- The post-election rally suggests confidence that economic growth will accelerate
- We see two forces at play — one fundamental, one dependent on Trump
- Keep an eye on the size and timing of tax cuts, new spending, and trade policy
The stock market rally of nearly 10% since election day seems to indicate a high degree of optimism about a boost in GDP, due in part to anticipated policy changes.
But, given the unpredictability of Washington, it’s possible there is a bit of overconfidence fueling the rally.
We see two forces at work in the rally: First, it reflects an improvement in nominal GDP since the middle of 2016, independent of the policy situation; and, second, it indicates optimism for the new Trump administration’s proposals for tax cuts, infrastructure spending, and regulatory easing.
As for the first, we believe the fundamental trend is relatively bright and appears to be sustainable, as jobs and income are on the rise. That leaves the political component.
Gauging the likely impact of Trump policies
It’s important to understand the different effects of the various policy proposals that have been raised by Trump and his surrogates, when they are likely to make it through Congress, and when their impact is likely to be felt.
A Congress unified under Republican control is likely to legislate many reforms within the first 100 days, a yardstick established by President Franklin Roosevelt’s New Deal program.
It appears that the likely policies coming from the Trump administration could boost GDP by 1%. Given that the most recent measure of GDP growth was 3.5% in the third quarter of 2016, this lift could put growth at its fastest rate since the third quarter of 2014.
The effect is often multiplied for corporate earnings
Investors often underestimate the leveraged impact of small changes in economic growth on corporate profits. Historically, increases in GDP have also produced an even larger impact for corporate revenues and earnings per share as a result of business operating leverage relative to fixed expenses.
But don’t count chickens before they hatch
The optimist case assumes that the Trump tax reforms and spending increases are implemented and that the protectionist rhetoric of his campaign does not lead to a trade war. Keep in mind also that moving legislation on Capitol Hill is all about process, and that a core of the Republican Party probably does not share the new president’s cavalier view on increasing government debt burdens. Not everything can happen, and compromises are likely on the items that make it into legislation.
The bears would argue that there is excessive optimism about economic acceleration and that the gap between reality and expectations is very wide. And, given the complexity in enacting these changes, the economy may not see the effects of Trump policy changes until 2018. Keep an eye on Washington in the next few months.