“Be fearful when others are greedy and greedy when others are fearful.”
—Warren Buffett
American consumers are more confident about the economy and their financial future than they have been in years.
As 2016 ended, the Conference Board said its consumer confidence index had reached its most optimistic level in the past 15 years and the University of Michigan Consumer Confidence index had jumped to its highest level since January 2004.
Economists closely watch the consumers’ mood because their spending accounts for about 70 percent of U.S. economic output. A positive reading means that people believe that their income levels will either remain the same or increase, and that have a favorable job outlook.
Since consumer confidence is a leading economic indicator, we should expect an increase in economic output over the near term.
Let me summarize some reasons for optimism:
• The U.S. economy grew at a 3.5 percent annual pace in the third quarter, the fastest in two years.
• Unemployment is at a nine-year low of 4.7 percent.
• All three major stock market indices —Dow Jones, S&P 500 and Nasdaq — are near all-time highs.
• Housing prices have exceeded their pre-recession peak.
• An upsurge in consumer confidence should encourage manufacturers to increase their inventories and invest in new projects and facilities. It also should induce homebuilders to increase their construction plans.
• President-elect Donald Trump’s appears likely to enact Keynesian fiscal stimulus policies such as cutting taxes significantly, expanding infrastructure spending appreciably and increasing military expenditures. Trump proposed cutting the tax rate on the highest earners from its current 39.6 percent to 33 percent. He also has said he wants to reduce the corporate income tax rate from 35 percent to 15 percent. Trump advocated increasing military spending by more than $500 billion to $1 trillion over the next 10 years. During the campaign, he indicated he would double Hillary Clinton’s $275 billion infrastructure plan over the next decade.
For investors, these developments seem to indicate that selecting an exchange-traded fund, such as XLY, that focuses on consumer discretionary stocks seems appropriate. Some of XLY’s holdings are McDonald’s, Amazon, Disney and Home Depot. XLI, the Industrial Select Investor, should also benefit. Three of its largest holdings are General Electric, 3M and Union Pacific Corp.
What can alter today’s optimism? Political unrest in Europe, the Middle East or Asia. A crashing oil market, a repeat of the American 2008 housing debacle and nation-state bankruptcies also could puncture positive sentiment.
Some portfolio managers have argued that a strong dollar will encourage more foreign investments in U.S. equity markets. Bulls on the U.S. dollar forecast that it will rise to parity against the Euro. The Euro on Monday was worth $1.0577.
If I were asked what is the biggest elephant in the room that could cause havoc, I would point to our nation’s burgeoning fiscal deficits.
Some economists worry that Trump’s policies will increase the U.S. annual fiscal deficit from the current 3.5 percent to more than 10 percent. To counter those policies’ inflationary implications, the Federal Reserve could raise interest rates significantly enough to become a drag on economic growth.
The combination of a larger deficit and higher interest rates could increase the interest cost on the deficit to more than $1 trillion over the next few years.
Originally published in the Sarasota Herald-Tribune
