The reported confidence of American consumers, CEOs, and small business owners has soared to record levels over the past few months, and it is now at a stunning contrast to the reality presented by hard economic data that should make Americans quite sober. Call it the Reality Gap. According to the Wall Street Journal, the U.S. economy ended last year expanding at just a 2.1% annualized rate, in line with what has been the slowest pace since World War II, and it's expected to expand at only 1% in the first quarter.
Also, recently released consumer spending data indicates that consumption rose by only 0.1% in February, that latest data available, missing the Journal's target. That's bad news because consumer spending accounts for around two-thirds of the American economic output. Adjusted for inflation, consumer spending actually fell. Any diminution of Americans' consumer confidence will eventually affect stocks and bring reality back in line with sentiment.
The Reality Gap
How is the economy doing in America today? According to a March 30 story in the Wall Street Journal, "based on surveys alone, one would think it is booming. Consumer confidence soared to a 16-year high in a Conference Board poll released this week. Surveys of small-business owners reflected optimism since the election. Chief executives of the largest U.S. companies say they are more optimistic now than at any point in the past seven years, according to a Business Roundtable survey." To be sure, the Trump boost that came in late 2016 and into early 2017 following his election victory sparked initial optimism due to promises for tax reform, deregulation, trade protectionism, and a general pro-business, pro-growth environment.
But, as the famous economist John Maynard Keynes recognized nearly a century ago, "animal spirits" often get the best of markets as expectations become detached from the underlying reality of the economy. Our animal spirits, partly stoked by Trump's vision of the American business landscape, are increasingly appearing detached given many forecasts for anemic economic growth.
The New York Times tells a similar story in a March 29 article pointing out that the "Trump Bump" may indeed turn out to be a "Trump Slump." The Times points to the fact that Trump's first months in office have encountered policy roadblocks by Democrats but also from within his own Republican party. For example, many free marketers and libertarian-leaning members of the GOP are strongly opposed to Trump's frequent talk of protectionism and trade wars. The Times also points to an increasing number of people who are dropping out of the labor force, giving a false impression that unemployment in the U.S. has fallen to a healthy level.
Another roadblock to realizing the optimism of consumers and investors is technical and not political. The Journal reports that inflation measured by the consumer price index (CPI) has risen above 2% for the first time in years, above the Fed's target rate of inflation. This trend points to the Fed raising interest rates further throughout 2017 which can have the effect of slowing down growth and increasing the cost to borrow, hurting both businesses and consumers.
The Bottom Line
Confidence among U.S. investors, consumers and businesses is soaring, stoked by Trump's promises of a pro-business, pro-growth America. However, the Trump Bump may turn out to be a Trump Slump as there is a widening reality gap between sentiment and hard economic data. GDP growth has remained subdued, political posturing may hamper Trump's policy goals, and inflation is rising which will translate into higher interest rates and borrowing costs. If real economic activity remains where it is, market sentiment will ultimately need to re-adjust lower, and that could mean a bear market for stocks.