Record high equities are no vote of confidence in a Trump-inspired global boom
The world has been waiting with baited breath to see how new US President Donald Trump is going to shape our future. Optimists have been hoping that the presidency will change Trump for the better.
Pessimists believe Trump will change the presidency to no good end. Judging by the 12 presidential decrees that Trump has signed so far, he is stamping his authority on the White House early on.
It is no use holding your breath. What is very clear is that we are heading into a new world order, with political brinkmanship, isolationism and protectionism on the up and political harmony, globalisation and free trade on the way out.
For the markets, it means we are heading down a rabbit hole of risk, with new uncertainties, economic dangers and a future fraught with financial hazards.
That is not the way markets are judging things right now, especially as the major equity indices flirt with an apparently never-ending succession of record highs. What the market may think about Trump’s political bluster is one thing, but the promise of tax cuts, massive job creation, huge infrastructure spending and US growth-promotion is clearly in the driving seat. From the market’s perspective, the outlook seems unambiguously rosy.
The trouble is that hitting the iconic 20,000 mark for the Dow Jones index is no vote of confidence in Trump succeeding in his quest to put ‘America First’. That is because we just don’t know. It is all a gamble in what looks like a very risky bet on a very loaded gaming table. The outlook ahead is so riddled with potholes, sinkholes and swallow holes that it promises to be a rough ride for investors in the years ahead.
In reality, what has been driving equity and bond markets to spectacular heights is the vast amount of force-fed monetary stimulus which has been pumped into the global economy since the global financial crisis first broke in 2008. The money has had to go somewhere and, in the main, it has found its way into the accounts of money managers, investment companies, hedge funds and proprietary trading accounts and for re-investment back into financial markets.
What John Maynard Keynes defined as the necessary ‘animal spirits’ vital to energise economic recovery during the Great Depression ended up as the ‘irrational exuberance’ and ‘investor euphoria’ which mainly turned the tide on the 2008 Global Financial Crisis. Sure, quantitative easing money found its way into consumer and corporate pockets, but the general glut of synthetic printed money from the central banks is still the single most important factor turbo-thrusting financial markets to new heights.
The main issue for markets is when the central bank gravy-train stops and markets start to focus on the real future fundamentals. Even though the US economy has been performing well in the last eight years, there is still a sense that the economy remains in post-recovery mode. The Fed has already started slowly withdrawing its support, and other monetary conditions have started to tighten. The worry is how much economic confidence will start to wobble as the policy salve is removed.
Rising money market rates and the jump in long term bond yields have meant a sudden rise in borrowing costs for US consumers and businesses. The stronger dollar is already starting to make a dent in US growth potential. This was made quite clear in the latest GDP data which showed the economy slowing sharply in the fourth quarter to 1.9 per cent from 3.5 per cent in the previous period.
The strong dollar sent exports tumbling and encouraged US businesses to import cheaper components from abroad. Trump has his work cut out to keep his pledge to repair the US trade gap and double the US growth rate to 4 per cent in the future.
It is all down to confidence now. Once markets start to doubt Trump’s ability to deliver the goods on election promises to ‘make America strong again’, equities will become more vulnerable. Right now, historic market valuations don’t look too bad, especially compared to the heady heights of the Dot.com boom in 2000, but they are bubbling up to exposed levels which need to be justified by solid economic fundamentals, not fragile promises.
At the moment, Trump is enjoying a honeymoon period with the equity markets and he needs to craft out concrete, believable policies to maintain the rally. Global markets can only run on empty for so long.
David Brown is chief executive of New View Economics