CNBC can’t wait for the Dow to crack 20K. The index came very close at the end of last week but was unable to do it. Many analysts believe that the post election rally of nearly 9% cannot be justified by any abrupt upswing in economic activity so it can only be explained by the renewed animal spirits of investors sparked by Trump and his team. Proposed policy initiatives like tax cuts, cash repatriation, less regulation, renegotiation of trade deals and a sprinkling of infrastructure spending seems to have stirred the optimism in investors. So Dow 20K…any day now. Don’t touch that dial.
Now that we are days away from the inauguration and the contours of the Trump administration are beginning to unfold, it’s fair to ask if the US equity markets are properly priced or if they are ahead of themselves. I would argue the markets have the positives from the proposed policies priced in but have not discounted the risks around implementation and, more importantly, have not priced the risk of good old politics.
The equities market appears to ignore anything that does not fit into the positive narrative. One of the better examples is the thought process around the border tax adjustment. It would seem to be just bad macro policy. Many market pundits are quick to emphasize this and point out that it would hurt the exact voters who elected Trump. The resulting higher import prices and a likely higher dollar would hurt everyone, so the market narrative seems to be that cooler heads within the administration will prevail and the issue will not get any traction.
But then there is the politics of a border adjustment tax. We are talking about a president and his followers who do not seem to understand the concept of a deal where everyone can end up being better off. His constituents claim they have never witnessed it. Their choice of president is a transaction- or deal-oriented person who appears to believe the size of the economic pie cannot grow, so you have to take it from others. When a deal is struck, you either get more and are a “winner”, or you get less and are a “loser”. The fact is that this tax can show his voters that he is strong (a winner) and is not afraid of taking on trade partners who apparently have done America harm. Importantly, this particular initiative can also be used as a bargaining chip for dealmaking when his people sit down with different trade partners to cut a better deal for America. Politically, it seems like a no-brainer.
The market does not seem to be giving the politics around this proposal enough respect.
I would suggest that the markets have been spoiled over the last twenty years, when policy has ruled over politics. This has sadly been the result of US government gridlock and many policies being enacted by unelected institutions, like the Fed. Following this election, this no longer appears to be the case. An investor must now consider politics more than in the past. One must cast their mind back to the politically motivated micro managing of Presidents Johnson, Nixon and Ford, to name a few.
President Johnson, for instance, believed he could battle inflation by bullying and manipulating companies. As Sebastian Mallaby points out in his biography on Alan Greenspan, Johnson became personally involved in trying to lower the prices of aluminum, copper, household appliances, paper cartons, newsprint, men’s underwear, women’s hosiery and glass containers, and “when egg prices rose in 1966, he had the surgeon general issue a warning on the hazards of cholesterol in eggs.” His micro-management made no sense in terms of economic policy but it was not stopped by cooler heads around him, those of whom knew that this would do more harm than good.
The US has a president-elect now who has started to bully and manipulate both foreign and domestic companies through social media on how they should allocate their labor resources globally. Some in the media have suggested he has already had a few “wins” doing this. Others have pointed out the similarities of actions taken by Mussolini in Italy. These tweets are obviously not based on robust macro-economic theory and cannot be considered good policy at any time, let alone unnecessary when the US economy is already at full employment. President-Elect Trump’s actions are the result of how he operates and are done in recognition of what he believes his voters want to see. If policy mattered more than politics, I would suggest the first thing on the administration’s plate would be tax cuts, not the repeal of Obamacare before any replacement has been contemplated.
The market wants to believe the best outcome and I hope it is right and I am wrong. However, until I see the brave souls who will act as the cooler heads and speak up or take actions to ensure that the good policies will be enacted, I will say that the US equity market is ahead of itself.
Welcome back to the 1960’s and 1970’s where politics trumps good policy.
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