On Tuesday, November 8th the American electorate shocked the pollsters, pundits, and political experts by electing Donald J. Trump as the 44th President of the United States. As I wrote in the blog post “How Will the Upcoming U.S. Presidential Election Affect Financial Markets?,” a Trump win increased the probability for short-term market volatility as investors assessed what a Trump Presidency might mean. And boy did we see volatility. As the election results began to roll in during the wee hours of the morning on Wednesday, November 9th, and it became apparent that Trump would win, global financial markets began to plunge. At one point the S&P 500 futures were limit down, dropping close to 800 points, while gold surged ahead 4%. But as the sun began to rise over New York on the 9th, S&P futures were only marginally lower. As trading opened in New York, stock prices were slightly lower and then began to surge throughout the day, finishing up close to 2%, a 7% advance from the overnight lows.
In the week following the election, the market sent several clear signals. Bank, infrastructure, and drug company stocks all advanced while bond prices fell and interest rates rose. Why? The market expects Mr. Trump to cut regulation on many industries, institute a large infrastructure program, and reduce individual and corporate tax rates, leading to higher economic growth and rising inflation expectations. The moves seen in certain companies are beginning to border on euphoric. Some have even begun to ask if this is another Regan revolution that ushered in one of the greatest stock bull markets in history. While that would be a welcome outcome, the setup of the market could not be more different than 1980. Let’s examine.
Difference in Interest Rates
In January 1980, U.S. interest rates were in the double-digits, with fears of hyperinflation. Today, interest rates are near an all-time low with fears of deflation. After Paul Volcker crushed inflation in the early Reagan years, interest rates began a 30-plus year march lower. Not only was this very beneficial to bond prices, but it also helped to ignite one of the greatest advances in stock market history. With interest rates near historical lows and likely to rise over the coming years, bond prices are likely to fall. In addition, rising interest rates may prove a headwind to rising equity prices.
Significantly Higher National Debt
In 1980, the level of national debt to the Gross Domestic Product (GDP) was relatively small as compared to today. With total debt to GDP now over 100%, increased government spending will likely push the debt and deficit higher, increasing the probability of higher interest rates and rising inflation. Higher interest rates may be an impediment to growth, as the cost of servicing the nation’s debt grows, crowding out investment in other productive areas of the economy. See our blog post on U.S. Debt Dynamics.
Stock Market Valuation
Today the S&P 500 index is trading at a price-to-earnings (P/E) ratio of 20 versus a P/E of 9 in 1980. The hyperactivity of central banks over the past 8 years led to an asset inflation in stock and bond prices. In spite of sub-par economic growth, financial markets have rallied significantly as new liquidity was pumped into the global financial system. Thus the setup for a new multi-year bull market, while possible, is not the same as when Reagan took office.
In summary, assuming much of President-Elect Trump’s economic agenda is passed by congress resulting in lower taxes, less regulation, and increased infrastructure spending, we would expect inflation expectations to rise, bond prices to fall as interest moves higher, and short-term economic growth to pick-up as increased spending moves through the economy. But because of the interest rate, debt, and valuation backdrop today, this does not necessarily mean the stock market will surge ahead in 2017.