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The Optimists vs. the Eeyores

Irwin M. Stelzer

Rarely have both exuberance and anxiety run simultaneously at the high pitch evident these days at gatherings of investors. The exuberants are the noisiest right now. Trump tax cuts have produced a surge in business after-tax profits—which even before the tax cuts were up double digits compared with last year. Millions of workers and their pension funds have received checks from companies benefitting from the tax cuts, and millions more will see their take-home pay rise in a few weeks when the new tax schedules cut in. International corporations are repatriating earnings to benefit from a special 15.5 percent tax rate, down from 35 percent. Estimates put total cash to be brought home by tech companies alone at $400 billion, with Apple accounting for half that sum.

But the exuberance is not only about the tax cuts. Friday’s jobs report topped expectations. Unemployment remains a low 4.1 percent, the economy added 200,000 jobs last month, hourly earnings are up almost 3 percent over last year after a long period of stagnation. In addition, personal spending in the final quarter of last year rose at a rate of 3.8 percent, the fastest pace in three years. Consumer confidence is high, and small business confidence hit a record in December. The home ownership rate rose in 2017 for the first time in 13 years, driven by millennials.

Throw in the faith some have that the president’s reduction of the corporate tax rate from 35 percent to 21 percent—and his roll-back of the regulatory state—have delivered us to a new plateau of between 3 percent and 4 percent economic growth. That faster growth will enable the tax cuts to “pay for themselves” by generating higher revenues for the Treasury, the faithful contend. So what’s not to like?

Which brings us to what we might call the Eeyores, A. A. Milne’s gloomy, pessimistic, stuffed donkey who knows that the end is nigh, and if not nigh, at least inevitable. For them good news such as the jobs report is really bad news in shiny gift-wrap. Their preferred indicator is the interest rate on 10-year Treasury bonds, which broke the 2.8 percent barrier yesterday. This, they say, is the beginning of a rise in interest rates that will slow the economy and pop the bubble in share prices, which even the optimists concede are “elevated,”—and the Eeyores say are inflated.

It will also increase interest payments on the national debt, which is soaring since Congress no longer contains fiscal hawks. The Treasury Borrowing Advisory Committee estimates that the Treasury will have to borrow close to $1 trillion this year, almost twice as much as last year, and borrow still more in 2019 and 2020. That’s a lot of IOUs to dump on a market in which buyers are beginning—only beginning—to worry about inflation.

To those who are counting on a “yooge” Trumpian infrastructure program to boost the economy in the face of rising interest rates, the pessimists point out that Congress is unlikely to agree to Trump’s plan to finance it with tax incentives for the private sector. Worse still: it takes 4.7 years for the average project to obtain necessary permits. Major projects often spend a decade seeking permits. Anyone who believes that Trump can deliver on his promise to cut that to one or two years is not familiar with the ability of environmental lawyers to make certain that nothing gets built that might inconvenience a bug or a bird or a bee.

Finally, what lyricist Richard Rogers would call the cockeyed optimists, “who forget every cloud they’ve ever seen,” are ignoring three things. First, the robust job market might prompt the Fed to raise rates four times this year, rather than the three now pencilled in. Second, consumers might not be able to continue spending at the current rate. The saving rate is at its lowest level in a dozen years, interest charges on credit cards are heading up, auto sales are already slowing, and any hint that the good times are no longer rolling will result in purse-zipping consumer retrenchment.

Third, there is geopolitical risk. Should the Democrats seize control of the House later this year (which is increasingly likely as important Republicans decline to seek re-election) it is almost certain they will try to impeach the president, no matter the result of the current investigation by special prosecutor Mueller. While that process unfolds it will take a lot of tough-minded investors to avoid an irrational lack of exuberance; it will take foreigners enthusiastic enough about America to ignore our mounting debt and political instability; and it will take investors and CEOs imbued with animal spirits to keep share prices elevated and business investment high.

In part the differences between the optimists and the pessimists is related to the time-spans on which they focus. Talk to cockeyed optimists about the long-run, when the bills for the tax cuts come due, and they will remind you that the great John Maynard Keynes assured us that in the long run we will have no earthly concerns. To them, this past week’s plunge in share prices is normal volatility.

Tell the gloom-besotted that analysts both on the left and the right of the political spectrum say we are in “a Goldilocks moment”, and they cite Maurice Obstfeld, chief economist at the International Monetary Fund, who warns, “the next recession may be closer than you think.” Change “may be” to “is,” and you have true Eeyores. To them, last week’s market drop is a warning that the party is coming to an end. Not for them “This time is different.”

That difference between the cock-eyed optimists and the Eeoyres is the source of anxiety. Stay in the market and risk substantial losses. Get out, and risk missing the next great upward move. Not for investors “don’t worry, be happy.”

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