Economic & Stock Market Outlook… January 10, 2017

Greetings and Happy New Year!

What a difference an election makes! The American people finally got so fed up with the graft and corruption in Washington and socialist policies that we refused to take it anymore! Something like 98% of the counties in America went Red in support of a man we all hope is someone who will, “Drain the Swamp” and put America and American’s first. I lead off with this because the election results are central to the future of our nation, economy and stock market.

In an effort to give you my view of where our economy and the stock market goes from here in 2017 and keep it succinct I am going to condense down into bullet points the positives and negatives and follow those with my summation opinion. So here goes!
 
Positives
 
Consumer Confidence has shot up! 59% are confident the economy will improve while 52% are confident that higher living standards are on the way.

Inflation is a low 1 – 1.2%. Fears are that it will rise but it’s more likely any price inflation will be muted due to a rising U.S. Dollar and over regulated banking sector. 

End of Obamacare – all signs are this is top priority for the new administration. Price increases have squeezed the financial life out of consumers. Any improvement in the cost of healthcare will transmit into increased consumer spending and savings.

Business & Personal Tax Cuts – A powerful incentive for growth! Up to now consumers have been driving growth. It will be nice to have business start contributing! A little known fact, 78% of a business tax cut winds up going into higher employee paychecks!

Repatriation of $2.5 to $5 trillion dollars. No one really knows how much money is trapped offshore due to our current outrageously high repatriation tax. The hope is that our corporations will reinvest this money into new plants and equipment and hire new workers. All a positive IF companies really do want to repatriate their money and if they have productive ways to deploy their capital. Personally I think this effect while positive, will not be as powerful as many believe (this is a long conversation I will leave for another day) but the overall improving business climate will no doubt help spur reinvestment into the United States. 

Improving regulatory climate. Trump says he wants two laws removed for every new law written. 

The Federal Reserve is likely to continue its easy money policies and be timid when it comes to raising rates. Janet Yellen and others at the Federal Reserve are Democrats and Yellen has already lashed out at Trump. Judging by what we’ve seen since the election there is concern the Federal Reserve will purposely tighten the money supply and raise rates to throw the economy into a recession. I discount this but if you see it happening you might surmise why! 

Improved trading pacts. NAFTA will be reviewed and renegotiated. The TPP is dead and Trump will negotiate individual trade agreements with individual countries. This is a big plus because getting out of or changing a bad comprehensive trade agreement involving many countries is very difficult. 

Dodd-Frank will be changed. Only 3 new banks have been started since the 2008 crash. I remember when it would have been hundreds! Lending has been stagnant as local and regional banks are handcuffed to lend. What we have is constipation of the money pipeline due in large part to Dodd-Frank. 

Democrats are so far to the socialist progressive left they are self-destructing. 

U.S. Dollar is at multi-year highs. King Dollar is long term great for the stock market. Every prosperous period in American history has been accompanied by a rising dollar. A rising dollar drives down commodity prices including oil. A higher dollar leads to cheaper input costs for business making businesses more profitable and more competitive and leads to lower prices for consumers helping keep inflation down. A strong dollar attracts investment capital from all over the world and everything we import is cheaper. From 1982 to 2000 the US. Dollar was up 178% and the S&P 500 was up 1,100%! 

Stock market multiples are reflecting a stronger economy and higher market. 

Business investment, which hasn’t moved in 20 years, may improve as much as 20%!  

Long term job creation may increase 150,000 per year which is a 15-20 million increase over the next 10 years. This is huge! Remember this is on top of our current rate of job creation! 
 
We still enjoy a historically low level of interest rates. 

Trumps work ethic and ability to short circuit the lying press using Twitter and his willingness to go directly to the people. We’ve all seen Trump working day and night. The man doesn’t seem to sleep! What a refreshing change from the Golfer and Chief who just awarded himself the Distinguished Public Service Medal which has about as much value as his Nobel Peace Prize. We now have a doer coming into office and a poser leaving.   
 
Negatives
 
Corporate buy backs of their own shares is ending. This corporate sleight of hand mathematically boosted earnings per share that drove stock prices higher. Some estimates attribute 1/3rd of the stock market price increases to this tactic. 

Our banking system is over regulated and thus our monetary transmission mechanism isn’t working leading to low money and low credit creation. Upside is it also leads to sustained inflation being very unlikely. 

Job creation is continuing to slow down. From 250,000 per month in 2015 to 175,000 in 2016. 1 in 5 households have no one with a job under the same roof! Wages up 2.8% annually with average hours worked up slightly to 1.4%. Looks like economy is peaking at a low level. 25-54 year olds (backbone of labor force) labor participation rate is very low and still falling. Businesses are finding it harder and harder to find talented labor despite abundant pool of applicants. In the meantime jobless claims are falling making one scratch their head as to what is happening. It seems we have a huge pool of workers who have given up looking for work. Maybe they are unskilled for today’s world or their benefits have run out? Reports call this fall in jobless claims inflationary. Maybe so but with so many out of work it’s hard for me to get too worked up over wage inflation. Remember too that we are still competing with the rest of the world and we have King Dollar. 

Biggest potential impediments to growth: Senators Mitch McConnell, John McCain, Lindsey Graham and other Republican Senators. Also Congressman Paul Ryan and other liberal Republican Congressman. Everyone expects the Democrats to put up a fight and they will but 2/3rds of the politicians up for re-election in two years are Democrats. These Democrats are likely to be more cooperative especially since Trump can and will call them out and even arrange for someone to run against them! So the Republicans are Trumps biggest challenge. 

2017 may see more wage inflation – currently running at 2.5% year on year. Companies have already squeezed out all the costs they can from operations. This means a hit to profits which is what we’ve been seeing the past 6 quarters. So while rising wages are positive for consumer spending it will take a toll on business profitability unless the expected tax cuts and lower regulatory environment spurs more business capital investment leading to productivity gains.
 
Fight to the death. I think folks are underestimating the coming, “Drain the Swamp” fight. I believe it’s going to result in a fight to the death. The Democrats have shown zero humility and in fact have not only doubled down on arrogance and stupidity since the election but have quadrupled down on it as evidenced by California hiring Eric Holder to defend them against Trump and his policies. As one political observer put it, “The Democrats are gearing up for a fight. Trump can’t expect to wound them (take out a few prominent names) and expect the rest to fall in line. Trump is going to have to kill them because if he doesn’t they will come back on him”. Unfortunately, I agree. This will make the climate in Washington anything but congenial. The one exception being as noted under the positive that a whole lot of Democrats are up for re-election in two years and thus may not wish to make waves and be called out for it but those facing prison will fight to the death.
 
 
Outlook/Forecast
 
The U.S. stock market will move slightly higher in the first half of 2017 fueled more by enthusiasm and long term expectations than short term facts as it will take time for many of Trumps changes to be passed and implemented and to finally take hold and show results.

While current Price Earnings ratios are high they are not overpriced and I see no likelihood of a recession and little likelihood of even a correction despite our current anemic economic expansion being the second longest in history.

If Trumps economic changes go as planned we will be setting 2018 up to be one of our best stock market years in history! For sure we will know a lot more by June or July. The stock market looks ahead 9-12 months so if overall changes are being implemented and things are going well come June or July I expect the market will accelerate upwards in anticipation of a strong 2018.
 
To my clients reading this. Please note that I will be getting with you over the next few days to realign your portfolios based on the economy and markets new reality.

Thanks everyone, have a terrific New Year!

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