When Wall Street Goes Pagan
One hears a lot about “animal spirits” these days, as if blood sacrifice and Celtic fire rings had replaced game theory in the pagan temples of Wall Street. Even now, with the Trump Trade somewhat diminished in the wake of the administration’s first 100 days, financial and industrial elites are still flirting with their inner pantheists.
It is both a seductive and forbidding concept, the notion that feral instincts alone can drive a market rally or, on the flip-side of the conceit, trigger its collapse once the spell breaks. It was most appropriately made famous by John Maynard Keynes, the Gandalf of the dismal science, who described it as “a spontaneous urge to action” uninhibited by “quantitative benefits multiplied by quantitative probabilities.” This might also be interpreted as “running with the pack.”
Don’t get me wrong. I come to amplify the Wicca’s call, not to muzzle it. We at Anfield believe that the last five months’ worth of market gains will endure and that the Trump Trade is even more credible now that some of the froth has been skimmed from the top. Major indices continued to advance in April and corporate earnings, after recovering from five straight seasons of abysmal reports, are now on target to post gains of 12% or so. Global manufacturing surveys – including the Chicago PMI, which vaulted to a 27-month high last month – suggests the synchronized global growth story is a lasting one. Both the University of Michigan’s consumer confidence index and the Bloomberg National Economic Confidence Index are hovering at stratospheric levels. Home prices are surging and while the dollar has weakened from its post-election highs the trend is fueled more by the relatively strong inflationary outlook in Europe than any secular or structural choke points in the U.S. economy.
And while first-quarter growth managed a mere 0.07%, it turns out that output was impaired by a post-election decline in spending by professional advocacy groups, which always surges during each national campaign and hit a record high in November.
The political environment in Washington, though still divisive and shrill, appears to be stabilizing after a rocky executive transition. The Trump cabinet has found its feet and the president has demonstrated a capacity to work with, rather than against, power centers both at home and abroad. Last month the White House unveiled a tax reform plan that many Beltway and Wall Street elites did not expect until next year, and it is entirely possible that a deregulation initiative may debut before the summer recess. There is also Trump’s close collaboration with the Chinese leadership in response to North Korean provocations. (It may be an alliance of convenience but jaw-jaw is better than war-war, as Churchill said.)
In general, we believe that market orientations skew to the upside. That said, however, it is not defeatist to be mindful of other, less inspiring fundamentals, particularly those based on hard data as opposed to consumer surveys composed largely by gut feelings.
While we of course welcome strong earnings growth, we would point out – as Goldman Sachs did last month – that on a year-to-date basis the top 10 S&P 500 contributors accounted for 37% of the index’s total returns, a ratio that is more than double their market capitalization. Furthermore, as Jeffrey Snider of Alhambra Investment Partners points out, it would take an economic recovery far more rigorous than our near-seven-year wet squib to validate current valuations. Meanwhile, bank stocks, which were to be the prime beneficiaries of rising interest rates and deregulation, are now underperforming the market.
Goldman Sachs also issued a warning this week that share buybacks, a major source of earnings growth, have been diminishing significantly as executions have plunged by 20% on a year-to-date basis and authorizations for new ones have slowed to their slowest pace in five years. The report states that firms generally regret repurchasing shares at high multiples, noting that the median S&P 500 asset now trades at the 98th percentile of historical valuations.
Significantly for an economy that turns on consumption, the most recent household income, savings and spending reports render a cautious, if not retiring, consuming public. Manufacturing output continues to disappoint and pending homes sales are stagnant. The brick-and-mortar retail sector is collapsing at the expense of what were once well-salaried jobs at a time when the U.S. economy appears to have exhausted its capacity to innovate new, labor intensive industries.
Finally, if indeed first quarter growth was whittled by record-low lobbying receipts, we may ask ourselves which is worse: growth that is so fragile that it can be hollowed out by a downward spike in election spending or the fact that consumption by Beltway Bandits is large enough to drive relative national output.
I repeat: Anfield supports the Trump agenda and we are confident the administration will deliver within the confines our coarse political culture will allow. We are also aware that the secular revolution that is transforming the US economy predates the Obama administration, let alone the current one. That being the case we think it prudent to simultaneously propitiate the gods of both quantitative analysis and animal spirits.
And while we’re on the subject of spirits, particularly as we enter high spring here in our California idyll, I’ll have mine with a lime wedge.