As rich as President Trump is, he would make Jeff Bezos look like a pauper if he could reliably predict and time stock market movements. But because the variables driving equity prices are so diffuse and manifold, no one person has that capability. For that reason, it is not only risky to trade volatile securities, but also to stake your presidency on their performance.
The president has repeatedly touted the performance of stock prices since his election as evidence of the merit of his record. Indeed, the S&P 500 has appreciated an impressive 24 percent since his election and 17 percent since his inauguration at Monday’s market close. Some indeterminable fraction of that appreciation is probably due to Trump administration initiatives, including tax reform and a taming of the regulatory state that have improved the economic outlook.
However, the dramatic selloff in financial markets since Jan. 26 should be a reminder to the president that the marker he has set for himself is tenuous. The S&P 500 fell 8 percent from Jan. 26 to Feb. 5, with bond and commodity prices not so far behind. Monday was its largest single day decline in percentage terms since 2015 and the 60th largest since 1950. By the standard set by the president himself, that is prima facie evidence that his agenda is faring worse than earlier.
But, ironically, the selloff appeared to be triggered last week by positive economic news. Good data, including surprising job growth and the fastest wage growth since 2009, increases the likelihood that the Federal Reserve will raise interest rates in accordance with its dual mandate of growth and price stability. That causes an increase in yields for fixed income securities, like government bonds, and also a sell-off in stocks by investors buying now-cheaper bonds.
The 10-year Treasury yield climbed from 2.04 percent in early September to 2.77 percent Monday thanks to higher inflation, growth, and tighter monetary policy. The implied trailing S&P 500 earnings yield meanwhile fell from an estimated 4.33 percent to 4.04 percent. The spread between the two is the lowest since early 2010. Thus, many investors sold risky stocks at a small discount to safe haven bonds, whose yields actually began to fall on Friday.
In this way, an economic success story indirectly staunched stock market exuberance. Specifically, higher wage growth in the first month of the new tax reform law, as predicted by news stories of hundreds of companies raising pay for workers in its aftermath, might have tempered Trump’s preferred measure of his own success.
There are still more reasons the president should worry that the stock market will lag other barometers of his economic record going forward. First, it is likely that the Federal Reserve will increase its baseline interest rate thrice this year because of higher wage growth and inflation. Second, Treasury yields remain slightly high compared to equity earnings yields on a historical basis. Third, absolute valuations are very high on a historical basis, with the cyclically-adjusted price-to-earnings ratio the highest since the dot-com bubble. While a lot of the recent rally was thanks to improved earnings outlook, a lot was also due to multiple expansion. It does not take a sophisticated technical trader to look at a chart of the stock market in recent months and think that the rally warranted a pullback.
Fortunately, the fundamental underpinnings of the U.S. economy are good at the same time that markets are getting rolled. Trump should sooner worry about GDP than the S&P. Real economic growth accelerated the last three quarters to an average of 3 percent compared to 2.1 percent over the previous eight years. The recent spate of growth is particularly underpinned by higher business investment, which was lacking in recent years, and should lead to higher productivity and wages.
Job growth continues apace despite a tighter labor market and wage growth is picking up. Price inflation has increased, but only to a healthy level of 2 percent. The yield curve remains normal, with long-term interest rates a premium to short-term, whereas an inverted one normally predicts recession. The Federal Reserve tightening appears orderly and reasonable from historically accommodative levels. And, finally, there is no clear evidence of a systemic economic bubble or excess leverage in the private economy.
The economy is on firm footing and there is some evidence of improvement under the Trump administration. However, there is not yet evidence that it has broken out from 18 years of tepid growth. And it might not break out in the next seven years, either, even with good management. Just as the president cannot easily influence the stock market over time, he cannot easily influence the economy. Nor should he be able to. The best we can hope for are marginal improvements in policy leading to marginal improvements in material well-being. And that is the basis on which the president should defend his agenda.
First, there is evidence that tax and regulatory reform will increase business investment and wages. Hundreds of companies have already announced pay increases to millions of workers in light of tax reform at the same time that wage data is improving. Most analysts expect the new law will grow the economy and almost none project it will shrink it. The deceleration of regulatory costs at the direction the Trump administration has led many businesses to plan new investment and hiring. Republicans consistently support measures that grow the economic pie, while Democrats support those that will shrink it, including tax increases, large minimum wage hikes, onerous environmental regulation, the Affordable Care Act, and so on.
Second, the president’s tax and regulatory agenda is desirable on its face for basic philosophical reasons. The new tax law reduces the penalty to work and investment by lowering tax rates across the board and pays for most of that by reducing special deductions and exemptions that privilege certain economic activity over others. The Trump administration is also trying to curb the burdens of the bureaucratic state for the first time after decades of inexorable growth. The body of law cannot be fair so long as it is too vast and complex for anyone but the best lawyers to understand. A regulatory budget is a small step toward protecting the freedom of American citizens from excessive and arbitrary controls.
The major elements of Trump’s economic agenda, excluding higher tariffs, stand on their own merit. Financial markets, meanwhile, are volatile, convoluted, and out of the president’s control. Politicians who try to live by them, might just die by them. Instead, the president should help his own cause by not avoiding the best arguments for his policies, even if they are not the easiest ones to make.
Important disclosure: Nothing above is meant to serve as investment advice or should be used to trade financial instruments. It is purely a high-level commentary on politics, markets, and the macroeconomy.
