Left vs. Right Populists – Result: Greater Washington Dysfunction – Outcome: Reduced Consumer Confidence, Adding to Economic Concerns

Populism Helped Create Conditions for the Partial Government Shutdown, Adding to Economic Concerns
In 2016, we saw the populist vote on the right help to elect a Republican president. Two years later, the populist vote, this time on the left, shifted the House from Republican to Democratic control. These two elections created the heated mix that led to the partial government shutdown and to even greater dysfunction in Washington on many other issues.

Eventually, the populist-influenced trade war and partial US government shutdown could put a damper on U.S. economic momentum carried over from 2018. More specifically, Bloomberg consensus estimates for 2019’s first-quarter gross domestic product (GDP) growth recently declined sharply to 2.16% (see Figure 1). This would represent a significant drop from the 2.6% GDP growth forecasted for the last quarter of 2018.

Figure 1
Consensus Q1-2019 GDP Growth (Annualized)

Source: Bloomberg

Resulting Weakened Political Leadership Undermines Financial Market Confidence
Political confidence importantly underlies the usual factors that drive both the economy and financial markets. Lacking political confidence, markets can falter and the economy can suffer. The current populist-driven split within this country reduces the political will to resolve differences on domestic issues as well as the trade war with China. That absence of political will undermines investor and business confidence in the leadership in Washington. Nonetheless, we remain cautiously optimistic that at least one domestic issue, as well as the trade war, can be resolved early in the year. However, there remains some possibility that their resolution could turn out unfavorably from the perspective of both investors and business leaders. This could prove particularly troublesome if the dysfunction in Washington ultimately leads to a greater-than-projected economic slowdown.

Where Does the Economy Now Stand? Consumers Financially Strong
Both employment — a lagging, or coincident indicator — and wages remain strong (see Figures 2 and 3). Adding to first-quarter income will be increased tax refunds generated by last year’s over-withholding as a result of the new tax law. The US Government Accountability Office (GAO) estimates nearly three-quarters of taxpayers over-withheld during 2018. Besides incomes, their comfortable financial positions — particularly compared to corporations — should also encourage consumer spending (see Figure 4). However, the question now arises whether the increasing disputes in Washington will ultimately pull down consumer optimism and thereby short-circuit their important spending contribution to economic momentum.

Figure 2
US Nonfarm Payrolls M/M (‘000)

Source: The Wall Street Journal — The Daily Shot

Figure 3
Wage Growth Exceeded Economists’ Forecasts

Source: The Wall Street Journal — The Daily Shot

Figure 4
Business and Household Sector Credit-to-GDP Ratio

Source: Federal Reserve Board Financial Stability Report

Headline Issues and Stock Market Volatility May Undermine Consumer Confidence
The first cloud over consumer optimism showed up with the decline in the recent University of Michigan Consumer Sentiment Index (see Figure 5). The index dropped to its lowest level since Mr. Trump’s election. This downward shift likely reflects, among other factors, trade war headlines and December’s stock market decline. As a result, despite their comfortable financial situation, less buoyant consumers may save more as opposed to opening their wallets to spend. In addition, increased stock market volatility and its potential negative wealth effect may test upper-income spending. If this proves the case, sales of travel, entertainment, and restaurant services along with luxury goods might suffer.

Figure 5
University of Michigan Consumer Sentiment Index

Source: University of Michigan

Business Confidence — Also Influenced by Stock Market Volatility
Figure 6 shows results, over time, comparing CEO confidence to movements in the S&P 500 index. The figure shows recent equity market erosion and volatility-depressed CEO confidence. Perhaps the recent market rebound reversed some of their concerns. Nonetheless, the ongoing trade war and Washington gridlock probably leads to a more cautious CEO outlook when determining their plans for capital spending. Confirming this outlook, a recent Morgan Stanley research report showed capital expenditure plans slowing (see Figure 7).

Figure 6
CEO Confidence

Source: Thompson Reuters Data Screen/Macro Ops

Figure 7
The Trend in Capex Plans Has Moderated in Recent Months

Source: Morgan Stanley Research

Investment Conclusions
Settlements of the partial government shutdown and eventually the trade war should bring positive short-term financial market reactions. Longer-term, increasing investment uncertainty will likely reflect the maturing economic cycle and a possible slowing economy later this year. Recognizing these longer-term uncertainties, our investment strategy calls for an equal asset mix of equities, alternatives, and short-duration fixed income securities. Among equities, stocks of corporations that can maintain consistent earnings growth at attractive valuations should benefit from the possible shortage of economic growth. We have debated within ourselves whether to lengthen, modestly, fixed income asset duration. This consideration reflects the growing likelihood that the Federal Open Markets Committee (FOMC) ends its rate hikes in 2019 with the possible economic slowing later this year. Our internal debate will continue and we suspect modestly lengthening duration will eventually win out.