Donald Trump’s presidency is only a month old and already it is mired in unprecedented controversy. But if there is such a thing as the “Trump trade”, it looks to be secure. This week the four key US equity indices set record highs for four successive days.
The continued strength of equity prices was not confined to the US, however. All-World stock indices also closed at record highs for the first time in nearly two years. Is it possible that, with deep political uncertainties arising from Mr Trump’s election, plus the possibility of higher inflation bringing a big sell-off in the bond market, investors have got way ahead of themselves?
The global economy is operating in such an unusual set of circumstances that it is hard to make any kind of fair valuation for asset prices. Equity markets and the dollar took off shortly after Mr Trump’s election in November, apparently in a belief that big tax cuts and infrastructure spending would pump up demand over the next few years. Since then, however, the rally may have gained more fundamental momentum from generally positive data in the US, including a reassuring season of earnings announcements, against a backdrop of low interest rates.
Further evidence for this more optimistic scenario lies in the fact that stock prices in the rest of the developed world have also been strong. Economic recoveries in the eurozone and Japan have apparently taken a firmer footing, and central banks in both economies stand ready to continue providing stimulus as required.
There are, of course, some substantial risks. Wall Street may well be paying insufficient attention to what is happening in Washington beyond a vague sense that a boost to domestic demand from tax cuts and infrastructure investment is coming. It is very possible — in fact probable — that both of those fiscal actions will place money in the hands of individuals who are more likely to save than to spend it, worsening the public finances without boosting the economy very much.
Moreover, investors seem to be discounting the possibility of a serious dislocation to the economy stemming from the plans for a border adjustment tax, a more traditional tariff-based trade war, or both. The first month of Mr Trump’s presidency suggests his florid rhetoric on matters of trade and immigration generally presages attempts to implement concrete — and damaging — policies.
Another risk is that runaway inflation will cause the Fed to hike interest rates sharply, choking off the recovery and hitting corporate profitability. This scenario seems less likely. Core inflation, excluding food and fuel prices, has been largely stable. Wage growth, which fell in January to the lowest rate since August, has signally failed to show any sign of running out of control. In any case, wages may have some catching up to do after being depressed for so long.
Janet Yellen’s hawkish testimony before Congress this week signalled that the Fed may well raise rates as soon as next month. But even if it delivers the two quarter-point rises that investors have priced in by the end of the year, US policy rates will remain low by historical standards.
To the extent that “Trump trade” is in fact based on economic fundamentals rather than resting on the actions of an erratic president, it does not look particularly overdone.
Certainly, the risks are there. But those dangers derive from the actions of unpredictable policymakers rather than an economy that is currently generating growth and profits at a comforting rate.
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