With the “Honeymoon” Over, the Next 100 Days Could Mark a Return to Reality for the Financial Markets
As expected, Trump fans and haters argued about the pros and cons of his first 100 days in office, but there is little argument about his impact on the stock market. The markets have hit new peak highs several times since November 8 in a “honeymoon” rally based almost entirely on optimism about Trump’s corporate-friendly economic policies. Yet, apart from all the irrational exuberance on Wall Street, Trump’s first 100 days were indeed a mixed bag worthy of debate.
We saw signs that his ambitious economic agenda might succeed, but just as many signs that it might stall, fizzle, or end up severely watered down. Meanwhile, the markets remain inconsistent with economic realities, and investors are waiting either nervously or eagerly (depending on their perspective) to see what the next 100 days will bring. Will it be the validation of Wall Street’s optimism? Or, will it be political gridlock, policy failures, increasing global tensions, and a dramatic directional change for the stock market?
Last month, I discussed the fact that an increasing number of analysts and economists are convinced that a major market correction may be on the horizon despite whether Trump succeeds or fails. I’ve also pointed out that even if that doesn’t happen, the markets aren’t likely to climb much higher with Trump’s value already priced into them based on optimism. In other words, even if he manages to deliver on his promise of 4 percent GDP growth, that should only allow actual corporate earnings to catch up with the overvalued market.
Tax Plan is Crucial
As for now, the markets are at record highs based on an annualized GDP growth rate of just 0.7 percent for the first quarter of 2017.* That’s down from 2.1 percent growth in the fourth quarter of 2016—and even though both of those are positive numbers, neither is anywhere near 4 percent.* So, clearly, Trump will have to get some of his policies through to get anywhere near his goal, and even the most optimistic pundits believe 3 percent is probably a more realistic target if and when Trump’s tax reform bill gets passed.
In fact, everything may hinge on his tax bill. Why? In a nutshell, it aims to put more money into the pockets of working families and corporations alike. It would give businesses big and small the opportunity to expand and create new jobs, and it would give consumers the opportunity to buy more of the goods and services produced by these thriving companies. Boom: there’s your 4 percent growth.
Specifically, the latest version of Trump’s tax plan seeks to consolidate the current seven tax brackets into just three, with rates of 10, 25, and 35 percent. Taxpayers in the top bracket would see the biggest cut (from 39.6 to 35 percent), but individuals and families in all brackets would end up paying less. At the same time, the plan would slash the current 35 percent corporate income tax to 15 percent. The plan also seeks to eliminate the estate tax and a 3.8 percent tax used to help fund Obamacare.
That all sounds great, but skeptics are quick to point out that Trump’s tax cuts far outweigh his proposed spending cuts, meaning they feel this plan is fiscally irresponsible in its potential to further increase our already massive federal deficit. Of course, the Trump administration’s counter argument is that a thriving company taxed at 15 percent will generate more tax revenue over time than a struggling company would at 35 percent. In other words, they contend that economic growth in and of itself will offset the tax cuts if given enough time.
Of course, we all know that politics isn’t a game that’s played patiently—or rationally most of the time. In an ideal world, Trump’s plan would get bipartisan support and a chance to succeed. The result could be the 4 percent GDP growth he’s promised within a few years and a stock market that remains high because reality is finally catching up with Wall Street’s fervent optimism. In fact, GDP might even notch 5 to 10 percent higher if corporations use some of their new spending cash on more stock buybacks, as is likely.
A “Dramatic Swing”
The oher possibility is that at some point in Trump’s next 100 days, it becomes apparent that he is going to have as much difficulty getting his tax bill through as he did his travel ban and his Obamacare reform bill. The result could be a dramatic swing from optimism to pessimism that potentially triggers a major market correction—something that many experts feel is long overdue. If it turns out to be the next major crash of our current long-term secular bear market cycle, history indicates it will be a drop of at least 35 percent and possibly as steep as 70 percent. That means investors hoping to cash in on that additional 5 to 10 percent growth if all goes well could end up losing a lot more than that if it doesn’t go well. However, the failure of Trump’s tax plan isn’t the only thing that might trigger such a correction, as I pointed out earlier. If unstable situations with North Korea, Syria, Russia, or other countries escalate, that too could serve as the black swan event that triggers the next crash. And, don’t forget we’re entering a traditionally challenging season for the markets anyway, thus the adage: “Sell in May and go away.”
Keep in mind, as well, that despite the record market highs, there have been signs all along that “big money” has “one foot on the gas and one on the brake.” The market’s upward momentum has stalled, and volatility has increased since Trump’s healthcare bill failure in late March. The most telling sign, however, is that the bond market has not dropped proportionally with the stock market’s rise since Trump’s election. The 10-Year Treasury rate remains at 2.3 percent and has remained below 2.5 percent since the healthcare bill bust. To me, that’s a clear sign big investors aren’t really as optimistic as they appear based strictly on the stock market—they seem to still be playing it safe.
* U.S. Bureau of Economic Analysis, https://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm
* Investment Advisory Services offered through Sound Income Strategies, LLC, an SEC Registered
Investment Advisory Firm. Wright Financial Group, LLC and Sound Income Strategies are not associated entities.
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Special guest David Wright from Wright Financial Group, makes his latest appearance on Newmasx’s “The Income Generation” with Dave Scranton.