Stocks marked time yesterday as politics once again trumped (no pun intended?) economic news. First there was the story of dirty politics surrounding Donald Trump Jr. Suffice to say, dirty politics isn’t a unique story, it probably won’t change the way we go about our lives, and time will tell how this story plays out. It is unlikely to move the economic needle, however, and almost certainly won’t have a major bearing on stock prices. The other political story is the continuing effort of Republicans in the Senate to get something done. Healthcare remains at the top of the list. It appears that Senators are ready to drop the demand for repealing tax cuts on high income wage earners in the hope that coinciding lower cuts in Medicaid entitlements may placate those concerned about the impact on elderly, frail and middle age workers. But with the bill changing almost daily and neither support nor input from the Democrats, it remains uncertain whether Leader McConnell can get the bill across the finish line. It now appears that the August recess will be delayed for two weeks in order to allow extra time for the Republicans to get something done. If not healthcare, they will try to finish a bill to raise the debt ceiling and some appropriation legislation passed before going home. At best it seems likely to be a tortured process. At worst, they will go home two weeks late with nothing accomplished. This is not exactly what was expected last November.
All this Washington turmoil appears to finally be translating into economic impact. The most recent survey of small businesses, for instance, shows a marked decline in confidence which is causing delays in new investment. While no one expects any increase in regulation (a good thing!), the hopes for economic stimulation and tax cuts are fading. That is not to say that nothing will be done; it’s still too early to reach that conclusion. But the lack of progress almost anywhere within the walls of Congress is disconcerting to a business population so hopeful for reform and lower taxes just a few months ago.
Last year, our economy failed to grow at 2% in part due to severe weakness in the energy sector. In 2017, the energy sector has rebounded some. While still far below 2015 levels of activity, the oil business is still growing faster than it did a year ago. So is housing. But after that, there are few rays of sunshine. Retail has been in a funk for months. Part of that is due to soft demand and part due to weak prices, particularly for gasoline and food commodities. While grain prices have rallied lately, oil prices are headed in the opposite direction and overall food deflation is still with us. Auto sales are also soft despite heavy use of incentives. Capital spending is OK but below prior forecasts. Corporations need years of visibility to properly plan capital projects. Today, one can barely see a few months ahead with any clarity. As a result, the chances are rising that U.S. economic growth will end up below 2% for the second year in a row.
The problems are many. Trump’s tweets are undermining party leadership. The White House has been slow appointing Assistant and Under Secretaries, and Democrats have worked hard to slow the approval process. The wheels of change, therefore, have ground to a near halt. Republicans can’t agree among themselves, and nowhere is that more apparent than in healthcare. Both the White House and Congress are so fixated on the concept of Obamacare “repeal” that improving healthcare has taken a back seat to coming up with any legislative package that can get 50 votes in the Senate. So far, Leader McConnell hasn’t come up with anything that comes close to getting a majority, but he still has a couple of weeks left. Republicans know that going home for August recess after accomplishing nothing would be almost disastrous. Therefore they are fixated on passing almost anything, good or bad. In the end, even a small package designed to fix the exchange issues, disguised as a “repeal and replacement” may be all we get. It’s disheartening at best, and perhaps politics at its worst. It’s rare that purely partisan politics makes good law, and one shouldn’t expect that this time will be different.
But all this aside, whatever Republicans accomplish or don’t accomplish in regards to healthcare shouldn’t move the overall economic needle a whole lot. The relaxation of regulation will help, but will be offset by Federal Reserve moves to raise short term interest rates and reducing the size of the Federal Reserve balance sheet, plus the impact uncertainty plays on investment spending. As noted above, it may already be affecting small businesses. There appears to be no obvious catalyst at the moment that will inspire greater economic growth. Around the edges, President Trump’s efforts to move away from trade agreements and limit immigration will be economic headwinds, not severe ones for the near future, but headwinds nevertheless.
For the past eight years, our economy has grown near 2% without any fiscal or government support, except for the monetary easing steps taken by the Fed. The emergence of Internet commerce, social networking, cloud computing and the Internet of Things (IoT) have been catalysts to growth, offsetting the lack of energy from Washington. Going forward, new waves set in motion by Google search, online retailing, social networking, autonomous driving, artificial intelligence, and virtual reality will drive us forward. If you look at the most successful stocks of the past eight years, many have touched one or more of these areas.
Thus, in our capitalistic entrepreneurial world populated by a government paralyzed by the chasms between liberals and conservatives, it has been the new corporate disruptors of our economy that have moved us forward. In their wake are yesterday’s has-beens and the poster children of the has-beens have been the large brick-and mortar retailers. They won’t disappear collectively, but will shrink to a fraction of their current size if they can’t adapt. So far, few have shown signs that they are equipped to survive, let alone flourish. The changes taking place will literally impact Main Street America. All our storefronts will change. Any place that sells products will have to adapt. This isn’t any different from when refrigerators were the death blow to ice men, or when the automobile replaced the horse and buggy. We were talking in our research committee this week about Digital Equipment and one of our younger analysts asked, “What’s a minicomputer?” The corporate graveyard is filled with those who fail to adapt. A lot of huge companies fail. Has anyone seen my Avon Lady?
As investors, change is a net positive. It’s what drives the economy forward. Technology is the driver for greater productivity. As consumers, what makes us more productive also drives us to move away from the old toward the new. As investors, we need to be aware of change and not hang on to legacy companies unable to adapt. All portfolios command attention. Companies hit speed bumps all the time. But there is a big difference between a speed bump and a sinkhole. There are some who say, for instance, that markets are overreacting to the shifts from conventional retail to online sellers. Maybe that is true in the short run. Amazon is not going to be the only place we shop. But the trend is irreversible, in my opinion. Conventional retailers that want to survive are going to have to change more dramatically than they have to date adapting to the new environment. ALL the mainframe computer companies except IBM are now dead. All the minicomputer companies, including the aforementioned Digital Equipment are now dead. Every big retailer who doesn’t heed the lesson is headed for the graveyard. If you don’t believe me, head for 8th and Market in downtown Philly and look up. Tell me if you see Gimbels, Strawbridge & Clothier, or Lit Brothers.
Today LeSean McCoy is 29. Brock Lesnar is 40. Bill Cosby turns 80.
James M. Meyer, CFA 610-260-2220
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