There was a significant outburst of enthusiasm from the financial markets, especially the equity markets, following the U.S. election result last November. The S&P 500 rallied by 3.5%, led by financials, industrials and cyclical stocks, and many other markets around the world also enjoyed a rebound.
Today, expectations are, as Donald Trump would say, “Huge.” The “animal spirits,” famously described by economist John Maynard Keynes, have been unleashed, or so it seems. Indeed, at the end of last week the Dow Jones Industrial Average broke through the 20,000 mark for the first time. And the VIX volatility index fell to its lowest level since July 2014. Is this the triumph of hope over fear, or are investors getting carried away with themselves?
Paradigm Shift
To be sure, there’s much to be positive about. Change is in the air and there’s a paradigm shift in the U.S. economy that’s almost palpable. Consumer confidence in the U.S. is ticking up, as is CEO confidence. U.S. small business confidence, for example, is at its highest level since 1994. This higher confidence, if translated into action, should lead to greater economic risk-taking as CEOs look to reinvest in their businesses after years of keeping their powder dry.
The much-vaunted U.S. infrastructure spend is also grabbing headlines, with excited talk of new investment in transport, telecoms and energy, among other areas. Again, this should lead to meaningful growth. And the planned reform of both corporate and individual tax rates should prove a boon for both companies and consumers.
Elsewhere, CEOs have long complained about the growing financial regulatory burden and the role of the Environmental Protection Agency. Both are in the new administration’s sights.
Turning to monetary policy, central banks have already done much of the heavy lifting, but their impact has diminished in recent years. What we’re seeing now is a gradual shift away from monetary stimulus to fiscal stimulus. The knock-on effect of this is the return of inflation and higher interest rates. Indeed, there is an expectation of two, maybe three, interest rate rises by the Federal Reserve this year. In short, we’re beginning to see the return of the business cycle and economic expansion – something we last saw way back in 2007/2008.
Tough Medicine
So what‘s the downside?
Without wishing to pour cold water on the current market exuberance, it’s worth noting that, after the November bounce, markets were relatively flat in December and the first three weeks of January. While U.S. asset prices may have risen, the real economy has not done quite as well. Indeed, amidst all the enthusiasm, there’s an underlying anxiety about how much the new Trump administration can actually accomplish. The implementation of new tax laws, regulatory reform and infrastructure policy, for example, will take much time and effort, and the process may run well into 2018. That said, we do believe these policy changes will have a positive long-term effect on GDP growth, and, importantly, earnings growth.
One of the most challenging issues, however, will be health care reform. It’s an important item on President Trump’s agenda and his administration will focus meaningful efforts on it. However, it won’t be easy to repeal and replace Obamacare. It’s an enormous piece of legislation to unwind and it’s not yet clear quite how they’re going to do it. Nor do we know what impact, if any, it will have on the health and pharmaceutical sectors.
Meanwhile, the surge in nationalism doesn’t bode well for global trade. Protectionism has been on the rise for a number of years and looks set to continue. The developments in Europe, in particular, concern us and the elections in France and Germany later this year could yet spook markets. Few investors predicted the U.K.’s “Brexit” vote, for example, and a year ago Donald Trump was viewed as a long shot.
Taken collectively, these issues raise the possibility of setbacks and disappointments along the way. Indeed, this year we’re likely to experience a bumpy ride. But my advice to investors is to focus on the long term, while remaining mindful of the risks and possible setbacks along the way.
Neuberger Berman’s CIO insight