• Vladimir Chlouba

Exuberant Equities in the Age of Trump

It should not surprise us if the first half of 2017 became known as the prime example of the markets’ unhinged proclivity to release their animal spirits. Indeed, particularly American equities have shown remarkable optimism and at times even exuberance, all despite (and sometimes because of) the policy whims of the current US administration. The S&P 500, a wider index that measures the performance of the US stock market, has risen by almost fourteen per cent since Donald Trump was elected in November of last year.


Consensus has it that equities rallied due to president Trump’s bullish policy proposals, particularly his hints at fiscal expansion, either actuated through large tax cuts, infrastructure spending, or both. Characteristically however, the markets seem to be cherry picking the proposals they deem desirable while conveniently ignoring those that are likely to cause considerable damage. Let us mention the already realized steps such as pulling out of the Trans-Pacific Partnership (TPP) as well as merely proposed policy changes of the likes of the infamous border adjustment tax (BAT, a tax levied on imported goods), which could seriously disrupt the US economy.


Furthermore, one must not forget that in the current economic climate, aggressive fiscal expansion could prove a double-edged sword. The American economy is already in the vicinity of full employment with inflation near the desired rate of two per cent. Because the unemployment rate can hardly decrease further, additional fiscal stimulus is likely to lead to higher inflation. This would force the Fed to take action by increasing interest rates. Higher interest rates would cause the US dollar to appreciate, American exports would lose competitiveness as a result and the entire economy could easily slip into another recession. More importantly, the Fed has long held its benchmark interest rate at particularly low levels and the central bank has not yet had enough time to create the space it needs to respond to the next crisis. Any development which would force the American central bank to rapidly increase interest rates only to subsequently slash them when a recession hits is precisely the kind of event Janet Yellen would prefer to avoid.


Effective Federal Funds Rate - the benchmark interest rate used by the Fed


Lastly, let us not forget that the underlying global uncertainty which had contributed to sluggish stock market performance during late 2014 and much of 2015 is not entirely gone. Quite to the contrary, recent developments on the Korean peninsula, in the Persian Gulf, and elsewhere make it palpably clear that a descent into another crisis remains a real possibility.


To be sure, not all is bleak and the committed optimist will find his reasons to remain sanguine about the future. First, company earnings have seen an improving trend recently. Second, the European economy appears to have gotten out of its long-lasting slump and the victory of Emmanuel Macron in the French presidential election, as well as the receding tide of populist politics in general, suggest that the Old Continent might finally embark on much-needed structural reforms. Be that as it may, the opportunities for a better future are yet to be taken advantage of, the many risks discussed above are already upon us.

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