The Trump rally is predicated on promises of things that may never happen or prove very difficult to fulfil. That in turn sets up the markets for a major disappointment when reality sets in. It is a classic case of a market buying the rumour and selling the news. Investor’s Digest of Canada columnist David Chapman warns: Buyers Beware!
One has to marvel at the current bull market in stocks. The current bull market as of Feb. 28, 2017 was 2,913 days long, with no correction exceeding 20 per cent. The bull started with the bear market bottom from the 2007 to 2009 financial crash, which occurred on March 9, 2009.
The granddaddy of all bull markets happened in the 1990s, when the Dow Jones Industrials ran from October 1990 to the high in January 2000. There was one significant correction in 1998, but even it was just under 20 per cent. That was 3,382 days.
Stock markets, despite periodic and even sharp corrections, just seem to go higher and higher.
Seemingly unending stock market rise
So, is this time different? After the shock of the 1929 stock market crash, followed by the Great Depression and Second World War, the market took 25 years before beating the highs of September 1929.
The 16 years from 1966-82 saw periodic forays towards the 1966 high, but it took until early 1983 before the market actually exceeded it.
Since then, despite the stock market crash of 1987, the recession of the early 1990s, the high tech/Internet crash of 2000-02, and the financial crash of 2007 to 2009 (plus the Great Recession that followed), the stock markets have recovered—sometimes with sharp setbacks—and then soared to new highs. That could further reassure anyone who has been told: “Don’t worry folks, this is just temporary.”
So what is different this time? In a word, debt. Since the bottom of the 1982 bear market, U.S. national debt has grown from $1.2 trillion to just under $20 trillion today (all figures in U.S. dollars). During the same period, U.S. gross domestic product (GDP) has grown from $3.3 trillion to $18.9 trillion.
In other words, it took $18.8 trillion of new national debt to create $15.6 trillion of GDP, a ratio of $1.20 of debt to create $1 of GDP.
New debt creation rate rising
To put that into perspective, all U.S. debt, which includes government, corporate, and consumer debt stood at $5.9 trillion at the end of 1982. Today it stands at $67 trillion, an increase of $61.1 trillion.
That translates into $3.90 of new debt to purchase $1 of GDP. It took the U.S. 206 years for everyone to accumulate $5.9 trillion of debt and a mere 35 years to add another $61.1 trillion. No wonder they call debt ‘easy money’.
It is expected that by 2021, according to www.usdebtclock.org, U.S. national debt will reach $22.5 trillion and all debt will rise to $75.7 trillion. It took $3.90 of new debt to purchase $1 of GDP for the period 1982 to 2017.
Since the Great Recession, all U.S. debt has increased $12.7 trillion and national debt has grown $7.7 trillion. GDP has grown $4.5 trillion. It has taken $2.82 to purchase $1 of GDP, or $1.70 of new national government debt to purchase $1 of GDP.
What all this suggests is that without more debt participation from corporations and consumers, the odds of the U.S. economy achieving three per cent growth as set out by President Donald Trump are low to nil. If debt accumulation had been maintained at $3.90 to buy $1 of GDP, then it would most likely have added at least another full point to GDP growth.
No wonder GDP growth has been sluggish. Debt is not growing fast enough. Has the consumer tapped out? Bank credit growth is sluggish. They are already in the process of tightening credit.
Since the Great Recession, the stock markets have been rising based on two things: bubble finance from the Federal Reserve—a wave of debt, record low interest rates and quantitative easing (QE)—and financial engineering from corporate America through leveraged financial deals, stock buybacks and mergers-and-acquisitions deals.
While this has been a boon to Wall Street and the top 20 per cent of the population, the rest of the population has seen little or no wage growth, a wave of part-time jobs and, although consumer debt growth has been sluggish, the burden of debt has increased.
Consumer debt is under stress
On the consumer side, there are potential signs of trouble in the mortgage market once again as interest rates are pressured higher and many mortgages come due over the next year. In addition, the delinquency rates on automobile and student loans are rising.
Since 2009, student loans have soared, rising to $1.4 trillion from $771 billion. Automobile loans have grown from $719 billion at the end of 2009 to more than $1.1 trillion today.
It is interesting to note that the used car index has fallen 6.5 per cent in the past year and a tide of cars is coming off lease agreements in 2017. Car companies have overproduced just as demand is slipping and many cars are coming back on the market.
The Trump rally continues. The rally is driven by the thought that there will be huge tax cuts, massive deregulation, fiscal stimulus with infrastructure, a wall, and the buildup of a ‘winning’ military starting with a $54 billion increase in defense spending.
All of this is supposed to ‘jack’ corporate profits. In terms of deregulation, one of the prime targets is the Dodd-Frank Act, designed to reform Wall Street and protect consumers. In Dodd-Frank stress tests in 2016, just two out of 33 banks failed. However, many were noted to have significant shortfalls. Loosening the regulations could result in a return to pre-2007 conditions that led to the financial crash of 2008. Under the severely adverse scenario, aggregate losses are projected to be $526 billion.
Majority of government expenses cannot be cut
Some of the proposed changes would be paid for by eliminating departments (such as the Environmental Protection Agency) and cutting back on everything else. The problem is, everything that can actually be cut back does not add up to very much.
Medicare and Medicaid, Social Security, defence, income security programs, interest on debt, and pensions cannot really be cut back. These constitute almost 89 per cent of the entire U.S. budget. That leaves a mere $448 billion from which to cut $54 billion and move it into defence spending, or an implied 12 per cent cut.
Congressmen and senators are already lining up to throw a wrench into that size of cut. Given the razor-thin majorities in both Congress and the Senate, it wouldn’t take many politicians switching sides to defeat massive cuts to programs.
In addition, the current spending doesn’t take into account the impact of an infrastructure program estimated at $1 trillion over 10 years, on top of the higher defence spending. Further tax cuts, as proven in the past, particularly under George W. Bush, largely benefit the well-off (Warren Buffett indicated Berkshire Hathaway might benefit to the tune of $27 billion), do little for the broader economy, and add to the debt.
Deregulation might be good, but the benefits largely accrue to corporations and banks. They don’t necessarily add any jobs to the broader economy.
The president reiterated his agenda in his speech to a joint session of Congress on Feb. 28, 2017. The Trump rally is predicated on promises that may never happen or prove very difficult to fulfil. That in turn sets up the markets for a major disappointment when reality sets in. The Trump rally is a classic case of a market buying the rumour and selling the news. Buyers should beware.
David Chapman is not a registered financial advisor, nor an exempt market dealer (EMD). He does not and cannot give individualized market advice. The information is only intended for informational and educational purposes. It should not be considered a solicitation of an offer or sale of any security. The reader assumes all risk when trading in securities and David Chapman advises consulting a licensed professional financial advisor before proceeding with any trade or idea presented in his newsletter. David Chapman may take a position and sell a position in any security mentioned in his newsletter. He shares his ideas and opinions for informational and educational purposes only and expects the reader to perform due diligence before considering taking a position in any security. That includes consulting with your own licensed professional financial advisor.
This is an edited version of an article that was originally published for subscribers in the March 24, 2017, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.
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