His campaign platform was based on pro-growth, lower taxes, tougher trade and immigration policies, and a more combative national security platform. What happens in the economy and markets as a result of his term in office may certainly mean more change than investors have been used to.
The election results have led to a new outlook for the economy and the markets. The rally in markets and expectations for growth may be based on renewed optimism that business investing will now be fruitful again. We’ve seen stocks rally, especially in cyclical industries since the election, while defensive stocks lagged, as expectations for higher growth, inflation and interest rates rise.
So far, Trump has been true to his campaign promises. He’s nominated and appointed businessmen focused on changing the political status quo. As Trump takes office, we might expect to see the impact of regulatory changes first with cabinet and agency appointments who are likely to take a different approach to enforcing current laws and regulations. Tax cuts are likely next with a Republican majority in Congress. Infrastructure investments will likely take longer to emerge.
Apart from the renewed optimism surrounding Trump, economic data had already been improving after what was a very weak first half in 2016. Both consumer and business optimism is high. Third quarter GDP growth came in at 3.5 percent, and expectations for fourth quarter are between 2.5 - 2.9 percent. Capitalism is a confidence game, and confidence is rising in the U.S.
While the recent stock rally was due in part to expectations of policy reform and stimulus, prospects for earnings growth also play a part. The earnings recession ended in the third quarter with profits rising for the first time in five quarters by 3 percent. The forecast for next year’s earnings continues to be positive. In fact, earnings expectations have almost doubled post-election.
The market is checking all the boxes in the traditional recovery playbook: rates up, stocks up, bond yield spreads tighter and business displaying a growth mindset. In contrast, prior to the election, any hint of a rate increase drove stocks down, reflecting that lower interest rates were needed to drive growth. Now growth is driving interest rates and investors believe business is back in the driver’s seat.
Long term interest rates rose by 85 basis points, which was the biggest rise since the Taper Tantrum in 2013. The change was fairly abrupt, leading to a steeper yield curve. Risk appetite remains strong though and corporate credit remains in demand. The yield differential between U.S. and foreign bonds should keep international demand for U.S. securities high as the European Central Bank and Bank of Japan continue holding their short term rates at or below zero.