A Trip to the USA

The United States political environment is rarely without interest but the sheer volume of surprising news in recent times has been staggering. In contrast economic news has been generally pedestrian and market movements have been so limited that the VIX index (which measures the expected volatility of the S&P500 over the next 30 days) recently touched its lowest level since 1993! Perhaps most surprisingly, against a backdrop of extreme polarisation, and following an election campaign notable for its combativeness, surveys of consumer and business confidence in the US noticed a sharp and unusually large increase. Despite a seemingly endless series of embarrassing leaks from the White House and almost daily predictions of impending impeachment, these confidence levels have largely been maintained.

Two of the Devon portfolio managers recently travelled up to the US. The main purpose of the journey was to undertake some in-depth due diligence on the US businesses of two of our largest holdings, Vista Group and GTN Ltd. However, while we were there, we had many other meetings with other companies, strategists and economists to help us better understand the broader situation in the US.

Let’s first note how significant the jump in consumer and business confidence has been. Immediately following the election consumer confidence leapt by more than 30%, up to a level not seen since the late 1990s. Although it has since retraced some of that move, it remains significantly higher than it has been since the early years of this century. Almost as remarkable has been the rise in small business confidence – the National Federation of Independent Businesses (the largest small business association in the US) maintains a survey of “small business optimism” and this index leapt by 13% on the election result and has also stayed at levels not seen since the early 2000s. Another striking data point is the enormous improvement in intentions to invest– the NFIB survey of small businesses reporting on whether or not “now is a good time to expand” saw a jump from just above 5% to nearly 25%.

So we are left with an apparent mystery – in an atmosphere of unprecedented partisan rancour and negativity, empirical measures of economic optimism have risen sharply. And in case there is any doubt that partisanship has scaled new heights, the Philadelphia Federal Reserve’s “Partisan Conflict Index” (there really is such a thing) has soared to 250 – having averaged just above 100 reasonably consistently through Reagan, Bush Snr., Clinton and Bush Jr. It rose sharply under Obama to around 180, before its latest jump under Trump[1].

Paradoxically, it is this increasing division which seems to best explain the apparent rise in confidence and optimism. The rise of fiercely partisan news sources (initially Fox News but subsequently other news sites) appear to have resulted in a very significant divergence in voters’ perceptions of current events. The most striking example of this can be seen in the University of Michigan’s survey which measures perceptions of government interventions favourable to business (chart below). Perhaps unsurprisingly this has typically provided quite a low positive response – until Trump. The massive jump in positive responses reflects the very positive view of the Trump administration’s likely effect on business presented by Fox and other pro Trump media sources. 

If we use education as a proxy for Clinton and Trump voters – an inexact but useful reference given the divergence in voter behaviour: Clinton won college educated or higher voters by 9% while Trump was the favoured candidate for those with a high school diploma or less by 8% (astonishingly Trump won non-college educated white voters by 39%) - we get to the nub of what has happened (chart below). Clinton voters, while having strongly negative views of Trump are (not yet) particularly negative on the economy. Trump voters on the other hand, have suddenly become much more positive about the country’s economic future. The effect of that combination is a sharp rise in overall sentiment.

Why should any of this matter? It is reasonable to be sceptical about the relevance of some pure confidence measures as they are frequently backward looking and offer limited insight into future activity. But there is good evidence that consumer confidence is correlated to consumption, and small business’ intentions to expand usually results in increases in hiring - US small businesses employ 80% of the US workforce. In normal circumstances we would expect this level of improvement in sentiment to roll through into measurable economic activity. Of course, to even the most casual observer it is apparent these are clearly not normal times. Whether improvements in overall confidence driven by responses to the political environment will lead to stronger actual activity is unknowable.

Overall economic data does remains solid – job creation is strong, wage growth is modest but rising and overall activity levels are reasonable (which is presumably the reason Clinton supporters remain sanguine about the economy). Given that back drop, and despite the omnipresent risks of a potentially unfit President in the White House, the simple maths of an already solid economy plus a material improvement in confidence suggests that there is a higher chance of economic activity beating, rather than disappointing, current expectations. This is a positive for equity prices and is a key reason why the US equity market is up almost 13% since last year’s election.