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Everyone on Wall Street is talking about 'animal spirits'

Myles Udland
Markets Reporter

Everywhere you turn, Wall Street analysts are talking about “animal spirits.”

“Scanning the survey data, we have seen across the board improvements post-election, indicating stronger animal spirits in the economy,” wrote economists at Bank of America Merrill Lynch in a note published January 9.

“Increased optimism should help to support a rebound in business investment.”

In a note out on Wednesday, Jim Paulsen at Wells Fargo listed the positive factors bolstering economic data since Trump’s election, including a new positive earnings cycle, a broader global economic recovery, an easing of global deflation, and, of course, the election of Donald Trump, who is seen by most in the business community as a pro-business candidate.

“This is an impressive list of positives, which for the first time in this recovery may be juicing animal spirits,” Paulsen writes. “The question is whether this surge in confidence is sustainable?” (Emphasis added.)

Over at Goldman Sachs, economist Jan Hatzius remarked in a note on January 9 that, “the surge in most measures of business and consumer expectations since the election does raise the possibility of a self-sustaining rise in ‘animal spirits’ that boosts especially the investment side of the economy.”

So what are “animal spirits”?

“There are three major platforms for Trump’s economic policies: tax reform, deregulation and infrastructure spending,” analysts at Societe Generale wrote in a note out January 9. “Tax reform is seen as having the biggest influence on growth in the next couple of years. Deregulation is less certain yet seems embedded in markets and can arguably be a modern word for ‘animal spirits’.” (Emphasis added.)

In short, “animal spirits” are a way to, in plain English, gauge how bullish corporate America is on their future prospects. When animal spirits are present, you’re likely to see a surge of hiring, investment, and spending as better days are assumed to be ahead for the economy. When animal spirits are non-existent, it is because a cloud of uncertainty is, these business leaders might say, “hanging over the investment environment.”

And as this chart from Bank of America shows, business investment during the post-financial crisis recovery has been lackluster. At best.

Source: Bank of America Merrill Lynch

In financial markets, animal spirits manifest in the price of riskier assets (think stocks), going higher in a short period of time. The post-election surge we saw in US stock prices was certainly a reflection of something resembling animal spirits coming out among investors, even if this was seemingly short-lived — over the past month stocks have gone nowhere.

Animal spirits aren’t always a good thing

Not all analysts, however, think the loosing of animal spirits on the US economy, at this point in the cycle, is a good thing.

“There is such a gap now between spin and reality it is incredible,” wrote Gluskin Sheff’s David Rosenberg in a note out January 19.

“Since the election, roughly 80% of the survey data have exceeded expectations. In contrast, less than half of the hard economic data have topped consensus views. It seems lost on the masses that we had but one decent quarter of growth last year — a year in which real GDP growth slowed to 1.6% from 2.6% in 2015, tied for the weakest pace this cycle. Yes, that is the rearview mirror, but the lags between was Trump campaigned on and what comes to the fore are likely to be quite long. Don’t be fooled — the US economy is soft, not strong.” (Emphasis added.)

In a research note titled “US: Animal Spirits,” Nomura chief economist Lew Alexander highlighted that while confidence has spiked in recent months, there’s been no meaningful change in the hard economic data.

Source: Nomura

“There is no question that business and consumer confidence have surged since the election,” Alexander writes. “What is less clear is what that means for the economy going forward.”

“It is certainly possible that this surge in confidence will lead to acceleration in private spending,” Alexander adds. “For example, small business expectations for the broader economy seem to lead their actual hiring and capital spending plans.

“It certainly appears that Trump’s economic message has been compelling for many consumers and business leaders. However, the surge in economic confidence has come before any new policies have been clearly articulated or implemented… If Trump and the Republican-led Congress do not take quick action, and if the economy does not quickly improve, this surge in confidence may prove to be fleeting.”

Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland

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