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The whole Trump growth story is about to face a huge challenge

With the first quarter coming to a close, the accepted narrative that this is going to be a breakout year for the economy is coming under closer scrutiny.

The Trump rally in the stock market has been predicated on the notion that a pro-growth agenda will lift the economy out of its plodding post-financial crisis recovery. Sentiment surveys have indicated big hopes for the future. However, that optimism has been slow to show up in actual hard data.

So as March turns to April, initial readings loom on how the economy has done in a broad sense. Much is at stake.

President Donald Trump at the East room of the White House in Washington, U.S. March 24, 2017.
Carlos Barria | Reuters
President Donald Trump at the East room of the White House in Washington, U.S. March 24, 2017.

"When you've got unbridled enthusiasm, people get excited about stuff, and then it runs up against fact," said Michael Yoshikami, CEO and founder of Destination Wealth Management. "The sentiment could change in a heartbeat as soon as a small group of facts conflicts with the sentiment."

The jitters have been further propelled by the raucous debate over health care, and the failure to pass a sweeping reform bill. Wall Street is worried that President Donald Trump and Congress' inability to agree on a measure will derail promised tax cuts and regulatory relief.

The current state of the financial markets is a conflict between equity investors who have pushed the S&P 500 up about 9.6 percent since the November election, and fixed income investors who have held government bond yields — typically a proxy for growth expectations — in check.

"There's a pretty clear signal the bond market is sending, which is that facts aren't being priced in by the market," Yoshikami said.

The slide from February to March

Investors have been nervous about growth, and that anxiety has been exacerbated by a closely watched indicator: the Atlanta Fed's GDPNow tracker, which keeps a running tally on how quarterly growth is progressing.

In early February, the gauge had pointed to first-quarter growth at 3.4 percent. That, however, tailed all the way down to 0.9 percent in March, and on Friday it got just an incremental bump to 1 percent.

That certainly wasn't the way things were supposed to go. And it may not in fact be an accurate picture of what's really happening.

In an analysis released Thursday night, Goldman Sachs asserted that first-quarter growth actually may be close to double what the Atlanta Fed thinks — more like 1.8 percent than the barely 1 percent indicated by the central bank's tool.

At the core of its forecast is a belief that growth has accelerated as the quarter has progressed, with the Fed forecast underestimating consumer spending, exports and inventory growth, all critical components in the GDP measure.

"We see reasons for improvement in March, reflecting encouraging consumer fundamentals and the likelihood of a late-quarter spending rebound (reflecting the arrival of delayed tax refunds)," Goldman economist Spencer Hill said in a note.

Hill addresses a central sticking point in the current growth quandary: the difference between "hard" and "soft" data.

The former refers to actual reports on spending, manufacturing, sales and the like. The latter consists primarily of sentiment surveys from consumers, investors and business executives about anticipated activity ahead.

"A hallmark of the GDPNow forecasting methodology is its avoidance of subjective adjustments, but in this instance we believe some role for judgment is warranted, particularly with regard to the international trade assumptions," Hill said.

CNBC's Rapid Update puts expected first-quarter growth at 1.3 percent.

Durables downer

Friday brought another round of decidedly mixed hard data.

Durable goods orders grew a better-than-expected 1.7 percent overall, but internal numbers were softer. Excluding transportation, the gain was just 0.4 percent, a little lower than estimates, while orders actually declined by 0.1 percent.

The importance of the numbers, particularly orders, is that it points to a softer outlook for business investment, considered a cornerstone for future growth.

Citigroup economist Andrew Hollenhorst said he remains "cautiously optimistic" on investment spending growth, even in light of the letdown from Friday's data.

"Despite the durables disappointment, we continue to think most of the weakness in Q1 GDP is transitory and will rebound in coming quarters," Hollenhorst said.

Joseph LaVorgna, the chief U.S. economist at Deutsche Bank, also sees a strong likelihood that hard data will begin to shift higher. An acceleration in capital expenditures is at the core of his forecast that full-year GDP gains will hit 3 percent, about a full percentage point ahead of Wall Street consensus.

"We are increasingly confident that the manufacturing sector is poised to contribute meaningfully to overall economic activity over the next several quarters," LaVorgna said in a note.

The first-quarter data has been the most fickle in the recovery years, typically understating full-year growth. Since 2009, the quarter has been the lowest of the year five times, and that could well be the case again this year.

There are troubling signs again in the first quarter of 2017, and if the trends in hard data don't swing, it could pose a risk to Wall Street's momentum. Peter Boockvar, chief market analyst at The Lindsey Group, posed a series of critical questions for the economy:

We certainly know the actual data in hand has lent itself to Q1 GDP growth of possibly no better than 1%. Are companies feeling better but not acting upon it just yet? Is it just the reality that we are late cycle in this recovery and we've pulled forward so much economic activity that it's just natural to slow down? Are companies worried about higher interest rates and thus reigning in some optimism because corporate debt has exploded higher over the past 7 years? With the auto sector such a huge contributor to economic growth since the recession and now signs of sales and delinquencies rolling over, is the ripple effect filtering into other areas?

His unsettling conclusion: "I would say all of the above."

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