START – A Guide to the U.S. Economy
By Logan Curti, Lynn A. Ferraina and Jasen Gilbert, CFP®
Based on the January 29 presentation by Garrett D’Alessandro, CEO of City National Rochdale
In the midst of a major transition within our government – the inauguration of President Trump and initiation of a Republican-controlled Congress – many people have expressed uncertainty about the economic conditions that face our nation.
START is an acronym that serves as a useful tool for predicting U.S. economic performance as it relates to our government. Stimulus, Taxes, Attitude, Regulation and Trade are directly impacted by congressional legislation and executive action.
By understanding the interplay between public policy and economic factors, we are able to make informed predictions about the outcomes for investors. We have compiled this article to guide you through the economic landscape over the upcoming years.
Stimulus
Perhaps the most effective way to stimulate the U.S. economy is through increased spending by the government, consumers and corporations.
In terms of public-sector spending, defense and infrastructure spending serve as the foundation for stimulus efforts. As part of our nation’s $18 trillion annual GDP in 2016, about $450 billion was spent on infrastructure projects, whereas more than $600 billion was spent on national defense1.
Infrastructure spending creates well-paying middle-class jobs, and our country has a pressing need for modernization. However, infrastructure projects have a gradual effect on our economy; building a new bridge or upgrading a water system can take several years, and we do not feel the full impact of the stimulus until the project is completed. On the other hand, increased defense spending serves as a means for immediately stimulating the U.S. economy.
The U.S. economy is currently entering its 92nd consecutive month of economic expansion – the longest streak of growth since the 1990s. During the past eight years of expansion, we have experienced a modest but steady rate of GDP growth (between 2-2.25% in annually)2.
Based on the campaign platform of President Trump and the GOP, the U.S. may increase defense and infrastructure spending. This suggests that there may be a low likelihood of recession during the next 18 months.
While the government plays a less direct role in determining consumer spending, about 65-75% of our economy is driven by consumers3 – buying groceries, automobiles, clothing, housing, etc. Healthy consumer fundamentals will help to boost economic growth. Given that the U.S. has a low unemployment rate (4.8%)4 and the lowest level of consumer debt since the early 1980s5, consumer spending may also be on the rise during 2017.
Another critical component of our economy is corporate spending. As a result of business-friendly reforms on taxes and regulations (discussed in the following section), corporations may have more buying power under President Trump.
Taxes
When Congress and the President discuss tax reform, there are two distinct areas of conversation: the tax rates and the tax code. The two parties have different priorities in regards to tax reform, with Trump emphasizing tax cuts more heavily and Congress more focused on simplifying the tax code.
Given that our tax code is more than 10,000 pages long and is full of pork for corporate interests, reform will be a slow, arduous process. Regardless of Congress’ intentions, we likely won’t see any materials changes to the tax code during the next year, or even during the tenure of President Trump.
However, City National Rochdale feels that corporations, wealthy individuals and upper-middle class people may receive substantial tax relief in the form of lower marginal tax rates. Corporations will likely experience the greatest amount of tax reduction. The top federal marginal corporate tax rate is currently 35%; the GOP is proposing a top marginal rate of 20%, and Trump is supporting a 15% top marginal rate6.
For individuals, President Trump is proposing a top marginal tax rate of 33%, while congressional Republicans typically favor a top rate of 35% (the current rate is 39.6%)7. In regards to the capital gains tax and the estate tax, both Trump and the Republicans have advocated for the absolute repeal of these measures. Upper- and upper-middle class individuals will find these tax cuts to be advantageous to their bottom line.
With significantly lower tax rates, the national deficit could rise substantially over the next several years. However, if these tax breaks serve as a catalyst for companies and individuals to start spending more, the economy could boom – which could result in a long-term reduction in the deficit.
Attitude
The attitudes of consumers also play a vital role in shaping the economy. When consumers feel confident about their financial situation, they are inclined to spend more and invest more.
Today, consumer attitudes are positive as a result of various factors. First, the U.S. is the wealthiest country in the world, and we have never held as much wealth as we do today. American households have an estimated $91 trillion of wealth, up from the previous high of $81 trillion in 20078.
Secondly, wages and median household income are on the rise for the first time since 20079. Higher wages for lower- and middle-class consumers help to stimulate the economy. As businesses receive lower tax rates and have more money to spend, we could see this trend continue.
Thirdly, as mentioned earlier, low levels of unemployment and consumer debt also play an important role in shaping positive attitudes about economic performance.
Lastly, when consumers are anticipating lower tax rates, they will be apt to put their tax savings to work – either by spending or investing the surplus. Increased spending and investment both serve to stimulate the economy.
On the other hand, uncertainty about complex situations can reduce consumer confidence. Because of the uncertainty involved with a major governmental transition – particularly given Trump’s reputation of being unpredictable – some emotion-based investors will react too aggressively. This attitude of uncertainty may bring more volatility to the market, but may not affect the long-term trend of steady economic growth.
When taken as a whole, the current public opinion regarding the U.S. economy could spur increased spending from consumers. The increase in our collective purchasing power may stimulate economic growth in 2017.
Regulation
Regulations on the private sector are a balancing act. While too few regulations can lead to volatility, overbearing regulations can hinder investment in our economy. Congressional Republicans want to loosen regulations, whereas President Trump has voiced support for eliminating most regulations. Despite this fundamental difference in opinion, the end goal is consistent: reducing regulations on business owners and corporations.
In particular, banking regulations have created a bottleneck in our nation’s financial system since the recession of 2008. In fact, there is more than $3 trillion in corporate and personal assets that are “frozen” in money market funds under the current system10. By loosening regulations, consumers and companies alike may begin to spend and invest this frozen money.
Under the regulatory and tax environment that have existed since 2008, corporate earnings have increased by 4-5% annually11. The new administration’s proposals to deregulate private enterprise and reduce corporate taxes may have a drastically positive impact on corporate earnings.
Trade
On trade issues, President Trump breaks from the mainline Republicans in Congress. While most Republicans have supported free trade agreements and globalist policies, President Trump has been outspoken in supporting domestic manufacturing and economic protectionism.
Trump’s call for tariffs – or “border adjustment fees” – could lead to an increase in prices for consumers. Levying a 20% tax on all imports from Mexico and China may incentivize consumers to buy more American-made goods; however, the actual burden of the tariff falls on consumers, who would have to pay 20% more for some of the goods they need.
Also, other countries could retaliate if we begin to levy tariffs against their products – sparking a trade war. In the case of China, retaliation of tariffs could be dangerous for the U.S. economy. China owns a significant portion of our national debt and produces a substantial amount of our consumer goods. The risks associated with tariffs against China and Mexico far outweigh the potential benefits for U.S. manufacturing.
When considering trade, the 80/20 rule (otherwise known as the Pareto rule) can be instructive. While the 20% of Americans who are involved in manufacturing benefit from protectionist policies and a weak U.S. dollar, about 80% of our population benefits from free trade and a strong U.S. dollar. In short, free and fair trade policies that embrace globalization lead to a positive impact on our economy.
Conclusion
The first four factors of START – stimulus, taxes, attitude and regulation – are positive indicators for economic growth under the Trump administration. On the other hand, protectionist trade policies could be a wild card that lead to volatility in the market.
Overall, 2017 should be an interesting year for investors.
References
1) Congressional Budget Office 2016 Year-End Report
2) Word Bank Annual GDP Growth Rate by Country, 1961-2015
3) Bureau of Labor Statistics Consumer Spending Report, Year-End 2014
4) Bureau of Labor Statistics Jobs Report, Q4 2016
5) Federal Reserve Consumer Debt Report, Q3 2016
6-7) Congressional Budget Office & Tax Policy Institute, 2016
8) US Department of the Treasury: Financial Crisis Response Report, 2015
9) Bureau of Labor Statistics Jobs Report, Q4 2016
10) A Financial History of the United States: From the Enron-Era Scandals to the Great Recession (Markham, J.W.), 2015
11) U.S. Bureau of Economic Analysis: U.S. Corporate Profits, 1951-2016
