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posted on 16 September 2017

Investors: Signs Are Everywhere

Written by , Clarity Financial

You don’t have to look very hard to see a rising number of signs that suggest the “Trump Trade" has come to its inevitable conclusion.

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Following the election, this past November the financial markets rallied sharply on the hopes of major policy reforms and legislative agenda coming out of Washington.

Eleven months later, the markets are still waiting as the Administration has remained primarily embroiled in Washington politics with a divisive, Republican controlled, House and Senate. While there are still “hopes" the Administration will pass through tax reform, the failure to “rally the troops" to repeal the Affordable Care Act leaves permanent tax cuts an unlikely outcome. That hopeful outcome was further exacerbated with the deal cut between President Trump and leading Democrats to lift the debt ceiling and fund the Government through December. That “deal" has effectively nullified any leverage the Republicans had to strong-arm a deal on taxes later this year.

The markets are figuring it out as well.

If you want to know where the economy is headed over the next few months, you don’t have to look much further than interest rates. Since interest rates are ultimately driven by the demand for credit, and that demand is driven by economic growth, their historical correlation is no surprise.

But like I said, if you want to know where GDP is going to be in the months ahead, keep a close watch on rates. I suspect, before year-end, we will see rates below 2.0%.

As a reminder, this is why we have remained rampant bond bulls since 2013 despite the continuing calls for the end of the “bond bull market." The 3-D’s (Demographics, Deflation & Debt) ensure that rates will remain low, and go lower, in the years to come. Think Japan.

But I digress.

Like rates, inflation is also closely tied to the direction and trend of economic strength. While the Fed continues to hope for a return of inflationary pressures, the real strength of the underlying economy suggests something quite different.

Again, following the election inflationary pressures surged on “hopes" of the “second coming" of the economy. Those hopes are now fading, and economic growth along with it.

But there is no better sign to watch than that of the US Dollar. The dollar is the representation of the world’s belief in the strength of the U.S. economy. A stronger economy attracts capital and investment which drives the dollar higher and further boosts economic growth. The opposite also applies.

The recent decline in the dollar, which is likely to continue, suggests that economic growth will weaken in the months ahead.

While it is not hard to see, or understand, the correlation between these individual “signs" and the direction of the economy, we can see it even more clearly by building a simple composite. The composite below is the dollar, interest rates, and inflation as compared to nominal GDP.

Currently, the composite index has turned down rather sharply and we should expect economic growth, to track along with it in the coming months.

All of these signs are worth watching closely. A weaker economy leads to weaker earnings growth and estimates are already under rather severe downward pressure. Given the overvaluation of the market, and hopes of legislative agenda beginning to fade, there is a significant risk to outlooks for the market in the months ahead.

The last few times the dollar, rates, and inflation fell following a previous advance, the outcome for investors was not all that great.

However, as I said above, we are indeed moving forward, but with caution.

“Here’s your sign." - Bill Engvall

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