This week the Trump rally continued. Two out of the three indexes are flirting with record highs. It feels like the markets want to go even higher, so don’t pay attention to those who do not understand the dynamics that are playing out in the markets.
Question: what would you expect the stock market to do if the nation’s Gross Domestic Product (GDP) began to achieve a higher, more historically, normal growth rate, say between 3%-4%? The answer obviously would be stocks would climb much higher in 2017.
Interest rates would also move higher because bond holders would be concerned that all that growth would ignite inflation, and inflation, as you might suspect, is a bond holder’s worst enemy. Until recently, given the slow growth of the economy (1-2%) resulting in an inflation rate of less than 2%, bonds provided at least a modicum of real income–no longer.
Just picture what a robust economy in the U.S. would mean to foreigners. Our country would be the envy of the world. Assuming a 4% growth rate next year, this country would not be that far behind China’s 6.5% growth, which would really stun off-shore investors. That would make our currency a great investment. Strong economy, strong dollar, the two go together like apple pie and ice cream.
Now take a look at the markets this week. The greenback is reaching highs it hasn’t seen in 13 years. Interest rates have skyrocketed with the ten-year, U.S. Treasury note now yielding 2.28%. That’s a big jump from the 1.75% it was yielding on Election Day.
Finally, the stock market, led by the Dow Jones Industrial Average, has gained ground almost every day since the election. Why has the Dow led the other averages? Investors, rightly or wrongly, believe that the Dow is the best way of capturing the stocks that will benefit the most from a large government spending program in infrastructure.
The entire premise that is fueling the stock market, interest rates and the dollar is that the new president, along with a Republican majority in both houses, will be able to launch a massive government spending program to resurrect the country’s aging infrastructure. This is something that the politicians, economists and voters have talked about for years.
Unfortunately, thanks to a divided congress, fears of expanding the deficit further, and just plain inertia of our legislatures, nothing has been done. Now, it can be, according to the wisdom of the market. If Donald Trump can deliver on his campaign promises and implement such a spending program, then the actions of the financial markets are entirely justified. The risk is he falls on his face.
That’s why investors are watching every move the Manhattan magnate is making. Clearly, Wall Street has been heartened by some of his early actions. Some potential cabinet member choices are experienced people. The right choices could go a long way in calming fears that his inexperience in both governing and foreign policy would be an enormous handicap.
And don’t forget the potential improvement in corporate earnings that would come from a tax cut, something the GOP would have little problem in getting through Congress. Depending on the size of such a cut, we might see a 6-8% improvement in earning’s results. That might convince some companies not only to repatriate some of the hefty profits they keep overseas, but could also convince companies, such as Apple, to move production (and good jobs) back to the states.
All of the above developments are why I believe that readers should remain invested with an eye to increasing your U.S. stock holdings at the expense of the bond portion of your portfolio.