Stock markets typically go gaga over a new president. The election is over and the voters who picked the winner bask in the hope that the candidate will actually keep those campaign promises that earned their votes.
This year the market is more gaga than usual. The Standard & Poor’s 500 stock index was up 4.97% in the last month as of the close on December 13. Pretty impressive for a stock market that started off near record highs.
There are a number of reasons that what I call Trumphoria has pushed stocks so far so fast. The election results came as a genuine surprise to many people on Wall Street who have had to reverse their positive and negative bets on a victory by Hillary Clinton. President-elect Trump’s campaign promise of a $1 trillion investment in rebuilding U.S. infrastructure has boosted hopes of higher economic growth. CEOs and the portfolio managers have been cheered by his promise to cut corporate tax rates to 15%. His promise to bring the hundreds of billions now stashed off-shore by U.S. companies back home and set off an investment boom sounds like it would add to economic growth too. And taxpayers on and off Wall Street have been cheered by his promise to cut taxes for individual investors–and thus spur even more economic growth. With those tax cuts looming next year there sure isn’t any reason to sell and take profits this year–better to wait for next year and pay less tax.
But, historically, the stock market honeymoon that greets a new president doesn’t last all that long before it runs into the limits of actually governing. Promises have to be compromised. The details, once spelled out, don’t gleam quite as brilliantly as the grand plans did.
Sometimes the nasty realities of Washington politics emerge almost immediately as they did for Barack Obama, who took office as Republicans proclaimed that they would make him a one-term president. Sometimes they last longer as a new president successfully grabs the moment to build momentum.
I give Trumphoria until February. I think the market’s enthusiasm will be tempered rather quickly as Trump gets introduced to the realities of Congress.
A new presidency goes through stages that can drive stock market optimism or pessimism. And those stages are, strangely, similar to those experienced in the purchase of a new car.
Buy one and your initial reaction is to see only the good things. It has that new car smell. You constantly discover new features and go “Wow! It does that?” All you hear is the powerful rumble of the motor and the quiet whosh of motion.
Sometime after that initial stage, though, no matter now good or bad the car ultimately turns out to be you start to hear a rattle where there isn’t supposed to be one. Or you notice that a piece of interior trim isn’t quite flush. Or you discover a new feature and go “God! I wish it didn’t do that.”
During the next stage you discover, truly, whether you bought a good car or a lemon by living with it and you learn, gradually, to cope with the mix of the good and the bad. Or you decide to sell as quickly as you can if the car is truly, truly bad.
Right now in the stock market we’re deep into Stage 1 but looking toward Stage 2. Neither Stage 1 or Stage 2 have little to do with whether a president’s whole term will be good, bad, or indifferent. No matter whether you’re talking about Warren G. Harding or Teddy Roosevelt for four years, in the shorter run, the realities of Washington inevitably take some of the shine off an administration not too soon after it takes office. Of course some Presidents manage to make this Stage 1 to Stage 2 transition rather ugly and rapid.
And that’s why, if the market’s enthusiasm for a Trump presidency is a good part of the rally over the last month and more, it’s important for investors to at least think about how long this enthusiasm for President Trump will last at its current level of enthusiasm.
I think that’s especially important because Trump was a rather unusual presidential candidate and he promises to be a rather unusual President. He ran as an outsider and promised to shake things up–that immediately puts him at odds with the powers that be in Washington who would prefer not to be shaken up. He ran and won as a Republican but many of this policies have nothing to do with Republican orthodoxy. Some, in fact, such as his policies on trade run head on into the interests of sizable parts of the Republican Party. And his management style, at least as it’s on display by his transition team, isn’t based on consensus building or gradual change and nuance. A President Trump seems likely to run up against the political realities of Washington very quickly.
I don’t think the stock market currently much cares about most of the issues that occupy the media. I don’t think the market cares much right now about Trump’s business conflicts of interest. Or about Steve Mnuchin, Trump’s nominee for Treasury Secretary, profiteering from the sub-prime mortgage crisis. Or about the policies a Trump Department of Education under Betsy DeVoss or the Department of Human Services under Ben Carson would pursue. Maybe the market should. But by and large it doesn’t unless those “extraneous” issues have an impact on the things that the market does care about.
Why do I think the new car smell starts to smell a little stale in February? Congress is back in session. The Trump administration submits a budget. Hearings on Trump nominees begins.
The $1 trillion infrastructure program is going to hit considerable opposition. That may seem strange to those of us who think rebuilding the country’s infrastructure is a no-brainer, but a considerable number of Congressional Republicans don’t believe in government spending for anything and another group of Republicans don’t believe in paying for any program with debt. With interest rates on the 10-year Treasury at 2.46%, I think borrowing for long-term infrastructure investment is a good investment, but not everyone agrees with me. Senate majority leader Mitch MdConnell has said that he’d like to avoid a $1 billion stimulus by making sure that most of the financing comes from the private sector. “What I hope we will clearly avoid, and I’m confident we will, is a trillion-dollar stimulus,” he has said. “Take you back to 2009. We borrowed $1 trillion and nobody could find that it did much of anything. So we need to do this carefully and correctly and the issue of how to pay for it needs to be dealt with responsibly.” Of course, a $1 trillion stimulus is pretty much what this rally has been hoping for. (By the way Trump has named McConnell’s wife, former Labor Secretary Elaine Chao, to run the Department of Transportation. Should give the McConnels something to talk about at breakfast.)
The Trump tax cut is going to face the same opposition on the same issues. On December 12 McConnell said “I think this level of national debt is dangerous and unacceptable,” McConnell said, adding he hopes Congress doesn’t lose sight of that when it acts next year. “My preference on tax reform is that it be revenue neutral.” Of course, you can score a tax cut revenue neutral using all kinds of tricks and gimmicks. Too much honest accounting, though, would put a dent in market hopes for a 15% corporate tax rate and for a big cut in personal income taxes.
The Trump administration will submit its first budget shortly after the State of the Union address. February is a reasonable target. President Obama delivered his last budget on February 9, 2016. The budget puts all a President’s spending and cutting ideas in one place. It’s way too concrete to leave everyone happy. (And, then, there’s the looming battle over the debt ceiling later in the year.)
At about the same time the Senate will begin the process of confirming Trump’s cabinet nominees. I think it’s safe to assume that after watching the Republicans refuse to even hold hearings on Obama’s Supreme Court nominee Merrick Garland and delaying a vote on his Attorney General choice Loretta Lynch, Democrats won’t be in any mood to give quick passage to the more controversial of Trump’s nominees. The Senate’s procedural rules don’t let the majority steamroller the minority in the same way as the majority can in the House of Representatives and the rules allow procedural moves that could force up to 30 hours of debate on each nominee and that would require McConnell to hold role call votes in each case. I think when all is said and done, the Senate will vote to confirm all of Trump’s nominees because in the end it only takes 51 votes to confirm and Republicans have 52 as long as they hold together, but you can expect the hearings for Mnuchin at Treasury, Rex Tillerson for State, and Jeff Sessions for Attorney General to be heated. The hearings on Treasury and State are likely to resonate with the stock markets since markets, and especially overseas markets are to this point assuming that Mnuchin’s ties to Goldman Sachs make him a reassuring choice. Anything that undercuts Tillerson’s credibility is an issue since the financial markets aren’t certain what to make of a Trump administration’s foreign policy.
And finally, with the turn of the calendar in January, the incentive not to sell in 2016 goes away. In all probability Congress won’t act on a Trump tax plan until June or July, but investors are probably safe in assuming that rates will be retroactive to the beginning of the year. So in January any one looking to sell at the current market peak can do so without worrying about paying a higher tax rate.
I don’t know that this kind of tax-timing means that some of this year’s November and December rally has been borrowed from the Santa rally and January effect (which usually starts in November) but I think it’s a reasonable possibility. If so, the January drop off in enthusiasm may be relatively large.
We’ll get a sneak peak at how important Mnuchin’s credibility is in the next few days after the Federal Reserve’s interest rates increase. Will President-elect Trump, who has made no secret of his lack of respect for Janet Yellen’s Fed feel compelled to Tweet something negative about the Fed?