To say that 2016 was a boring and predictive year is an understatement, probably the two biggest items impacting the economic fronts were the cantankerous election ending in a Trump win and the BREXIT sending ripples through Europe. But what should we expect in 2017?
Year of the Dollar
Courtesy of wikipedia
While interest rates are certainly in flux between the western nations (US raising the second time in 10 years while Japan and Europe continue to ease), there is a floor in spread between them, mainly due to the government interventionism in their policies (purchasing bonds). The volatility however comes from the flow in the dollar vs. other currencies.
While most of the analyst, news pundits, and economists are looking towards Trump’s policies setting the tone and most are in agreement that the Fed will be limited in their hikes (between 1-3 times or 25bps to 75bps), I believe the biggest factor going unchecked in setting economic fundamentals and even markets is the dollar.
The dollar is currently ripping higher against other western currencies, much like the Dow Jones and other market indices simply based on the perception that Trump’s policies will lead to a strong economic growth through pro-business type policies. Certainly, his criticism of the Federal Reserve and his rhetoric towards higher rates, coupled with the Fed rate hike in December is only fueling the dollar run higher.
The perception of a Trump presidency (what it will be like – pro business) is fueling the order flow into US equities and the dollar. Whether people argue that the US is a “safe haven” or they are a believer in Trump’s pro-business agenda – the results are the same, inflows into the US markets.
While it is a measure of confidence in the US markets and certainly a boon for imports and ultimately US consumers, it does have a significant impact on economic growth and exports.
The dollar (Trade Weighted Dollar Index: Major Currencies) had made its first run up in mid-2014 as the US Federal Reserve switched course and started laying the expectations of a rate hike. It was coming and we saw flows into the dollar by mid 2014 and breaking above 80. The first rate hike since the 2008 crisis finally came in December of 2015, but the 25bps did little to curb leverage buying (mortgages, margins, etc.). However, we saw a rather huge sell-off in the equity markets in January of 2016 and economic data on exports continued to weaken. The market remains in flux for most of the year as economic data reflected anemic growth, toss in a circus of an election and no one was willing to make any significant investments. With weak economic data on growth, an election, and no more rate hikes by the Fed, the dollar index remained in the 90 – 95 range.
November changed everything. The Donald winning had everyone switch from focusing on his unfiltered and politically incorrect speeches and tweets to taking a serious look at his policy plans. The main stream media had us believe that Hillary was just going to walk into the White House in a blow-out election. CNN had predicted she would win by over 400 electoral votes, MSNBC had her above 350, even Fox news was skeptical about a Trump victory. So why bother to look at his policies if he is not going to win. After the election, people started considering what to expect from a Trump presidency. Many of my fellow market professionals across the board quickly started reading Trump’s Contract with the American Voter (I suggest you read it if you have not, to get an idea what his policies are – not just his tweets.)
Regardless of what you think of Trump or what the mainstream media likes to focus on (his tweets), the real rubber that meets the road will always be policies. It is policies that will impact the economy and markets, it is policies – which are actions and not words – that are the true measure of what to expect. Many of my associates, even those that oppose Trump, agreed. Whether you like him or not, if his policies get traction and are passed in his first 100 days, it is a boom for the markets and the economy. Well – in the short-term at least.
I would break down his policies in to several buckets as per impacting the market and economy. The policies also have a short-term and/or long-term impact to either the economy or markets. Additionally, there are those policies that generate a perception of economic strength without much meat, but perception is a huge factor that can drive markets (less so the economy).
Dollar’s Second Move Higher
It is when Trump won and those in the market took the time to digest his policy plans that we started seeing money flow into the markets and the second leg up in the dollar. Looking at the Japanese Yen and the Euro both collapsing in kind. The trade weighted dollar index could break 100 very soon.
Japanese Yen has moved over 11% since the election.
A strong dollar is a double edge sword for the economy and has both short-term and long-term impacts. Without getting into the weeds I think it is important to break this down into simple and general ideas to contemplate. Let’s look at the Pros and Cons of a strong dollar.
As a net importer combined with being the world’s leading consumer (on a per capita measure), a strong dollar means imports are cheap. The dollar buys MORE, when it comes to imports. We could see prices on consumables decline or at least increase very slowly on a stronger dollar. Oil (gas), food, consumer staples, electronics, and a host of items you would buy at Walmart and Target. A strong dollar may not impact housing prices as you would expect, meaning that rather that declining in price we could see housing prices increase based simply on the flow of capital coming in from foreign monies seeking either a “safe haven” or a place to park capital and hedge against inflation in their own currency.
While I, like every consumer, enjoys the increase in buying power on imports, we also need to export. As strong dollar significantly impacts exports (both goods and services). A foreign purchaser of US goods and services must pay more, once your account for the exchange rate. Obviously foreign purchasers will seek third parties with lower valued currencies for their imports and that will hurt U.S. exports. Foreigners will be less likely to vacation in the US as prices will be significantly higher. Note, I am traveling to Spain on business in January and was shocked to see how prices have dropped on hotels when factoring in exchange rates.
Unfortunately, the cons significantly outweigh the pros, based on two primary factors.
US is a debtor nation, consumers purchase on average far more than they earn and use debt to consume. The 2008 crash and subsequent recession, boiled down into one succinct reason; We ran out of credit and could no longer finance debt.
We have recovered somewhat, but a vast swath of supposed “middle class” still have limited access to credit as they remain at their debt limits. With wage stagnation and the inability to ramp up debt financing, growth in the US – based on debt consumption is going to be tepid. Certainly, a strong dollar helps them consume MORE for the same amount spent, real net growth will remain tepid.
While it seems that debt financing as a percentage of disposable income has declined, lets not forget that interest rates have declined to zero. What happens when interest rates go back up? Obviously, debt financing as a percentage of disposable income will increase.
The US for the most part is at full debt consumption saturation. The only real new growth of debt consumption is coming from the millennials. As they start entering the job markets, they have income and that means access to credit and into the cycle of debt consumption. The marketing shift in the US has certainly moved to the millennial markets (just look at advertising growth on Facebook and social media). Unfortunately, the millennials are already burden with debt (college loans) before entering the job market, which hampers their access to credit and their ability to finance additional debt. The bigger problem is that population growth rate in the US is 1.84 children per women, which his below the replacement fertility rate of 2.1. What does that mean, well our population is getting older and the rate of replacing people vs aging and death rate is negative. Our population (without the reliance on immigration) is shrinking and shifting to an older average age. Ironically it is immigration that has offset our population declines. As of the 2012 net population growth is .75% over a 12-month period, without immigration it would be negative. Note the average growth rate for industrialized nations is 1.1%. Unfortunately, the bulk of the immigration as measured in the labor force is at the low or unskilled labor pool, which equates to low income and limited credit availability. The burden of growth as a measure of consumption rates sits squarely on the millennials shoulders and that is just not enough.
If we look at wage growth percentage minus the percentage of income used for debt service, its negative (3%). Overlaying the increase in Student Loans (over 125% increase since 2008) and it looks like our millennials are going to have a tough time. I hate to imagine a rate hike, which will push debt service vs. wage growth further negative, regardless of how we tackle the student loans. I appreciate Sanders and Warren wanting to cut student loan rates or full debt forgiveness, but that does NOT solve the problem and only further puts the onus on the US tax payer as it adds to federal debt, pushing the nation not only further into debt, but increasing deficit spending as debt service will increase. This of course can trigger a lack of confidence in the US dollar as well.
Combining the fact, we are at the upper bounds of debt limits for US consumers and the demographic issues, our nation must focus on exports to generate real growth.
All goods and services are measured in two categories (which are sometimes subjective); quality and price. Price, unfortunately, usually out weights the quality of the goods. We general gravitate to lower price goods, looking for a bargain, discount, etc. In many cases quality suffers because of price. The luxury goods markets are the one exception.
If the US needs strong exports to boost economic growth, we really need to be conscious of price to compete with other nations. Companies certainly have a direct ability to determine the prices of their goods and services, but they are unfortunately subjugated to the value of their currency. They can only lower their prices so far to make up for the strong dollar and of course lowering prices means lower margins and that means fewer job creations.
The luxury export markets of course are not adversely impacted as much by a strong dollar, people that wish to purchase a “name brand” will do so as quality trumps price in these cases. However, this is a very narrow segment of consumers.
Trump Policy Impact
Trump’s policies are conflictive when it comes to the economy and the markets. On one hand, many are solidly pro-business DOMESTICALLY, on the other hand many are solidly Nationalistic and/or Protectionist – meaning they can have a negative impact on exports we need. Collectively these create a strong dollar position by helping domestic growth and protectionism. Because of the consumer debt limits and demographics, this could have a negative impact of economic growth in the long-term and may also stall market growth.
The problems are we just don’t have any idea if/how/when these policies will be enacted. Yet in the meantime the dollar and markets are reacting they are coming.
Make America Great Again, Again?
Perceptions drive markets. Trump is not even president, but the market is rallying, dollar is rallying, and we are seeing deflationary pressures in US consumables and a short-term increase in US consumption. However, Trump has not implemented any of his policies yet, he is not even president. Is the market getting ahead of itself? Has the market already priced in those policies? Can the market go higher? The answer to those questions are all yes, because we just don’t know anything at this point. The market is moving on assumptions and perception, not on any fundamental or material data at this point.
While Trumps polices (if and how enacted) can certainly help economic growth domestically, chances are we will not see any real fundamental results from any of those policies until at least sometime in the 2nd quarter of 2017 at the earliest. It takes time for the economy to feel the real impact of policies and it will take more time for that data to be realized and then analyzed.
Regardless of his policies and more importantly to the growth of our economy is value of the dollar. If the dollar remains strong or gets stronger, his policies will not mater as foreign nations will seek alternative imports (other than the US) and that will lead to weak economic growth and companies must make tough decisions that will impact their bottom line.
At the beginning of the 2008 crisis and through 2014 the US and western central banks have worked together. The birth of QE and similar central bank interventionist policies have created monetary stimulated reliant economies. The currency war began when the western nations broke from each other and common policies. Japan fired the first salvos as the US and Europe started talking about returning to “normal”. Japan unloaded massive stimulus, increase in money supply, and even started purchasing their own market securities, then took rates negative. Europe quickly followed suite and broke with the US, as they started following Japan to boost their economy. The US Fed continue to talk about rate hikes and then at the end of 2015 raised rates for the first time. The second rate hike this month means we continue to take an opposite approach to our western allies and thus create more tension between our nations. Clearly the dollar is rallying and that is NOT what the Fed wants, as it creates deflationary pressure and they are on track to target 2% inflation.
It takes years, if not a decade for a currency war to play out and historically speaking they have never ended well.
At the end of the day TRADE drives everything and can lead to prosperity and growth or to war and famine. Producers (exporters and credit facilitators) are the winners and consumers (importers and debt accumulators) are the ultimate losers.
Economic growth all comes down to the dollar value. While the market can continue to rally, I believe after the New Year we may see a stall and even a retracement in the market sometime in January. 4th quarter results will show some strength, but the strong dollar will (and has) already brought a series of warnings from companies all through 2016 on their future growth. Over 50% of the S&P 500 revenue is based on exports and that percentage of revenue continues to grow. We are becoming ever more reliant on exports.
Trump will likely face his first foreign trade deals sometime in early 2017 and how those go will determine the tone going forward on exports and the dollar.
Will Trump lean more Nationalistic and Protectionist, which may seem to help domestic growth (directly tied to demographics) and continue to strengthen the dollar?
Will Trump lean more to Export lead growth, negotiate deals that are pro-exports, and be cognizant of how fiscal and monetary policies will impact dollar value?
The world wants the US to continue to consume. Our ability to maintain strong consumption growth is hampered by demographics and debt financing. We need to produce to grow and to increase consumption.
While Trump’s policies seem pro-business and in essence they are, his trade and foreign policies could hamper exports. While the mainstream media is in a furry over his tweets and rhetoric, my largest concern is his protectionist and nationalistic policies. While I agree that our trade agreements are one-sided (for the most part) and better deals can be in place, threatening businesses that leave and/or creating nationalistic policies can hamper exports, jobs, and economic growth.
Trump also has a battle with the Fed. His anti-Fed rhetoric is just words right now and currently the Fed is squarely in control by President Obama’s appointed governors who can serve out their terms (are all Keynesians leaning socialist) and most of their terms out last Trumps first term. There are two empty seats that need to get filled in the governor positions – which Trump can start realigning the Fed.
My worry and/or concern is that Trump will ignore the impact his policies and to an extent his rhetoric (tweets) may have on the dollar. He may not understand the long-term impact a strong dollar has on exports and growth. He may blame the strong dollar on the Fed, which is partially correct, but he needs to come to terms that fiscal and monetary policies work together and are not mutually exclusive.
Trump has an opportunity to bring the US into a new growth paradigm, but that requires a monetary policy as well as a keen eye on how the dollar impacts not just imports and buying power, but more importantly exports.
It is easily to be allured to a strong dollar because you can BUY more and seem far more wealthy, which is true on an individual basis, however for a society to be economically successful it must PRODUCE and we are (whether we like it or not) in a Global Producer and Consumer world. Right now, we are the consumer and we must become a net producer to see a strong and vibrant long-term and more importantly sustainable economy.
We continue to bet on the US’s ability to consume and that is a risky bet. While Trump seems to be a radical change from typical politicians, he needs to get on board with Producing and not just producing for Americans but for the world. We need to export! I think he understands this, but some of his policies seem to be conflictive on export growth.
The market and dollar are moving on perceptions and assumptions.
The dollar will determine our future.
Support & Resistance
INDU 19,000 – 20,000
We could see 20,000 – sure why not, it is only 30 stocks and a couple of stocks are the core driver of the move higher. While I would not bet on it, I can’t deny it has physiological impacts (the financial media can’t stop talking about it), it maybe a place we see sellers step in. We could see some sell pressure at year-end for nothing other than tax reasons.
NDX 4900 – 5000
The tech heavy index didn’t participate in the Trump rally, in fact it sold off in the beginning of December and only recently rebounded and broke above the 4,900 level. There is certainly some volatility in this index and I suspect we could continue to see volatility and some pull backs after the first of the year.
SPX 2240 – 2280
The index is stalled after the rally in November and the follow-up rally in December. There is a lot of action around 2260 in the futures market – seems like a fight to break higher or lower. Short-term boundaries from a break-out will be a jolt to 2280 to 2240. A break-down to 2240 and without finding support will see a drop to 2200-2200 before buyers step back in. I think we are in for a pull-back in the beginning of 2017.
RUT 1360 – 1380
The broad-based index has confirmed that money is flowing into the markets. We had a good rally from 1260 break-out into 1360 and have now stalled. That market wants to move higher, but needs more confidence and that right now is solely based on assumptions and perceptions, we don’t have any fundamental data to support the strong growth. That could come with 4th quarter GDP and holiday sales numbers. However, unless they really surprise to the upside, I think we could be in fore a pull back to 1300 – 1320 range.