Increasing optimism among US corporate management teams, signaling higher capital spending to come
Economic data released in the first week of February shed a positive light on the US economy, and with the fourth quarter earnings season in full swing, management commentaries are also indicating renewed optimism about the prospects for US economic growth in 2017.
Amid uncertainties about the new administration’s policies, corporations are focused on the outcome of lighter regulation, corporate tax reform and overall, an expectation for a more business friendly environment under a new regime.
While overall fixed investment remains soft, business confidence is improving. Anecdotes from the earnings conference calls point to a higher level of capital expenditures if corporations get clarity on tax reform, and the commodity sectors have already budgeted increased spending for 2017. Of course, the devil is in the details. The Republicans are not united on reform proposals and the administration’s plans are still vague, causing markets to discount them somewhat. The market is much more focused on regulatory reform and the Trump reflation story.
President Trump signed executive orders aimed at reducing financial regulations
The pen is proving to be mightier than the sword. The financial sector reacted favorably on 3 February after President Trump signed two orders aimed at reducing restrictions put in place after the financial crisis. The President has ordered a review of the Dodd-Frank Act, signaling that the rules, in their current form, are overly restrictive on bank lending and have forced banks to hoard more capital rather than lending to businesses. The fiduciary rules, which are scheduled to go into effect in April, will also be reviewed.
With over 50% of the Standard & Poor’s 500 (S&P 500) having reported, fourth quarter 2016 results are showing roughly 4% revenue growth and 6% earnings growth. Management teams are optimistic that a pro-business agenda under the current administration will bode well for corporations. However, there is a growing divergence in earnings revisions, with domestic companies offering more upside revisions, while the trends for global companies have deteriorated. The outlook for cyclicals and financials is bullish, and we are seeing increased optimism from companies set to potentially benefit from lighter regulation and corporate tax reform (see Exhibit 1 below).
Elimination of interest rate deductibility and tax relief on repatriation of cash currently held overseas could have a significant impact on credit markets, while the impact from border taxes will be mixed in the short run. A border tax will hit sectors relying on imports, such as retail, apparel, and parts of manufacturing relying on imported raw materials or semi-finished goods. The longer-term impact of a border adjustment tax, however, is uncertain and will depend on the response from other governments.
Credit fundamentals have weakened over the past few years, but expectations for better earnings should mitigate the deterioration. Financials’ credit trends are set to improve and non-financials are seeing signs of stabilization. Additionally, the stress in commodities is easing.
Exhibit 1: The NFIB Small Business Optimism Index between 1995 and 2016. We are seeing increased optimism from companies set to potentially benefit from President Trump’s policies.
Source: Bloomberg, as of 06/02/17
As expected, the Fed held rates steady at the meeting on 01/02/17
Despite the pickup in economic momentum this year, the Federal Reserve held rates steady, as expected on 01/02/17, the first meeting of the Federal Open Market Committee in 2017. This was understandable given the uncertainty and lack of clarity over the planned fiscal stimulus under the new administration.
Among the economic data released in the first week of February, the jobs reports showed a continuing tightening of the labor market and reflected generally healthy conditions. Job creation was solid, labor costs did not appear to be accelerating and participation edged higher. January’s 227,000 increase in payrolls exceeded the 180,000 consensus estimates and represented a solid improvement from the fourth quarter average of 148,000. It was the strongest gain since September 2016. The surge in January reflected broad-based private sector strength. During the fourth quarter of 2016, productivity increased by 1.3%, marking an improvement over the previous two quarters, but still remaining weak. Wage growth was slightly disappointing, and unemployment ticked higher to 4.8% on an increase in labor force participation. In addition to the improving employment picture, the US consumer could also benefit from individual tax reform, but if border tax adjustment passes, higher prices on imported goods will ultimately dampen these positives.
The Trump phenomenon could have big-picture implications for US corporations. It has also become apparent over the past few months that we have shifted from a deflationary theme in 2016 to one of reflation, with inflation expectations moving higher. Corporate management teams are signaling increased optimism fueled by expectations for reduced regulation and more business-friendly policies under the new administration. In addition to business confidence improving, the labor market continues to tighten, which should be beneficial for the US consumer.