Realities vs Expectations of The Trump Economic Agenda
The stock markets continue to push higher. On seemingly endless momentum, they nudge forward, establishing new all-time highs along the way. As of July 26, the benchmark S&P 500 has recorded 29 record closes for the year. Market volatility remains low and the S&P 500 has not fallen more than 5 percent off its all-time high in over a year. In short, reality has been kind.
But much of this success has been predicated on certain expectations, primarily, the proposed economic policies of President Trump. Soon after his election victory, the financial markets quickly priced in a highly pro-growth and inflationary economic agenda. Tax reform, deregulation, infrastructure spending and incentives to repatriate corporate overseas funds became the economic cornerstones of the new Administration.
These initiatives, the markets surmised, would help propel economic growth, and ultimately, corporate profits. Combined with a healthy labor market, the resulting inflationary pressures would trigger an environment of interest rate hikes, already being proposed by an eager Federal Reserve. On the political front, President Trump and a Republican controlled House and Senate would be able to pass through legislation with urgency. Consequently, stock values soared.
Since the November 8 election, the S&P 500 is up 15 percent. But stock valuations aren’t just high, they’re very high. To illustrate, the consolidated P/E (price-to-earnings) ratio for the S&P 500 is 22.1, well above the 10-year average of 16.7. The P/E ratio is a preferred metric that measures the market price of a company’s stock relative to its earnings. A high P/E ratio indicates the price of stock is overvalued based on the actual earnings it has achieved.
The expectations of President Trump’s economic agenda have certainly been a key driver of the bull market and ultra-high stock valuations. Inherently, markets tend to react first and assess later. But did the markets overreact to the initial euphoria of a Trump-based economy? Increasingly, the Fed, tasked with establishing America’s monetary policy, and the financial markets, are starting to ask that very question. In a recent Bank America Merrill Lynch survey, a record 83 percent of fund managers said that U.S. stock markets are overvalued.
Is President Trump’s economic agenda pro-growth and inflationary? Yes. But much of this rally was derived on the assumption these policy initiatives would be passed with some measure of expediency. It’s been over six months since the January 20 inauguration, and the financial markets are growing frustrated with the lack of progress.
Despite controlling both chambers of Congress, it’s clear that President Trump has not been given a carte blanche waiver. At some point, President Trump and the Republicans will have to deliver. To justify the high valuations currently imbedded in stock prices, his economic policies must be converted into legislation. The more difficulty President Trump has in getting his economic agenda through Congress, the greater the concern that stock markets will remain overvalued. His continuing setbacks raise a growing concern of when, and in what form, will this legislation actually get passed?
While the financial markets aren’t bailing on the “Trump trade”, cracks are certainly beginning to form. Attempts to repeal and replace President Obama’s Affordable Care Act have failed. Odds of a third Fed rate hike planned for 2017 are dwindling. Investigations into improper ties to Russia may further delay or stall President Trump’s agenda. The signature piece of his economic plan, tax reform, once planned to be passed this year, looks to be pushed into 2018. Either way, President Trump’s economic agenda, once thought to follow a path of least resistance, has increasingly become mired in uncertainty.
For now, the markets still embrace a wait-and-see mentality to the legislation that has yet to “catch up” to the realized valuations in stock prices. There are some tailwinds to help provide cover as they wait. Economic growth should continue at a moderate pace and the labor market remains strong with low unemployment. The initial results of the latest corporate earnings season have been positive, and slightly above forecasts. At some point, the reality of high valuations must start to connect with the expectations set in President Trump’s economic agenda. So far, the financial markets have been patient, but patience can wear thin.
Opinions expressed herein are subject to change without notice. Any prices or quotations contained herein are indicative only and do not constitute an offer to buy or sell any securities at any given price. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets, or developments mentioned.
Quad Cities Investment Group, LLC is a registered investment advisor with the U.S. Securities Exchange Commission.
