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Q2 – Is the Awakening Real?

By April 7, 2017Newsletters

In 1990, Robin Williams starred in a movie entitled, “Awakenings,” about a patient who, after being provided with a specific medication called L DOPA, was “awakened” from a 30-year catatonic state, only to return to that catatonic state shortly thereafter due to a decline in the efficacy of the drug after repeated use.

The Q1 “Trump Bump” appears to be an “awakening” of certain animal spirits. We believe that Q2 will be the vector quarter that establishes a new trend line, or returns the economy to the 2% post-recession GDP trend. We are keeping our eye on:

  • Conversion of rhetoric from business perspective – negative under Obama, positive under Trump. Under the Obama administration, middle market business executives expected perpetual increases in taxation and regulation. Under Trump, the rhetoric is reversed in favor of less regulation and taxation. We are watching the evolution of tax legislation, particularly the unfavorable Border Adjustment Tax, deductibility of interest expense, and the carried interest treatment.
  • Sector confidence – “A” Player CEOs are generally optimistic regarding opportunities in their sectors. We are paying attention to the overall confidence levels of our CEO and PE board member clients and are looking at capital investments in 2017.
  • The gradual process of increasing interest rates is not impacting the desire to make investments and complete transactions. Should there be a substantial increase in rates (+ 100 basis points in a year), we would expect highly-levered or recapitalized acquisitions from 2014 to 2017 to experience stress.
  • Oil and natural gas prices – O&G exploration, production, and service companies have substantially driven costs down, proving the U.S. has found a globally competitive cost structure that is here to stay. As long as the price stays above $40 per barrel, the U.S. energy sector could provide a tailwind for the overall economy.
  • Auto appears to be peaking. In February 2017, 1.33MM vehicles were sold in the U.S., down about 1% from February of 2016. Furthermore, the “days to turn,” or the number of days a vehicle is on the dealer lot before being sold, hit 74 days in February – the highest of any month since July 2009. Bad news in this sector could offset any good news in energy.
  • International events. Q2 will be substantial in terms of providing visibility on international events, the global economy, and the value of the dollar. European elections, Chinese economy and lending, and events in the Middle East will all shape how we see the second half of 2017.

Finally, we are experiencing a systemic phase of innovation in which most industries’ value offerings are materially impacted by technology: technology, policy, human capital, and international competition will all contribute to change.  In this way, Darwin trumps Trump in terms of impact. As Darwin noted, “It is not the strongest of the species that survive, not the most intelligent, but the one most responsive to change.”

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