Tag: Gary Cohn

What Do Trump Stock Market Tweets Mean for the Fed Chair Decision?

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Another stock market record, another @realDonaldTrump tweet basking in it.

Yesterday’s example: After the Dow Jones Industrial Average hit 23,000, the president tweeted “WOW!” with an animated stock chart. Trump is certainly soaking in the sunshine of an index that has gained 25% since election day.

But this enthusiasm is headed for a crossroads. Trump likes to tweet about stock market milestones. But Trump also has a decision to make about who will lead the Federal Reserve. A hawkish pick for the Fed chief could increase the chances of a stock market correction.

Who is in the lead for the next Chair of the Federal Reserve?

How we got to 23,000; or life before before Trump stock market tweets

For years, many have argued that the low interest rate policies of the Bernanke and Yellen Feds have led to high asset prices, including in stocks.

Real interest rates – measured by the 10-year Yield minus CPI – turned negative in September for the first time since February. Overall, real yields are still well below the historical norm. In the 1990s, real yields were between 3 and 5 percent. The post-crisis, historically low rate environment is one of the key components for our currently lofty market valuations.

But if Trump picks a hawk on monetary policy – someone like John Taylor or Kevin Warsh – the Fed’s baseline interest rate could be hiked faster and higher than it would under a Janet Yellen or Gary Cohn regime (Though real interest rates have actually fallen as the Fed has increased interest rates over the past two years. See: The Janet Yellen Paradox: When Raising Rates Doesn’t Equal Tighter Financial Conditions).

Could we have a hawkish Fed and continued market record highs?

History shows that markets have performed well after a rate hike cycle. According to a Charles Schwab analysis,

As shown in the chart below, the S&P 500 Index returned an average of 9.0% and 5.5% before and after, respectively, the start of a Fed rate hike campaign. In all 11 of these instances, the S&P 500 Index generated positive returns for the six months before a rate hike. Additionally, market volatility rose around the time of each initial rate increase. In spite of this volatility, the S&P 500 Index generally resumed its upward climb after the rate hikes, generating positive returns in 8 of 11 instances.

Stock prices grew slower after a rate hike, but market more often than not continued to trend upward. But let’s take this bull case with a cautiously optimistic bent. First, 11 is an incredibly small sample size, so we need to understand what happens when rates rise. Second, we have to consider what could derail the bull market.

Stock Market Correction Ingredients

First, higher interest rates mean higher discount rates.

  • Higher interest rates put downward pressure on price. All future expected earnings are discounted by the prevailing interest rate (plus a risk premium), so as rates rise, price tends to fall. In textbook finance, this is as true for bonds as it is for the broader market.

Second, higher rates could hurt earnings growth.

  • To support the current stock market levels, earnings would have to grow even faster to offset that increase in interest rates. The question is whether or not the market can support faster earnings growth.
  • Higher interest rates impact earnings in two ways. It increases the cost of capital for companies, so borrowing in the capital markets becomes more expensive. Higher rates also decrease the incentive to invest in new projects, because the return from sitting on cash is higher.

A standard market valuation is the Price-to-Earnings ratio. Higher expected earnings growth tends to lead to higher prices. Analysts are predicting double-digit earnings growth throughout 2018, according to a recent analysis by Factset. These expectations have led to the lofty market valuations – the S&P 500 Forward 12-month Price-to-Earnings ratio hit 18x earnings for the first time in 15 years.

If earnings growth falters on the back of higher rates, however, that could cause market valuations – and market prices – to tumble.

Which will win out, Twitter or Monetary Policy?

Since Trump likes Twitter, and likes to talk about how his administration’s policies are increasing stock market levels, would he really want to risk that by picking a hawk to lead the Fed?

The Fed is said to be the one who takes away the punchbowl after economic growth leads to inflation. So who does Trump choose? It is difficult to imagine that Trump would take away his own Twitter punchbowl with a hawkish choice to head the central bank.

Trump may say he loves John Taylor, but this could simply be a baseless statement to appease Republicans who distrusts the current Fed leadership. Trump is a “low-interest rate” guy who likes lofty valuations. The choice for the next chair of the Fed will probably reflect this.

Weekly Wrap: Fed Chair Musical Chairs, Jeff Sessions Wrong About Dreamers and Jobs, and Taxing 401(k)s

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This was first published on Facebook. To get the Weekly Wrap hot off the press, please like us on Facebook.

Welcome to the 6th edition of the Weekly Wrap, where we won’t step down for “personal reasons” anytime soon.

Fed Chair Musical Chairs

And no, this isn’t about saxophonists Alan Greenspan or Ben Bernanke (below).

Stan Fischer, Central Banker Extraordinaire, Steps Down

Stanley Fischer handed in his resignation this week citing “personal reasons.” He will step down from the Fed’s #2 post in October. This is a big deal. First, because Fischer is considered the top authority in the world on central banking.

  • Peter Coy in Bloomberg Businessweek: “Fischer is royalty in central banking circles. He was born in Northern Rhodesia, now Zambia. As a professor of economics at Massachusetts Institute of Technology, he taught former Federal Reserve Chairman Ben Bernanke and current European Central Bank President Mario Draghi, as well as Larry Summers, a former Treasury Secretary, and Gregory Mankiw, who headed President George W. Bush’s Council of Economic Advisers. Among others. Fischer also ran the Bank of Israel from 2005 to 2013, earning an A from Global Finance magazine. (Bernanke got a B.)”

Second, what next?

  • JPMorgan Chief U.S. Economist Michael Feroli: “It adds a further element of uncertainty to policy and who will be running policy early next year. It adds to the cloudiness of the outlook for monetary policy.” (Bloomberg)

The Apprentice: Fed Chair Edition

Bettors on the online politics betting site PredictIt are now giving Kevin Warsh a 29% chance to have the top job in February. Janet Yellen is second at 27%.

Gary Cohn went from 30%+ last week to 13%, allegedly because of his comments to the FT about Trump’s response to Charlottesville. 

Warsh is a former Fed official, and has been critical of the Fed’s dovish policy in recent years.

  • In January, Warsh colorfully wrote in the WSJ: “In recent years, the rationale for the Fed’s choice to loosen or tighten policy has been as nebulous as Justice Potter Stewart’s famed definition of pornography: You know it when you see it.”
  • Warsh also criticized the Fed’s stance of “data dependence,” arguing it should instead be “trend dependent.”

This type of critique and an implicit commitment to increasing rates (labor market has been trending positively for years!) will be a slam dunk to congressional Republicans.

But what about the White House?

Don’t Count Out Yellen

As Nick Timiaros and Kate Davidson of the WSJ wrote in June, “The Republican president told Ms. Yellen he considered her, like himself, a “low-interest-rate” person, those familiar with the exchange said. During a conversation that lasted about 15 minutes, they discussed how economic policy might help the millions of U.S. citizens who felt left behind during the postcrisis recovery.”

Takeaway: Low interest rates can be a president’s best friend, especially when you want to become “the greatest jobs president that God ever created.” But remember, this has to be cleared by Congress – will the White House bend toward the prevailing sentiment in the Republican-controlled Hill and put up a more hawkish nominee?

DACA and the Economy: No, Dreamers won’t take your job

The White House’s decision to end the DACA program in six months is a political missile launch. But while the future of the program gets debated, it has huge economic impacts.

Noted economist Jeff Sessions: “[DACA] has denied jobs to hundreds of thousands of Americans by allowing those same illegal aliens to take those jobs.”

This is just plain incorrect. Economists have been fighting for decades to rid the public of the scourge of the lump of labor fallacy.

  • The lump of labor fallacy is the idea that there are a fixed number of jobs in an economy. The theory argues that if an immigrant takes a job, a native American has thus been denied a job.

The idea of a zero-sum job market has been proven incorrect. Repeatedly.

Some noted economists came out in full force at the statement:

  • Bloomberg View’s Noah Smith wrote an impassioned takedown of the idea: “It’s obvious that the number of jobs in the world isn’t fixed. Imagine if the United States deported every single American except for Jeff Sessions. Would Sessions then have his pick of any job? No, he’d be in the forest trying to eat berries to survive.”
  • Moody’s Chief Economist Mark Zandi wrote to Politico: “The dreamers are generally well educated and thus likely in jobs for which demand is strong and labor shortages are increasingly a problem. And African American and Latino unemployment rates are close to record lows. If we kick dreamers out of the country, then there will only be more unfilled positions. Repealing DACA is particularly wrong-headed economic policy.”

A quick snapshot of the labor market also quickly takes the idea out to pasture.

 

June JOLTS data: There is no shortage of jobs available.
There are more job openings now than at any point since 2000. And workers continue to quit at increasing rates – an indication that those people think they can find better opportunities than what they currently have.

Take solace, or be further depressed? Using the lump of labor fallacy as a political WMD isn’t exclusive to the United States.

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What’s next? Trump seemed to walk back on the idea later in the week — First, tweeting “Congress now has 6 months to legalize DACA (something the Obama Administration was unable to do). If they can’t, I will revisit this issue!”

Takeaway: According to economists, DACA is a place where “America First” nationalism and the desire to become the “best jobs creating president ever” are incongruent.

White House: Pay for tax cuts by taxing 401(k) contributions. Maybe.

Business Insider’s Josh Barro, not a fan of the politics of this possibility:

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I’ll bite. Time for a round of “State Your Unpopular Opinion”: This is actually a good policy.

You might be yelling into your computer screen, “But if you tax something, then people do less of it!

That would indeed be bad – Americans clearly save far too little for retirement. But…

You could actually save more for retirement by taxing 401(k) contributions upfront

Taxing 401(k) contributions upfront would be the equivalent of treating all 401(k)s as Roth 401(k)s. Those work just like Roth IRAs: you get taxed when you contribute, but get to withdraw tax-free.

A simple example: You are going to retire next year, so you have one year of 401(k) contributions before withdrawing. You want to make the max contribution of $18,000, have a current 20% tax rate, and will earn a 6% return.

Here’s the catch: If you contribute the maximum allowable amount to a regular 401(k), you must invest your tax savings to close the gap between it and the Roth 401(k). But if you contribute well below the max – say, $5,000 a year – it doesn’t matter (assuming your tax rate is the same now and in retirement).

If you do contribute the max $18,000 to a 401(k)…

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Assuming your tax rate stays at 20% in retirement, the Roth is better by $173.

If your tax rate increases to 25% at retirement, suddenly the Roth is better by $1,116. If you’re making $18,000 annual contributions to your 401(k), moving to a higher tax bracket is a distinct possibility.

This is just over a period of one year. Compound this scenario out over 30 years, and you would have hundreds of thousands of dollars more in your account at retirement. BUT NOTE: If your tax rate were to fall in the future, the plain ol’ 401(k) could be worth more.

Takeaway: Taxing 401(k) upfront sounds bad, but it’s really not that big of a deal for you. In fact, it can be great for you. For the government, however, the math works in the opposite direction. The Treasury gets more money upfront in exchange for less tax revenue in the future. It’s just an accounting trick to make short-term deficits looks better. But it could increase deficits over the long run if personal income tax rates go up.

Other Links and Notes

Tyler Cowen, writing Tyler Cowen types of things: “But I wish to suggest that price gouging, in spite of its obnoxious-sounding name, is usually the best of a set of bad alternatives. If you are inveighing against high prices after a storm, basically you are lining up with the interests of American big business, at the possible expense of storm victims.” (Price Gouging Can Be a Type of Hurricane Aid; Tyler Cowen, Bloomberg View)

Inequality in a very human form — a janitor in the 1970s Rochester vs. a janitor in the 2010s Cupertino: “In the 35 years between their jobs as janitors, corporations across America have flocked to a new management theory: Focus on core competence and outsource the rest. The approach has made companies more nimble and more productive, and delivered huge profits for shareholders. It has also fueled inequality and helps explain why many working-class Americans are struggling even in an ostensibly healthy economy.” (To Understand Rising Inequality, Consider The Janitors at Two Top Companies Then and Now; Neil Irwin, NYT)

Hurricane Harvey and San Francisco — a great primer on the economics of land use policy: “The point is that this is one policy area where “both sides get it wrong” — a claim I usually despise — turns out to be right. NIMBYism is bad for working families and the U.S. economy as a whole, strangling growth precisely where workers are most productive. But unrestricted development imposes large costs in the form of traffic congestion, pollution, and, as we’ve just seen, vulnerability to disaster.” (Why Can’t We Get Cities Right; Paul Krugman, NYT)

Relevant to today’s political discussions — technology doesn’t kill jobs, but rather shifts jobs around to more productive firms: “This demonstrates something routinely overlooked in the anxiety about the job-destroying potential of robots, artificial intelligence and other forms of automation. Throughout history, automation commonly creates more, and better-paying, jobs than it destroys. The reason: Companies don’t use automation simply to produce the same thing more cheaply. Instead, they find ways to offer entirely new, improved products. As customers flock to these new offerings, companies have to hire more people.” (Workers: Fear Not the Robot Apocalypse; Greg Ip, WSJ)

Weekly Wrap: August Jobs Report Whiffs as Other Data Hits; Trump’s Tax Reform, Like Game of Thrones with Investment Bankers

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This was first published on Facebook. To get the Weekly Wrap hot off the press, please like us on Facebook.

Welcome to the 5th edition of the Weekly Wrap, where jobs day is as exciting as Christmas morning is for a 5-year-old.

This week’s economic data dump

This was a massive week for economic data. A few highlights:

  • Q2 GDP: Revised upward to 3.0% vs. expectations of 2.7% (Business Insider)
  • Consumer spending: Jumped 0.3% vs. expectations of 0.4% (Bloomberg)
  • Pending Home sales: Fell by 0.8% in July (NAR)
  • Consumer confidence – hits second highest level since 2000 (Bloomberg)

Capping it off is today’s jobs report:

  • Net jobs: 156k vs. 180k expected; down from July’s 209k gain
  • Unemployment rate: Jumps to 4.4% vs. last month’s 4.3%
  • Hourly earnings: +2.5%, below expectations of +2.6%
  • Coal mining jobs: +0, vs. last month’s -100

After the report, treasuries fell, the dollar weakened, and the market jumped. This points to investors betting that the Fed pushes off the next rate hike.

Things are… humming along?

  • The employment numbers cap off a week of mixed data. The Q2 GDP number is quite positive, but employment and wages were softer than expected.
  • There is a divergence between the consumer confidence number and the consumer spending. This mirrors the giant gap between the hard data (investment) and soft data (confidence) in the business community.
  • Then, there is the question about what the Fed will do. Will strong GDP numbers signal a coming rate hike? Or will the lack of inflation, tepid consumer spending (which makes up 70% of the economy) and ho-hum wage growth give the central bank pause?

Takeaway: People say they are optimistic about the economy, but their spending – especially on big ticket items and homes – are more muted. That will only become more muted if wages taper off.

Something to watch for: What impact will Hurricane Harvey have on the United States economy? Economists see GDP growth being lowered by 0.2% in Q3, but being raised by the same amount in Q4 (Bloomberg). There’s often optimism that after a giant disaster like Harvey the economy will get a boost (classic Keynesians…). But it will most likely be a wash.

Trump’s Tax Tactic: Give it to the Goldman guys

It was a fascinating week for tax reform. We had so little for so long (as we recently discussed), but things could be finally moving:

  • Julie Hirshfeld Davis and Kate Kelly of the New York Times wrote a fascinating look at the state of the White House’s tax reform this week. It pits economic advisor Gary Cohn and Finance Minister Steve Mnuchin against both Congress and each other.
  • The football hasn’t exactly moved, however. Trump has stated a desire to work with Paul Ryan and Mitch McConnell on a plan, but a hot Tweet finger could make that difficult.
  • Steve Mnuchin told CNBC this week that the White House has a “very detailed” tax plan that is being discussed across members of congress. More detailed than the couple hundred word tax reform one-pager?
  • Trump stated in his presser this week that big corporate tax cuts would lead to higher wages. There’s a bit of an issue with that, however – corporations have seen all-time highs in profits, while wages as a percent of GDP have fallen to all-time lows. Even with unemployment in the 4% range, workers hardly have any wage bargaining power. It isn’t clear how tax cuts would filter down to the pockets of workers.

Takeaway: It isn’t a dirty secret that tax reform could be a huge boost to the economy. But can the Trump White House get out of its own way to actually make it happen? What happens if tax cuts for corporations just go to (wealthy) shareholders, instead of the employees of those companies?

Other Links and Notes

Millennials: Scrappier than you give them credit for. “There is a common misconception that millennials are workshy. The Global Shapers Annual Survey 2017 shows that young people are, in fact, very career orientated. When asked to name the most important criteria when considering job opportunities, salary came out on top, followed by a sense of purpose and career advancement. Only around 16% said they are willing to sacrifice career and salary to enjoy life. To underline the point that young people are not lazy, the survey found that the vast majority of respondents (81.1%) would be willing to move overseas in order to advance their career.” (5 things we learned from one of the world’s biggest surveys of young people; Callum Brodie, Word Economic Forum)

Passive investing has been called worse than communism. That’s… extreme. But a case is made against the shift to simple index tracking. “Like climate change, the forces driving investors to passive investing may be too far along to turn back. The velocity toward index-driven dystopia appears to be increasing.” (The Worst Case Scenario for Passive Investing – Part I; Stephen Gandel, Bloomberg Gadfly)

Costco’s ecomm business has grown, but is it doing enough to fend off the Amazon monster? “Half of Costco’s shoppers are Amazon Prime members, Kantar Retail says, up from 14 percent five years ago. Sharing too many of the same subscribers could be risky, since Planet Retail RNG analyst Graham Hotchkiss says Amazon now offers many bulk-size goods at prices that rival Costco’s. And Amazon’s pending $13.7 billion deal to buy Whole Foods Market Inc. will give it a firm foothold in groceries—the primary reason people shop at Costco, according to Barclays’s Short.” (Costco Is Playing a Dangerous Game With the Web; Matthew Boyle, Bloomberg Businessweek)

St. Louis Fed chief James Bullard, skeptical of the value of the Philips Curve. “For monetary policy purposes, we should not base our notions of what will happen with inflation solely on ideas related to low unemployment. While we certainly want to keep an eye on inflation readings, there seems to be no strong case for being pre-emptive with respect to inflation simply because the unemployment rate is low.” (Does Low Unemployment Signal a Meaningful Rise in Inflation?; James Bullard, Federal Reserve)