Just hours after the Nov. 8 U.S. election results were known, Wall Street’s analysts and economists decided they knew exactly what a Donald Trump administration would mean for the economy and markets. Investors agreed so readily that the first two years of Trump policies already seemed to be reflected in the markets within the first month after the election. Of course, the post-election forecasts were very different from the ones made only days before the election, often by the same people and firms.
The market moves after the election were logical, but many of them went too far. They assume all the positive policies the analysts can imagine will be enacted, and there won’t be delays, compromises, or offsetting factors. The combination of a Trump administration and a Republican majority in Congress is likely to improve economic growth and business profits with lower taxes, less regulation, infrastructure spending and some changes in trade policy. But some of those benefits will be offset by tighter Fed policy, the effects of a stronger dollar and continuing weakness in other economies.
Speculating about the new administration and Congress is fun, but it isn’t the best way to improve our finances. It takes a while for new policies to be implemented and have a real effect on the economy. We’ll continue to focus on what’s happening in the markets and economy now and be alert for changes in trends and valuations.
The United States ended the year with a continuation of the self-sustaining economic growth that’s been in place for a couple of years now. It’s not blockbuster growth, but it’s consistent. Household spending supports most of the growth, as the slowly improving labor market boosts consumer confidence and spending. Housing provides modest support to growth, though it is uneven and slowed over the last two years. Manufacturing and energy production seem to be ending a two-year downturn and may spur growth soon.
There also are rising inflation pressures in U.S. Productivity, which has been declining. Higher wages increase demand and help businesses sustain price increases. The commodities rebound also takes away a major deflationary pressure. I’ve said for a while that I think the bear market in commodities is over, and that still looks to be the case. The rise in the dollar will help hold down inflation, offsetting some of the pressures on rising prices. We’re not looking at 1970s-style inflation, but we’re near the Fed’s target and are likely to rise above it.
The Fed will continue to tighten monetary policy by raising interest rates and limiting bond purchases, as long as growth is maintained. It will do that partly because it wants rates to move closer to historic averages and partly to offset some of the inflation pressures. Tighter monetary policy will offset some of the benefits of growth-oriented fiscal policies, though not all of them. The European Central Bank continues its easy policy, but in December indicated it wants to scale back its policy in another year or so, much like the tapering the Fed did in 2014. A tapering in Europe would stall growth if Europe isn’t in much better shape than it is now.
Stocks have had a strong rally since the election, especially stocks of smaller companies that primarily have U.S. customers. But stocks continue to face some headwinds that might not be completely overwhelmed by the policy changes investors expect. Strength in the dollar, of course, hurts the revenues and profits of large companies with global business. Also, higher interest rates mean earnings have to increase to justify current or higher stock prices.
While lower taxes and regulations should boost earnings, other trends in place are hurting profit margins. Higher wages are one factor weighing on margins, and rising commodity prices are another. Companies also are less likely to boost share prices by borrowing money to pay dividends, buy back stocks, or acquire other companies. A possible support for stock prices is that the strong dollar is likely to attract more investment dollars to the United States. Overall, the factors affecting U.S. stock prices are mixed. Markets initially focused on the potential benefits from new policies. But if there are delays or disappointments about policy changes, investors could quickly become less optimistic about stocks. The markets appear to reflect the most positive effects of the likely new policies. (Positive for stocks, that is, but negative for bonds.) There was an element of a buying panic among investors who were wrong about the election and the likely market implications. The margin of safety is narrower now, because investors expect a jump in earnings. Expect a new buying opportunity after the first disappointments in the rate of policy change or the substance of the changes.