The initial market reaction to the election of Donald Trump was overwhelmingly negative. US stocks fell, as investors became frightened of the uncertainty surrounding an untested leader. Yet, weeks later, markets in the US rallied, producing a modest gain. The Dow is up 8.7% since the election. Is this the beginning of Trump magic?
There are three reasons why the Trump election may be the driving force behind the rally. First, investors may be responding to projections of economic growth in a deregulated economy. Second, investors may be counting on a softening corporate tax code to bolster profits. Third, they may be looking to promises of infrastructure spending as a reason to buy.
The trouble with all three of these arguments is that they rest on the shifting sands of an unknown political platform. Trump’s campaign made a wide variety of promises, many of which are now being rolled back. While deregulation may be a boon to oil companies with fossil fuel heavy portfolios, those gains will be offset by the losses in renewable technology, which will no longer benefit from a favorable government contract environment. Banking deregulation is as likely to produce losses as gains, as investors fear the creation of another bubble.
Reforming the tax code is always a political nightmare. Every cut has to be offset with an increase somewhere else or a decrease in spending somewhere else. Neither tax increases nor spending decreases are politically popular. There’s reason to question Trump’s ability to move any significant tax package through congress. The recent re-election of Paul Ryan as Speaker of the House suggests that the Trump presidency may be more politics as usual instead of sweeping change.
Infrastructure spending also seems like a shaky place to build investment plans. Infrastructure expansion and revitalization has been a significant part of the past two campaign cycles. Significant legislation has not been forthcoming.
It’s premature to lay the credit for this economic gain on Trump. Markets have typically responded more to legislation than campaign promises. Savvy investors know better than to put much faith in candidates seeking election.
Instead, there are two key factors driving this rally. First, Q3 earnings were strong, growing by about 4%. This is especially startling given projections that they would shrink by about 1%. Companies doing better than expected tend to attract more investment capital. Holiday spending is also up, expected to exceed $1 trillion. Increased consumer spending tends to drive both production and hiring, leading to growth.
Second, the Federal Reserve recently raised interest rates. This is a serious boon for the financial sector. Beyond that, it’s a strong signal that the worst of the recession is over. The Fed’s rate decision is a good indicator that things are back on the way up.
Smart investors know better than to buy into campaign hype. The market responds to evidence, not rhetoric. Trump may produce great economic gains, but he hasn’t yet.