America First Investing

Ever since American stocks started to sizzle in 2013, clients have bombarded financial advisors with questions about why they are diversified in international equities. Four years later, a new president with a nationalist agenda is engaged in an unprecedented frenzy to attempt to drive domestic economic expansion in what conventional wisdom holds is a 2% GDP growth world.

One believer that the U.S. economy can break out of secular stagnation decisively is Phil Orlando, chief equity strategist of Federated Investors. If even part of his scenario materializes, Orlando thinks the Standard & Poor’s 500 Index could reach 3,000 by 2020.

Central to his thesis is that a combination of lower corporate and personal taxes, repatriation of trillions in corporate cash, deregulation, higher defense and infrastructure spending and fully expensed depreciation can unleash a new burst of productivity growth. His prediction hinges on Congress passing “something remotely resembling” the broad agenda President Trump has outlined.

“What we are looking at is structural reform. Three percent GDP growth is doable,” Orlando says. “If we are wrong, we are wrong to the upside.”

Virtually all confidence and sentiment indicators have gone vertical since the November election. In February, the Philly Fed index stood at a 30-year high. “There is an 86% correlation between confidence and GDP growth,” Orlando notes.

Maybe so, but both the equity market and economic expansion are celebrating their eight-year anniversaries. If business activity picks up, couldn’t an increase in inflation and interest rates eventually impact growth and price-to-earnings multiples?

It doesn’t have to. Orlando postulates that the S&P 500’s earnings could reach $150 a share by 2020 and its P/E ratio could climb from 18 to 20. “It is not until Treasury yields get to 5% that multiples start to contract,” Orlando says, adding that history shows they typically expand on their way to that mark. To those who fear pro-growth policies mean higher budget deficits, he says a 1% GDP increase would translate into $300 billion more in federal tax receipts.

At first glance, Orlando’s call of a 3,000 S&P 500 in 2020 looks easier to reach than a sustainable 3% GDP growth rate. Some other equity strategists’ forecasts have a sunnier outlook for stocks by a country mile. Raymond James’s Jeffrey Saut, another smart observer who, like Orlando, has been spot on so far in this current bull market, has called for a 5,400 S&P by 2025.

GDP growth has only two components—population and productivity—and Orlando acknowledges the U.S. population is only rising at a 0.5% clip, the lowest in history, while demographics tilt toward aging workers and retirees. Productivity could pick up significantly, but getting to 2.5% seems a stretch.

Trump’s desire to drive job creation to 25 million over the next 10 years translates into a pedestrian 208,000 jobs a month and should be easily achievable. That’s about what the economy did under Obama’s second term, which delivered only 2.1% growth and was hardly a barn burner.

To sustain a 3% GDP rate, the nation needs many of the 23 million Americans aged 24 to 55 who aren’t looking for work to re-enter the labor force. But “we also need more immigrants,” Orlando argues. Eight of the 11 million undocumented workers are “gainfully employed” in industries where they are needed, like agriculture, hospitality, childcare, eldercare and construction.
For all President Trump’s tough talk on immigration, he has displayed a willingness to make 180 degree turns in midsentence. Ever the optimist, Orlando thinks a consolidated Congress could finally pass immigration reform.

Cruel as it is to say, chambermaids and nannies aren’t going to fuel productivity growth. New innovations like burger-flipping robots aren’t going to drive human employment either.

It’s another class of immigrants who might flip productivity figures. Just as U.S. manufacturers have 300,000 jobs they can’t fill, there are 500,000 high-paying technology jobs that remain open. Three-quarters of graduate students in America studying science, technology, engineering and mathematics are foreign-born.

Orlando suggests “stapling a green card to their diplomas,” which high-tech companies would love to do. The people who start the next Microsofts and Amazons may well be American college dropouts, but the people who build those organizations are likely to have advanced science degrees.

How realistic is all of this? Orlando concedes he doesn’t expect everything to happen. He also worries that Trump is making “the same mistake” as his predecessor, putting health care first and squandering a lot of political capital on an intractable, intensely emotional issue. Others fear that if Republicans squabble too long over replacing Obamacare, tax reform could be jeopardized.

Were the U.S. economy to enjoy a 3% run rate, it could lift many sectors and individuals that the new normal left behind. “Two percent growth has been both a blessing and a curse,” says Ben Mandel, global strategist at J.P. Morgan Asset Management. “The distribution of growth in this economic cycle has been highly uneven.”

Since mid-2016, the composition of global growth has been more uniform, with pleasant surprises coming from many places, even Europe. The surprises have been “all positive and evenly distributed,” Mandel notes. While he views the U.S. as a 2% growth economy, Europe is a 1% grower that is now expanding at 1.5% to 2%. That latter rate probably is temporary.

Trump’s agenda provides a test case for animal spirits. Mandel thinks that the U.S. will recover from several years of zombie productivity, but to sustain 3% growth it will require a radical increase in worker efficiency, signs of which haven’t surfaced. Still, J.P. Morgan continues to advocate overweighting American equities despite their high valuations.