Is President Trump Responsible for the Dow’s Surge?

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Confidence that Mr. Trump’s new policies will recharge corporate earnings has contributed to the rise of the S&P 500 by more than 8% and helped the Dow Jones Industrial Average to hit the much-anticipated 20,000 point threshold. Many economists and strategists for Wall Street banks are divided on the causes of the recent rally.

The Trump reflation consists of markets betting that the new president’s policies will stimulate inflation and growth. Investors responded to this by moving out of bond markets into equities.

Tom Beckett, Chief Investment Officer of Psigma Investment Management, advises against too much Trump trading: “We are somewhat skeptical about the ability for Donald to practice what he tweets.”

The White House’s recent agenda suggests a strikingly contradictory mix of free-market and anti-growth policies. Since Donald Trump’s election in November of 2016, the business community has been questioning the Trump administration’s ability to reach its promised annual growth rate for the American economy. The administration’s ambitions proposals target a very robust 3-4% level that has been unprecedented since the peak of the technology bubble in 1999-2000. The Federal Reserve, on the other hand, places its expectation at a more conservative 2%.

Confidence that Mr. Trump’s new policies will recharge corporate earnings has contributed to the rise of the S&P 500 by more than 8% and helped the Dow Jones Industrial Average to hit the much-anticipated 20,000 point threshold. Many economists and strategists for Wall Street banks are divided on the causes of the recent rally. The debate around whether or not U.S. stock indexes will continue to appreciate continues to get more heated as Mr. Trump falls behind on getting his tax and regulatory agendas through Congress.

Nobel Prize winner Robert Schiller attributed the recent rally to “animal spirits” that Mr. Trump’s surprise election caused. Mr. Schiller cautioned investors against the risk of markets taking a nosedive from its current potentially overvalued position. This could take place if investors believe that the President cannot deliver the degree of GDP growth he has promised.

While the term “animal spirits” reminds many of us Alan Greenspan’s famous “irrational exuberance speech” from 1996, referring to asset prices reaching unsustainably high levels, research data shows that the “Trump rally” in the market  was not completely caused by irrational investor psychology. While Trump’s surprise election provided the spark that improved the so-called animal spirits in many sectors, he won the election as the economy was already improving. Most of the upward movement in American stock prices can be attributed to positive developments from economic growth indicators such as the unemployment rate, consumer confidence, and meeting the inflation target. To this effect, Citigroup has even created an Economic Surprise Index that measures data surprises and developments relative to market expectations.

These findings demonstrate that the stock market has the highest positive future earnings outlook (expressed by forward looking Price to Earnings, P/E ratio) when the recent economic data have beaten the expectations. Jim Paulsen, who is the chief economic strategist of Wells Capital (Wells Fargo Asset Management) took this relationship a step further and quantified annualized stock market returns and Economic Surprise Index. Since 2010, average annualized percentage price gain in S&P 500 proved to be high as 28.6% when the reading of the Economic Surprise Index was at the highest quartile, while it only appreciated by 3.4% per annum when the reading of the index was at its lowest quartile. Mr. Paulsen believes that the direction of the economic surprises is an important driver of the stock market, and the level of economic surprises (whether economic surprises are common, collected under highest quartile of readings, or rare, collected under lowest quartile of readings) dictate the performance of the stock market.

Mr. Paulsen argues that “many attribute racing stock market to a ‘Trump Bump.’” He worries that a presidential misstep or failure to deliver on a campaign promise will leave stocks vulnerable to a significant correction. He argues that “the stock market is far less susceptible to Trump’s antics.” Instead, he attributes the current rally to “a broad global synchronized bounce in economic momentum.” The impact of animal spirits in boosting consumer confidence and fueling the economic momentum cannot be stripped out entirely. However, it is somewhat relieving  to see that there is evidence of persistent economic improvement or, in the words of Mr. Paulsen: “This has not been a stock rally based on some flimsy Trump Hope,” but rather underpinned by “one of the largest and most persistent economic improvements of the entire global economic recovery.”

At the March 15th Federal Open Market Committee (FOMC) meeting, Federal Reserve’s Chairwoman Janet Yellen remarked that U.S. economy is doing well overall and remains resistant to shocks. The strengthening of the economy has been reflected in investors’ increasingly positive future outlooks. Ms. Yellen has also agreed that most businesses and investors are not as affected by the uncertainty caused by the new administration’s proposed policy changes but rather by paying more attention to signs of economic improvements. While the pace of annual economic growth in the U.S. is in line with the long-term target rate of 2%, Ms. Yellen maintains that “the monetary policy remains accommodative to create more room for strengthening in the labor market.”

Despite steady economic performance, Ms. Yellen has been criticized by President Trump for not providing a timely increase of the rates and blocking economic growth. Mr. Trump has publicly expressed his disapproval of the chairwoman and has stated that he intends to replace Ms. Yellen at the end of her term. At the end of the March 15 meeting, Ms. Yellen was asked if the Federal Reserve is standing in the way of the new administration’s proposed growth agenda. To the surprise of most of her critics, Ms. Yellen remarked that the Fed “welcomes faster growth in terms of price stability and productivity growth.” In other words, the central bank welcomes any policy changes that the new administration finds useful in bolstering more rapid economic growth.

After this announcement emphasizing a solid recovery in consumer confidence and in job market growth, the U.S. Equity Index future experienced strong upward movement in the pre-trading hours on March 16th. Some concluded this was indicative of expectations of economic growth. While this could be true, the impact of “animal spirits” created by Trump’s promises of policy changes is considered by some to be a substantial threat to the stability of stock prices.

In the time since November 9th, markets have been seeing the impact of so-called “Trump Reflation” both on stock and bond markets. This reflation consists of markets betting that the new president’s policies will stimulate inflation and growth. Investors responded to this by moving out of bond markets into equities, by selling bonds, which lose value in inflationary times with fixed interest payouts. In place of these bonds, they purchased equities, which benefit from higher growth. Investors like Tom Beckett, Chief Investment Officer of Psigma Investment Management believe that this reflationary trade is largely responsible for the stock market rally following Trump’s election.

While Mr. Beckett recognizes the sizeable importance of animal spirits caused by Trump’s promise of economic policy changes, Mr. Beckett advises against too much Trump trading: “We are somewhat skeptical about the ability for Donald to practice what he tweets.”

Elif Korkmaz is a student at Cornell University’s School of Industrial and Labor Relations.

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