Is Trump Rally on Stable Ground?
Stocks continue to rally following Donald Trump’s presidential election victory, with the major benchmark indices in record territory. Many sectors have really benefited from the “Trump bump.” But is the U.S. economy, and by extension, the U.S. stock market, really on stable ground? And is the Trump-led rally sustainable?
The fact of the matter is, no one really knows what’s going to happen when Donald Trump takes over the Oval Office on January 20, 2017. But the markets are reacting as if they do. Investors are convinced that Trump’s policies will be good for U.S. business and their retirement portfolios. Unfortunately, the rally over the last three weeks may be more than a little premature. It may even be wrong.
Advertisement
Investors are content in embracing the idea that Trump will implement all of his business-friendly policies, including lower taxes, less regulation, and $1.0 trillion in infrastructure spending.
At the same time, investors assume he will not implement any of the negative ideas he outlined. This includes breaking up trade agreements and implementing higher tariffs on imports from China and Mexico. Both could easily negate any of the benefits from Trump’s “Make America Great Again” policies.
Rising Interest Rates May Be the Only Certainty
Again, Trump’s policies are not just untested; they’re essentially unknown at this point. But the raft of seemingly positive economic indicators does point to one thing: rising interest rates.
Should Trump’s economic policies gain traction, interest rates will continue to rise in 2017. On the flip side, if Trump’s economic agenda stalls economic expansion and instead produces inflation, rates will still rise.
Rising interest rates and inflation coupled with a strong U.S. dollar would have serious implications on those laden with debt (as a result of near-zero interest rates), which includes both U.S. consumers (the group responsible for powering U.S growth) and corporate America.
In the second quarter, household debt in the U.S. advanced by $35.0 billion to $12.3 trillion. The increase is driven mainly by credit cards and auto loans. Auto loans are a constant, but Americans are embracing credit card debt again after cutting back after the recession. Credit card use among those with low/subprime credit scores are at their highest levels since 2008. (Source: “Household Debt Balances Increase Slightly, Boosted By Growth In Auto Loan And Credit Card Balances,” Federal Reserve Bank of New York, August 9, 2016.)
In effect, consumer debt continues to drive U.S. growth. Yes, correlation is not causation, but higher interest rates on increased debt, especially in a country where more than half are living paycheck to paycheck, does not bode well for the economy.
What about Wall Street? Stocks have nosebleed valuations. We may no longer be in an earnings recession, but after trillions of dollars in quantitative easing and artificially low interest rates, returns are still moribund, and the chances of falling back into an earnings recession is not exactly remote.
Further, the odds of corporate America being able to recover quickly are slim, especially when you consider that corporate spending has been exceeding cash flow by a near-record amount. Many U.S. companies have been financing their stock repurchase plans with debt in order to boost their financials and stock prices.
This is not a sustainable practice. Debt may not be so bad when interest rates are low, but it’s a different matter when they start to rise. And rise they will in 2017.
Investors may not be paying attention to valuations, but eventually stocks will be measured by rising earnings. Rising interest rates, rising debt levels, and a stronger U.S. dollar (which will undermine exports) will undercut revenue and earnings growth even further.
Investors and corporate America are enjoying the Trump-led rally, but that may not be the case in 2017.
