It’s sink or swim time for President Trump and global financial markets
Investors are beginning to question whether a lame duck presidency is in the offing
You can bet your bottom dollar Donald Trump was hoping for a fairy-tale start to his presidency. All fanfare, folkloric feats and derring-do.
Yet 70 days in, it is more like a cautionary tale straight off the pages of the Brothers Grimm and Hans Christian Andersen. It’s Trumpelstillskin and the Emperor-has-no-clothes-on rolled into one.
It is not just one lonely voice at the back of the crowd hollering that Trump’s new policy finery is starting to look less than impressive. There is a much bigger chorus that Trump could fail to deliver on his growth-boosting promises. Investors are beginning to question whether a lame duck presidency is in the offing.
There is a lot at stake. For months, global markets have been pumped full of adrenaline on hopes that Trump’s tax-cutting, budget-busting reform plans could double US economic growth potential up to 4 per cent per annum, boosting domestic jobs and providing new stimulus for the rest of the world. Judging by equity market price action in the last week, doubts are creeping in with a vengeance.
You can hardly blame the markets for all the hype. Overfed on a blow-out diet of low US interest rates and easy cash, Trump’s promise of an extra big dollop of fiscal stimulus was only going to bloat the market’s appetite for more risk assets and for stocks to keep hitting new highs. Over the last eight years, investors have been locked in a candy shop with an over-abundance of funds from quantitative easing to feed the sugar-rush.
Clearly, irrational exuberance and animal spirits can only go so far without taking on more fuel. And unfortunately for equity market expectations, the cheap money infusion is reaching the end of the line. The Fed’s patience has run out on cheap money and recent official whispers about it shrinking its quantitative easing balance sheet now have to be taken much more seriously.
This would not be so bad on its own, but Trump’s policy initiatives are getting badly bogged down. With the White House obsessing over “Wire Tap-gate”, the much-vaunted health-care act imploding and the president’s travel ban derailed, it is no wonder markets are having doubts about Trump’s ability to push through his economic agenda.
This should be the point when Trump is winning friends, building alliances and influencing events, but the new administration is clearly floundering. If Trump’s election mandate to deliver more jobs and growth seems in any sort of doubt, the present stock market rally could go into a spectacular flame-out.
America’s S&P 500 Index is in its second longest bull market and stock valuations are looking increasingly overstretched. The S&P forward price to earnings ratio has jumped to around 18, putting US equities at their most expensive level since 2004. With 10-year US Treasury yields sitting at 2.4 per cent, matching the S&P index dividend yield, stocks are losing their lustre.
Market fear gauges are looking edgy again. The Vix volatility index is creeping up, US junk bond spreads are widening, the US dollar is losing ground and oil prices are dipping. It has all the hallmarks of investors getting into safe haven, flight-to-quality mode again, which, if there is a sudden rush to the exits, could hit higher risk assets and emerging markets extremely hard.
The spectre of an all-out global stock market meltdown is the last thing the world economy needs at this stage of the recovery cycle. World trade growth is still as flat as a pancake right now and there is nothing left in the global policy jar to tackle the onset of another major economic downturn.
Over the coming weeks, investors will be looking very carefully at how the US economic recovery cycle is shaping up and whether Trump shows any signs of a fresh start and clean slate consolidation.
US economic data is going to be critical. Anything which suggests the American economy is heading towards a more modest 2 to 2.5 per cent growth range rather than Trump’s 4 per cent target could poleaxe the equity and credit markets. Not because another recession is impending, but because expectations have been overstretched to the limit.
President Trump’s credibility is on the line. He needs to show better statesmanship and inspire market confidence in his leadership. It’s a case of sink or swim, not just for his presidency but for the future stability of global financial markets.
If Trump fails the world will be in for another rough ride.
David Brown is chief executive of New View Economics