Update 165: Trump Markets on SOTU-Eve — Rhetoric, Rally, and Reality
Amid the vote and another Dow close at a record high — for a 12th straight session — and with President Donald Trump’s maiden State of the Union speech tomorrow, the feeling of rubber meeting runway on some major economic policy positions and proposals from the new administration was palpable in Washington today. No doubt tomorrow’s wonk Super Bowl that is SOTU in Washington for D.C. will also be watched closely by an excited market and a more apprehensive public hungry for concrete proposals.
Will the animal spirits that have pushed capital market indexes to rapid gains and record highs since Election Day be vindicated in the end? Or will the skeptical analysis provided below turn out to be more prescient?
Market Rally and Reality
Since Donald Trump’s victory just over three months ago, we have seen a market rally on Wall Street that has pushed the Dow Jones Industrial Average past the 20,000 mark, a record. The President will point to the rally as an early sign of his success.
An excited stock market can be notoriously fickle. This one is driven by the expectations of a tax-slashing, deregulatory regime. But there are signs of growing impatience in town halls and on Wall Street as the administration had kept private counsel regarding its legislative program for tax reform, infrastructure and investment, and the fiscal balance.
The Reflation Play
The expectation of a large fiscal stimulus through Trump’s trillion–dollar infrastructure plan caused investors to sell bonds and buy stocks instead. Investors bet heavily that a fiscal stimulus from the new administration would turbo charge growth, and maybe inflation.
This bet, known as a reflation play, should — and may well — be second-guessed soon. Investors know that inflation is gathering steam and it is likely to accelerate (the degree depending largely on independent monetary policy). But they risk assuming that the president’s upcoming and continuously postponed fiscal policies will be enacted and will produce the promised four percent growth economy.
The changing patterns of growth in the bond market versus the stock market shows an internal debate amongst investors, some of whom are more tepid in their expectations of am impending higher growth rate. Contrary to December, 2016, the bond market has seen a turn since the post election reflation rate, signaling that the stock market is potentially engaging in very risky behavior. And a rising bond market is a clear sign that some investors subscribe to a more skeptical analysis.
This Has Happened Before
We are seeing the most significant market rally in 30 years, we should look at the parallels between 1987 and 2017. The recovery from the 1980s recession saw rapid economic growth, which ended in a smooth transition to stable expansion and lower inflation. As a result, the stock market rallied in 1987 and reached a high of 2,722 points, which was a significant increase of 44% compared to the previous year. What followed in October of that year, known today as Black Monday, should serve as a warning sign for stock investors today. A crash starting in Hong Kong and echoing around the world resulted in the Dow dropping over 500 points, or 22 percent.
While it may not mirror the world wide crash of 1987 or end in tears for other reasons, we may see a sharp or longer-term decline in the stock market as time passes and the political process or just the administration fail or delay getting results (read: jobs).
The State Of The Union
We’ll look more closely at this important speech tomorrow, only to note for now its relation to the foregoing. The reason for the post-election stock market rally can be summed up in three key expectations of Donald Trump’s administration:
In tomorrow’s State of the Union address, Trump is expected to outline many key economic proposals, ranging from tax policy to infrastructure policy to deregulation. Every major investor will be watching and the Wednesday market open should give us an indication of how robust the Trump rally is. Per today’s the Wall Street Journal, “Mr. Trump’s speech to Congress could move the markets, if he provides fresh details on budget, tax, and infrastructure plans.”
Real Economy vs. the Capital Markets
It’s expected universally that the Obama recovery, bequeathed to Trump, will continue, as unemployment remains below five percent and wages have started rising. What would a massive and untimely stimulus mean for the economy?
Cue the bond vigilantes of 2009, if there are any left.
Three financial companies ranked in the top four among the 30 companies lists in the Dow for stock price gains since the election: Goldman Sachs, JP Morgan Chase, and American Express. The relative losers:
Mnuchin may have spoken too soon when he said that the stock market is “absolutely” a report card for the Trump administration. Once again, as this administration reckons with reality, the stock market will be quick to notice that a massive stimulus will not be hitting any industries this year.