Prospects for corporate and household tax reform, along with the Trump administration’s official promise to focus on deregulation, have fueled speculation about whether Keynesian “animal spirits” could lift U.S. economic growth from the 1.5%-2% range in 2016 to as much as 2.5%-3.0% in 2017. Business and consumer confidence measures have surged, and if maintained, that argues for an acceleration in growth as businesses and households start to consume and invest more today.
Still, we are somewhat cautious about building into our forecast too much optimism: Our 2%-2.5% growth forecast for 2017 is unchanged since the election. Animal spirits (emotional responses that inform consumer confidence and behavior) are prone to shifts that are difficult to predict. While businesses and consumers now appear focused on President-elect Trump’s promises to reform the tax code and deregulate, we are cognizant that they could shift to the more controversial aspects of his tax reform agenda (e.g., the “destination tax”) and rising tensions between the U.S. and China. Moreover, underlying indicators of uncertainty have also increased post-election, which could put a damper on growth.
Animal spirits: what the surveys say
To measure economic optimism and uncertainty, we look at various business and consumer surveys that we’ve found to be useful leading indicators of inflection points in business cycles. Among the four surveys that have released post-election data, all show a material rise in sentiment, with expected easing of the regulatory and tax burden cited as a specific contributor to the optimism:
- Preliminary results show the December University of Michigan Consumer Sentiment Index surged 4 percentage points (ppts) from the prior month, close to a cycle high and reportedly “largely due to consumers’ initial reactions to Trump’s surprise victory.” Surveyors went on to say that “more consumers spontaneously mentioned the expected positive impact of new economic policies than ever before recorded in the long history of the surveys.
- The Duke CFO Optimism Index was also up, rising 6 ppts as surveyors indicated that “CFOs are much more optimistic about the U.S. economy following the election of Donald Trump, particularly with respect to regulatory and tax reform.”
- The Business Roundtable CEO Economic Outlook Index advanced 4.6 ppts as “America’s business leaders are encouraged by President-elect Trump’s pledge to boost economic growth.”
- Finally, the NFIB Small Business Optimism Index rose 3.5 ppts to its highest level in over a year. According to NFIB, the November index was basically unchanged from October up to the day of the election and then rose dramatically after the election results were known.
If the upswing in business and consumer confidence surveys persists, it would indicate a likely acceleration in growth – a welcome prospect after the sluggish pace of activity in 2016.
Other measures point to greater uncertainty
Not all measures of sentiment are pointing to a post-election rise in animal spirits, however. For instance, the Economic Policy Uncertainty Index by researchers Scott Baker, Nick Bloom and Steven Davis has also increased (see chart). This index uses disagreements among forecasters, the volume of news articles related to issues of economic policy, and tax code expiration data as proxies for uncertainty. And unlike the sentiment surveys, it is negatively correlated with growth activity. The researchers theorize that as the underlying factors rise, businesses and consumers become less certain and more pessimistic about the economic outlook and change their behaviors accordingly.
Mixed signals for investors
Taken together, these animal spirits indicators are sending somewhat conflicting signals about the future of U.S. growth. On the one hand, survey-based indicators have clearly surged. But on the other, less subjective measures of uncertainty based on forecast dispersion and economic news coverage have increased.
In our view, it’s too early to say with conviction how post-election animal spirits will evolve. However, based on equity and bond market moves since the election, we wonder if market participants – like business and consumer survey respondents – may be too focused on Trump’s pro-growth policies and not focused enough on the more controversial aspects of his agenda.