Dysfunction Junction

The exodus of CEO support following President Trump’s response to Charlottesville shook the foundations, but the stock market outlook has remained constructive. Every administration has its share of difficulties early on, many self-inflicted, before settling down. Since the election, stock market participants have been optimistic that the Trump agenda (infrastructure spending, tax reform, and reduced regulations) would boost growth in the economy and in earnings. Achieving the full agenda was never going to be easy, but that shouldn’t matter for investors. People generally believe that the White House has a lot more control of the economy than it really does.

Market enthusiasm picked up sharply following the November election. However, even with one-party control of the White House and both chambers of Congress, getting stuff done was not going to be easy. This is the Republican Party’s best chance for tax reform. First up, however, the Affordable Care Act would have to be repealed and replaced. There are a number of taxes in the ACA. Eliminating them would reduce the tax base and create a better starting point for tax reform. However, that would also mean leaving tens of millions of people without healthcare insurance. The Senate’s narrow failure to repeal the ACA reduced the scope of possible tax reform.

Still, there’s a reason we haven’t had major tax reform in the last 30 years. It’s hard. The administration’s goal was to substantially lower tax rates on individuals and corporations. To offset the loss of revenue, it would eliminate deductions – except for the deductions for home mortgages and charitable contributions. Deductions (also called “tax expenditures”) totaled $1.5 trillion in FY16. They are why the tax code is so complicated. However, to get a lot, you have to give up a lot. Nobody wants to give up their current deductions. Hence, significant tax reform is virtually impossible. We may still see lower tax rates in the months ahead, but on a much smaller scale than had been expected earlier.

During the presidential campaign, both major candidates called for increases in infrastructure spending. The question is how to pay for that. Hillary Clinton would have raised taxes or increased government borrowing (effectively spreading the cost over several years). Donald Trump would fund infrastructure spending through public-private partnerships (House Republicans were never going to go along with $1 trillion in additional public spending). Eight months in, we have now had two infrastructure proposals from the White House: privatization of air-traffic controllers and a streamlining of the permit process. Presumably, more is in the works, but there’s no push for funding the repair of roads and bridges, which was what both Clinton and Trump focused on during the campaign.

Much has been made of the improved sentiment this year. Consumer confidence, small business optimism, and homebuilder sentiment remain elevated. However, consumers don’t spend confidence and businesses don’t exist to sell stuff to other businesses (the consumer is always the final endpoint).

Consumer spending is driven mostly by income, but wealth and the ability to borrow are also factors. Following a soft start to the year, consumer spending growth rebounded in the second quarter, but the monthly data suggested a loss of momentum heading into the second half of the year. Retail sales results for July were a bit better than anticipated, and we saw some increase in estimates for May and June, but the underlying trend still appears to be lackluster-to-moderate (positive, not especially strong). Retail payrolls have been soft over the last five months, consistent with the spending data.