This special guest commentary was written by Peter Atwater of Financial Insyghts. This piece was originally published on March 19, 2017.
The Mirage – “Consumer confidence rose in March as Americans were more satisfied than any time in 16 years with the current state of their finances and the economy, while remaining sharply divided along party lines about the outlook.”
That was how Bloomberg summed up Friday’s University of Michigan survey: Great, but highly partisan. While on average Americans feel good about things today, underneath the surface, eighty-seven percent of Republicans expect continued gains in the economy over the next five years, compared to just 22 percent of Democrats.
As I have offered repeatedly, when it comes to reported confidence, 2017 is 2009 in reverse.
What few took note of were these conference call comments from Michigan survey director Richard Curtin:
Consumers recognize, even Republicans recognize, that there’s lots of uncertainty about what economic policies will be passed and what the regulations will be… We have this unusual situation where we have a rise in optimism and a rise in uncertainty. (Bolded for emphasis.)
To explain the significance of this comment, I would draw your attention to this simple slide.
As I have offered before, confidence requires perceptions of control and certainty. While one or the other is good, both are required. Confidence is not only about how we feel about the future, it is about we see ourselves faring in that future, too. Today, per Mr. Curtin, while Republicans may have a heightened sense of control, they, along with Democrats, sense a rise in uncertainty.
What Mr. Curtin unknowingly revealed is something that I have been concerned about since Election Day. Republicans aren’t “confident;” they are “relieved” and now hopeful. With the arrival of the new administration, and Republicans gaining control of both the House and the Senate, Republicans feel empowered; and, as a result, they are, as Mr. Curtin put it, now “optimistic.”
While optimism accompanies confidence, the two are not at all the same. There is a vast difference between being optimistic about something happening ahead and being confident in it happening. There is hope and then there is trust.
At the risk of oversimplification, I’d offer that the mood migration that we have seen among Republicans since Election Day is not from the lower left box in the chart to the upper right box, but a shift from the lower left box to the upper left box.
While Republican voters are more optimistic and feel a much greater sense of control, they are not confident. They still do not have a high sense of certainty.
On the surface this may seem like I am once again dancing with angels on the head of a pin, but the distinction matters – a lot, too.
Environments of high control and low certainty are fragile. A poker game, for example, is an environment of high control and low certainty. So, too, are stock picking and active investment management. An environment of high control and low certainty defines games of chance.
To be fair, neither we nor those measuring confidence pay much attention to the distinction between the upper left and upper right boxes. Both environments express, if not ooze, optimism. Heck, the pharmaceutical, casino and financial services industries together spend billions of dollars every year in advertising trying to convince consumers that there is no difference between the two boxes. Whether it is a drug or an investment, consumers are routinely told to ignore the potential adverse side effects arising from uncertainty.
This chart from Gallup, though, suggests that ignoring the potential side effects is exactly what investors and Republican voters have done since the election of Donald Trump. Consumers’ “Economic Outlook” – “optimism” – went from -21 just before the election to +15 a week ago.
Beyond the recent sharp decline in the black line evident in the chart above, I have two concerns with the current positioning of Republican voters in the upper left box today.
First, if the new administration has shown anything in its first days in office it is that uncertainty is the team’s normal operating environment. Stop, start, yes, no, true, false – we’ve seen more shifts in position from the Trump administration than a day-long yoga class.
Based on what we’ve witnessed so far, the new administration has no sense of the distinction – let alone the importance of that distinction – between the upper left and upper right boxes.
Rather than taking small steps that foster greater and greater certainty and build confidence over time, the new administration has thrown caution to the wind. From healthcare to financial services reform to the budget, nothing is now certain. They are, for lack of a better term, gambling with America’s future, comfortably running an administration in the upper left box.
While that would be worrisome on its own, the current positioning of Republicans requires that Trump’s followers keep on winning. With Republicans’ optimism entirely a function of a greater perception of control, the new administration has no choice but to do whatever-it-takes to keep that perception aloft. To put things differently, if you think things look authoritarian now, just wait until uncertainty rises.
With Republicans having been mobilized into a cognitive “casino” with the election of Donald Trump, the new administration can’t now let them lose. Even more, having just gained control, after a long time without it, Republicans aren’t going to let it go of their new found power voluntarily.
But whether the consequence is greater authoritarianism or increasing stridence among Republicans, the confidence of Democrats is likely to be seriously threatened. With the zero-sum thinking that exists today in the White House, there is no way the new administration is going to take a bipartisan gamble that potentially boosts Democrats’ confidence, if it in any way puts at risk Republicans’ high perception of control.
The net of it all suggests a probable outcome that looks like this:
Republicans (in green) will remain in the upper left box, while Democrats (in red) will move further and further into the lower left box. Needless to say, not only does this all but ensure extreme political partisanship ahead, but it will seriously limit economic growth. Without certainty, no one – Republican or Democrat – will move to up and to the right. All of that “optimism” being reported by Michigan, Gallup and the NFIB won’t translate into action.
(And while it is a topic for another day, I would not underestimate the vicious cycle that is likely to develop as “underconfident” Democrats lash out at the administration, which in turns results in greater authoritarian actions resulting in further backlash…)
To be clear, if the parties were reversed and there were a Democratic administration behaving in the same manner as the new Trump administration, I would be outlining the same scenario. What I see are confidence-driven, far more than ideology-driven, behaviors. “Box position” matters.
To sum it all up, optimism, not confidence, is at a 16 year high. While the stock market and surveys, like the one released by the University of Michigan on Friday, are reflecting hope, below the surface, uncertainty is building. Unless the new administration begins to takes steps to reduce growing anxiety, the bright future that consumers and investors see today will quickly evaporate.
Just like a Las Vegas casino, it will all have been a mirage.
EDITOR'S NOTE
This is a Hedgeye Guest Contributor note written by Peter Atwater, founder and president of Financial Insyghts. He previously ran JPMorgan’s asset-backed securities business. He is also the author of the book Moods and Markets (FT Press, 2012) which details how investors can improve returns by using non-market indicators of confidence. This piece does not necessarily reflect the opinion of Hedgeye.