May 17, 2017
At the 2011 White House Correspondents’ dinner, the 44th president of the United States, Barack Obama, and comedian Seth Meyers spent several minutes making businessman Donald J. Trump the butt of their jokes. Was this the trigger that sparked Trump’s decision to go into politics, fueling his desire to be taken seriously on the political scene and prove that he could govern the United States of America? Now that the symbolic milestone of his first 100 days in office has come and gone, it’s worth trying to understand the rise of this unpredictable man and what his policy agenda means for financial markets.
Three debates against his Democratic rival Hilary Clinton and a few scandals later, Trump emerged victorious in the November 9, 2016 election, astonishing the majority of pollsters who had predicted a Clinton win. His victory did not bode well for stock markets. Futures on U.S. indexes crashed as soon as CNN announced that Trump was the projected winner in the swing states of Ohio and Florida. Dow Jones Industrial Average futures were quick to follow, nosediving over 800 points. Stocks had priced in a Clinton administration with its well-defined policies and high degree of stability. Yet despite the election night dips, markets opened the trading day by greeting the President-elect with gains, bucking the trend set by falling futures contracts only hours beforehand.
Mr. Market: emotional and unstable
These events bring back the issue of investor emotions and their impact on securities valuation and market movements. Election night was the perfect time to dust off the wise words of Benjamin Graham, the father of modern financial analysis, and his now famous character, the bipolar Mr. Market. Graham employed this allegory to explain often extreme market fluctuations. Some days, Mr. Market values securities rationally. But other times, his judgment is clouded by irrational fear or exuberance. Let’s just say that during the 24 hours that followed the election, Mr. Market went through an emotional roller coaster ride.
The day after Trump’s victory, investors welcomed the new president with stock market gains that many analysts credited to his rather conciliatory speech and his promises of tax reform, strong job growth, and investment in U.S. infrastructure. The market priced in the promise of fiscal stimulus and the perception that the new president might just have what it takes to act like a statesman after all. A few months in, U.S. financial markets were still buoyant, having posted gains of over three trillion dollars in market capitalization. Markets have since gone on to smash several more records, with the Dow Jones hitting all-time highs of 20,000 and 21,000 in a single month. These gains mean that Donald J. Trump’s first 100 days in office have seen one of the best stock market performances since the end of World War II. But they also raise the following question: Do investors’ stock valuations overestimate Trump’s chances of successfully implementing his agenda?
Broken promises or temporary setbacks?
With the president’s first attempt to repeal and replace the Affordable Care Act blocked in Congress and his migrant travel bans stymied, the market may start to feel that the House of Representatives and the Senate are increasingly unlikely to pass tax reform, major tax cuts, or an infrastructure spending bill, despite the Republican majorities in both chambers. The president has yet to deliver any details on infrastructure spending, and his tax reform plan fits on an 8 ½ x 11 sheet of paper. Let’s not forget that Trump had no political experience prior to joining the race for the Republican presidential nomination and that he has openly acknowledged how difficult it is to navigate the U.S. government’s inner workings. So it makes sense to question the new president’s ability to get congressional approval for his projects. Projects could be watered down to appeal to the party’s ultra-conservative wing. This would entail further delays in passing and implementing policies, resulting in underwhelming fiscal stimulus.
According to economists at Goldman Sachs, investors are misinterpreting the president’s political agenda and calendar. Changes to the Affordable Care Act took more of Trump’s time than forecast, pushing back the timetable on his other pledges. As a consequence, many projects may end up being postponed and will probably not be as far ranging as initially thought—if they even make it through Congress in the first place. Republicans’ traditional aversion to debt explains why Congress is nowhere close to passing Trump’s colossal 10-year, one trillion dollar infrastructure plan. Indeed, U.S. debt is on the verge of surpassing the $20 trillion mark, up from $9 trillion only 10 years ago, whereas infrastructure spending will need time to make its effect felt on the economy. Considering all these promised fiscal stimulus measures, a second question needs asking: What with the U.S. Federal Reserve tightening monetary policy, Fed chief Janet Yellen announcing that the U.S. labour market is nearing full employment, and the Federal Reserve Bank of St. Louis declaring that the U.S. economy is outpacing its growth potential, do our southerly neighbours really need a fiscal stimulus package at all?
Uncertainty in America, volatility in the markets
The market optimism triggered by Trump’s policies could give way to pessimism, lending credence to the old adage “Sell in May and go away.” Uncertainty surrounding the president’s policies and his difficulty in securing legislative approval could lead to heightened market volatility. The “America First” agenda and the push for protectionist trade policies could also have a chilling effect on the world economy. Overall, increased specialization in the production of goods and services based on the comparative advantages of each country involved in international trade gives free trade a leg up over autarkic models. As a result, a market correction could be in the offing, providing a propitious time to invest.
Jean-François Pakenham, CFA