Sentiment is a peculiar thing. It can turn on a dime. Recently, those dimes have piled up quickly. Since early November, significant new paper wealth has been created from rising stock prices.
The big shift in investor sentiment over the past eight weeks undoubtedly centers around Trump’s victory and the anticipation of Republican control of all three levers of the federal government.
Since the election, the broad stock market has leapt about 7% and stock indexes of smaller, domestic companies have popped about 15%. Is this supportable?
Perhaps it’s true plans for fewer regulations and coming tax cuts may explain some of it. Possibly it’s true that plans for increased infrastructure spending has had some effect. Maybe it’s also true the president-elect’s cabinet appointments foreshadow even more pro-business policies to come.
Yet, these factors alone are difficult for me to explain such a sudden mood shift. Change often happens slowly and, as a result, markets often overshoot expectations.
Here are a few things that concern me with investors’ recent – almost instant – positive reaction to the election.
First, tax cuts aren’t all created the same. Much depends on who receives the tax cuts and what they choose to do with the extra money.
When tax cuts accrue to the wealthiest households, they tend to spend less of their windfall than do the poor. The Bush tax cuts – also heavily weighted to the wealthy – were an example of a lower “multiplier” effect on economic growth. Similarly, if the currently anticipated tax cuts end up sitting in the bank, the effect on the economy may be far smaller than many now anticipate.
While it’s true some will invest back in the economy, that decision will be driven only by a clear-eyed assessment of unmet demand for goods and services. Absent that new demand, many businesses may choose to instead increase dividends, buy back their own stock, or pay down debt. These actions aren’t nearly as impactful on growth as hiring new workers, investing in research and development, building new factories or even raising wages for workers.
Second, given the importance of global trade, it’s troubling to hear the chatter of imposing tariffs, watch the strengthening of the US dollar or read threatening tweets about trade wars. The notion that it’s all just tough talk may be unwise to assume. In response, large multinational corporations will flex their well developed lobbying muscles. But, it may prove quite difficult to put the protectionist genie back in the bottle.
Finally, stocks are trading at all-time highs. Reputable measures of the stock market’s value, such as the Shiller Price-Earnings metric, should not be waived off so readily. An immutable law of finance is the higher price you pay, the lower your future return.
The past two months of 2016 reminds me of something Warren Buffett once said, “Investors pay a very high price in the stock market for a cheery consensus.” If today’s sentiment on Wall Street can be described in a single word, cheery, most certainly fits the bill.
