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GOLD MARKET FLASH NOTE

Sunday, 20th November 2016

Facts vs. Fantasy: Can Trump Meet the Market's Expectations?   

Sorry to bring some real economic facts into the Trump economic boom fantasy but it is very unlikely that the market gets what it imagines. Here’s why.

The Trump Plan

There are two key promises that have the markets very excited...tax cuts and an infrastructure program.

The Trump plan cuts taxes for everyone. The top 1 per cent of income earners get a 14 percentage point reduction in their tax rates; everyone else gets a four percentage point cut. The bottom 20% receive a one percentage point cut to their rates. As a fiscal policymaker, you want to cut most the taxes of those who have the highest marginal propensity to consume. That is how you get the biggest bang for your buck from an aggregate demand standpoint. This plan fails in that regard.

The non-partisan Center for a Responsible Federal Budget estimates Trump's plans would increase the deficit by $5.3 trillion over the next ten years. In 10 years' time, one-quarter of all revenues would go to service a debt load that will breach US$30 trillion. Debt-servicing costs now absorb seven cents of every federal revenue dollar. Can this pass a Republican Congress whose members are committed to deficit reduction?

Goldman, Sachs strategist Alec Phillips writes that "there is substantial support in Congress for proposals to cut taxes and reform the tax code and that there is likely to be sufficient support to enact a modest infrastructure package, perhaps combined with tax reform." But as Center for a Responsible Federal Budget notes, the budget blueprint that the House approved earlier this year (the Paul Ryan budget) seeks to reduce the deficit from current projections by $7 trillion over the next ten years, mainly through spending cuts. "These estimates imply the Trump fiscal plan and the House Republican fiscal plan are roughly $12 trillion apart over ten years, or a difference equal to more than one-quarter of total federal outlays," according to the Center. Here's their projection. Ask yourself: Is Paul Ryan buying this?

As Goldman's Alec Phillips concludes: "market expectations of quick fiscal expansion may be running ahead of political and legislative realities."  The markets are also ignoring the significant negative impact of the huge tariff increases that Trump has promised.

Meanwhile, the Data Says Recession

The two main indicators that everyone watches to understand the direction of the economy-retail sales and labor market conditions-are both trending down towards recession. Can a Trump administration reverse these trends in 2017 as the market seems to expect? Let's take a look.

First, retail sales. There was an awful lot of cheering when the November 15 release of October retail sales showed an uptick of 0.8% which beat analysts' consensus estimates of 0.6%. Once again, the bullish bias in reporting failed to look under the hood. The improvement was driven by a surge in gasoline prices. Consumers did not use more of the product, which would suggest growth, they just paid more for it and consumed less of other things, in this case restaurants meals and furniture. The data below clearly shows a downward trend of lower highs and lower lows since 2013.

Consumption drives roughly two-thirds of the economy. Of that, retail sales comprise about 40%. The ongoing deterioration in retail sales is a serious constraint on growth. How is that going to change quickly?

Digging deeper, it only gets worse. Consumers are straining to keep their spending at current levels. Disposable Personal Income (DPI) is not keeping pace with spending so consumers are going further into debt to maintain their standard of income, as shown below. This is not sustainable, especially in a rising interest rate environment.

Now, let's look at labor market conditions. The easy measure is to look at jobs added per month but this is clearly inadequate because it leaves out key factors such as wage rates, labor participation rates and hours worked. Fortunately, the St. Louis Federal Reserve publishes a Labor Market Conditions Index (LCMI) monthly which is derived from a dynamic factor model that incorporates 19 seasonally-adjusted labor market indicators. Here, again, we have a clear trend of lower highs and lower lows which goes back to 2010.

In our view, these charts show a slowing economy that reflects declining business investment, falling productivity and an enormous debt load. The stock market is betting these trends can be turned next year by a new administration in Washington. A miracle has been priced in. Color us sceptical. Based on the trends, we think we are more likely to get a recession.