The supply or production side of the economy driven by individual and business interests was for about eight years due to anti-business and anti-private sector policies. The rationale for these policies was a socialist agenda coupled with a lack of understanding of how a market based economy (i.e., capitalism) works. The result was slow and declining rates of economic growth on the supply-side of the economy because business expectations for a payoff to investment were lacking. For example, recent data indicates a growth rate of 2.6% in 2015 that fell to 1.6% in 2016, both of which are well below our post WWII long-run growth trend of about 3.3%. Thus, our supposed economic recovery has maintained a “recessionary” character since the beginning of the Great recession in 2007.
Monetary and fiscal stimulus aimed at the expenditure side of the economy had little effect. Fiscal stimulus bills directed money at things with little pay-off as politicians directed the money toward their re-election prospects and their political cronies, and price increases absorbed some of the expenditure stimulus. If the fiscal stimulus were directed at only infrastructure there would have been bigger expenditure multipliers plus a longer run supply-side effect through increased productivity. Monetary stimulus piled up in the banks as excess reserves. Banks didn’t want to loan at low-interest rates and excessive banking regulations reduced incentives to loan excess reserves even more. Of course, business expectations for a pay-off to borrowed money were also lacking. Thus, the monetary stimulus did nothing to stimulate economic growth. Attempts to regulate prosperity such as increasing the minimum wage at the trough of the Great Recession in 2009 also retarded economic growth. In fact, the labor demand curve had shifted so far to the left that the minimum wage increase occurred in the elastic range of the labor demand curve causing a decrease in total income to the entire group of minimum wage workers. Naturally poverty rates increased and per capita income declined. Moreover, economic growth rates during the supposed “recovery” phase remained below the economy’s long-run trend and became the slowest and weakest “economic recovery” ever seen.
The slow rate of economic growth over the previous eight years means that anything looks better now. Consequently, expectations on the business or supply-side of the economy have improved and the stock market has reflected this. Also, recent data indicates that the index of consumer expectations from the Michigan Consumer Survey is improving on the expenditure side of the economy. Yet, President Trump’s economic agenda has yet to be put in place. The first part of Trumps agenda involves decreasing excessive regulations. This will increase business or private sector investment because of increased expectations for greater returns. This will lead to more hiring and will finally begin to put upward pressure on wages. The shift of the labor force participation rate to an upward trend and individual leaving under-employment in search of better jobs will initially push up the unemployment rate, but the unemployment rate is a lagging economic indicator and will eventually decline again after a real economic recovery finally begins to take hold. The second part of the Trump agenda is a reduction in corporate tax rates and capital repatriation incentives will re-allocated increased capital investment into the stock market and the economy. Whether this occurs will require a bill upon which congress must agree. Trump and congress must hurry with their repeal and replacement of the ACA (Affordable Care Act or “Obama care”) quickly or fixing the tax code will begin to fall into questionable territory. The last part of Trump’s agenda involves increased expenditures on infrastructure. This is problematic because of Trump’s desire to build up the military. Funding a military buildup and increased infrastructure investment, that mainly leads to a supply-side productivity increase and not a limited multiplier effect that will quickly go to zero, will require a tax code change that funds them both or it will not be “revenue neutral.” Moreover, since our public debt to GDP ratio is about 105% at the moment, it is unlikely that increased deficit spending will occur.
All of this suggests an increase in economic activity in all forms because of a decrease in burdensome and costly regulations. This, in turn, supports increased earnings and a favorable long-run stock market. On the other hand, if increased expectations that manifest themselves in the stock get too far ahead of economic reality there will be corrections and the stock market will be a bumpier ride. Adding to the short-run risks are Trump’s desire to re-negotiate trade agreements and to re-allocate capital investment into less productive and therefore more costly production in the US. Increased friction in international trade is not only less efficient, as is capital misallocation, but may cause periods of increased riskiness that lead to “risk-off” periods in the stock market. Some have pointed to “Trump Stocks” such as those in the energy or banking sectors as the best long-run investments. The banking sector is probably the best bet as regulations will decrease and interest rates will increase (due to the FED and increased private sector borrowing and economic growth). On the other hand, energy futures do not reflect a big “bank for the buck” for investments in that sector. Moreover, coal may never recover due to lower natural gas prices and cheaper oil. Cheaper energy prices make it more difficult to find really explosive energy plays. Technology is argued by some to be neutral relative to “Trump Tweats” — as opposed to the pharmaceutical industry — but higher returns among technology firms depend, to a large part, on free trade and exports. Thus, technology investments must be carefully scrutinized as to how they are affected by trade disruptions. That said, anything in the “internet of things” area and that might benefit from increased private sector infrastructure investment will be the best plays. Moreover, things can become overbought quickly in this sector and the willingness to rotate out of “hot” stocks and into those just becoming “hot” is the best strategy.
An example of the difference between global economic sectors that suggests the U.S. stock market is not getting too far ahead of itself includes the difference between some emerging market economies and the U.S. economy. Since the beginning of 2017, broad-based measures of the stock markets in emerging market-based economies such as Argentina, Poland, and Brazil have increased at more than twice the rate of the broad based U.S. stock market. Similar to the U.S., Argentina and Brazil have recently elected new leaders that favor capitalism over their previously socialist governments. Also, Poland's government is a right leaning "law and order" party. Because of these political-economic similarities, the U.S. economy and its stock markets could respond similarly, with business and consumer expectations simply leading the way. (The frequently mentioned "animal spirits" rationale is a Keynesian pejorative that means absolutely nothing, except that it applies more to leftists who's animal spirits constantly push for more bad government).
