Trump's Stock MarketSubmitted by Affiance Financial on March 16th, 2017
On election-day, pundits estimated a stock market rally if Hillary Clinton won the election and a decline if Donald Trump was elected. The conventional thinking was based on the erroneous assumption that markets would benefit from a continued era of certainty under Clinton while the uncertainty of the potential changes surrounding a Trump victory would lead to a market decline. It would be an understatement to suggest the conventional wisdom was wrong. Since the United States 45th President, Donald Trump, won the election on November 11th, 2016, the stock market has reacted with an almost singular and positive response. The S&P 500 has gained nearly 10 percent during the four months since election-day.
Trump’s market moving agenda has been communicated in headlines and tweets that have propelled markets higher. The main themes that have focused on expansionary fiscal policy are; lower taxes (personal and corporate), increased government spending (infrastructure and defense), and deregulation. The expectation is that because of the Republican control of the House, Senate, and Presidency, the President’s agenda is likely to be enacted.
Industries targeted by Trump’s proposed legislation have reacted significantly; financial services stocks are up nearly 18 percent, defense industry has gained 14 percent, and industrials jumped 12 percent. While much weight has been placed on the Trump agenda as the obvious catalyst for the stock market’s advance, we would point out that S&P 500 earnings grew by more than 22 percent in the fourth quarter of 2016, the best quarterly growth rate since 2013. Earnings are forecasted at similar year-over-year growth rates for the next few quarters before slowing in late 2017.
We would note that the seeds for the current earnings rebound was sown during the prior two years, when a “stealth recession” was reflected in uneven economic growth across the country. Driven largely by the collapse of energy prices, many central U.S. states were in recession while the coasts continued to prosper. Higher energy prices have helped to stabilize GDP growth and bolster corporate earnings. Increased corporate earnings have actually reduced the S&P 500 index valuation during the past year, from 19x forward earnings in December of 2015 to about 17x today. This compares favorably with the long term average of 15x forward earnings. The combination of expansionary fiscal policy, growing corporate earnings, and investors’ enthusiasm is helping to drive stock market momentum.
The term “animal spirits”, coined by famous economist John Maynard Keynes, is likely appropriate to describe the optimism of investors to act constructively while not fully discounting all of the information. For example, though Trump has stated he wants a massive tax cut for the middle class and a commensurate reduction of corporate taxes, no specific Congressional legislation has been proposed to reduce taxes. Similarly he has indicated he will ask for a massive increase in military spending as well as spending on national infrastructure to include roads, bridges, and a wall on the Mexican border, but legislation is still to come. Finally, he has stated he will roll back regulation especially in banking (Dodd-Frank, Volker rule) and healthcare (Obamacare). Trump has started on his agenda by signing more than 26 executive orders and introducing an Obamacare replacement plan.
Against a backdrop of positive animal spirits and rising stock prices, the Federal Reserve Bank has made it clear that the monetary stimulus they have provided to the markets since the financial crisis in 2008 is ending due to the economy’s strength, low levels of unemployment, and higher expected inflation. The Fed raised interest rates by 25 basis points in December of 2015 which was the first interest rate increase since the financial crisis in 2008. The Fed raised rates by 25 basis points again in December of 2016 while indicating several more rate increases are expected this year.
It is an interesting paradox to witness the Fed’s desire to slow economic activity before inflation becomes a problem while the legislative and presidential branches of government look to add significant fiscal stimulus. We would highlight that rising rates designed to temper strong economic growth is not a death knell for stocks. In fact, it is positive in the near term to prevent inflationary growth, but it is also a warning that the Fed will moderate expected excesses. If rates were rising to quell stagflation or exploding wage growth our views would be much more cautionary.
Markets have clearly focused only on the upside while discounting any negative outcomes from the administration’s current fiscal policies or related initiatives. For example, massive tax cuts without associated spending reductions will lead to a massive increase in government debt. Already at the highest levels since World War II, the deficit has exploded from 30 percent of GDP in 1980 to its current post-war high of 106 percent. The administration’s more restrictive approach to immigration policy may make it harder for businesses to find workers, accelerating labor market shortages and increasing wage pressures. The President’s isolationist global posturing and desire for more restrictive trade policy will make consumer goods more expensive and increase inflation while the real potential for trade wars would negatively impact workers, consumers, and the economy. The potential negatives will take more time to develop and may create problems that current politicians will likely prefer to punt to future generations.
In short, the economy appears to be strong and poised for continued growth in the near term. We fully expect fiscal stimulus to materialize and further boost economic growth while the Fed works to simultaneously temper growth. Looking forward and digesting all of the news leads us to a more balanced conclusion. We know that much can still happen between the desire and implementation of Trump’s agenda. Most of what may derail the current trends cannot be discerned today. Markets do not move in a straight line and we expect a market pullback and increased volatility during the year. Maintaining a long-term focus is difficult, that being said, we will continue to monitor market developments and make any adjustments we deem necessary.
As always, we will continue to be loyal stewards of the money you have worked so hard to earn.
The views stated in this newsletter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change with notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.