The economy continues to do well, but not too well. That is, it is chugging along rather steadily but not so fast as to suggest closing in on the next recession any time soon. The stock market is not always in lock step with the economy because it rests on not only fundamentals, but such things as investor expectations and sentiment as well. The recent supply side tax cut that reduced corporates rates appears to underly market exuberance. If exuberance is not supported by earnings growth and increasing profits then a larger pull-back will happen sooner. On the other hand, if earnings and profits pick up, then the VIX may remain low and the rally continue with minor pull backs the only consequence.
In the near term, the January 19th government funding issues looms as a potential road bump that may increase volatility. Trump has the Democrats in a tight spot in that they want DACA and will only get it if they agree to fund the border Wall. Don’t expect that to go smoothly.
This tax cut, like the Kennedy tax cut and Reagan tax cut in the early 1980s will have longer lasting supply side effects than the deficit financed fiscal expenditures under Bush and Obama that occurred on the basis of Keynesianism. Obama doubled the national debt but didn’t get any significant economic growth to show for it. This is because he tried to kill what he tried to stimulate. Regardless of the misguided Obama, Keynesian fiscal stimulus multipliers have only short-run effects because multipliers go quickly to zero and the expenditures never increase economic activity enough to pay for themselves. On the other hand, supply side policies are not limited to tax cuts.. The more recent regulatory reductions reduce costs, increase market opportunities, and have long-lasting supply side effects. They may also be a larger and more long-lasting effect than the tax cuts. Thus, it could be that the market is actually underestimating the supply side stimulus effects of the Trump agenda. Any infrastructure expenditure will also increase productivity and have long-lasting supply side effects as well (along with the usual short-run expenditure effects). Unfortunately, the Obama debt build up to greater than 100% of our GDP limits the likelihood of any such expenditure making its way through congress.
On the negative side. Bull markets will come to an end if there is greater than a 20% sell-off. The best way to protect your portfolio is to increase the percentage of cash you hold or go completely to cash before it happens. Short of such a big correction, any sell-off within the context of a bull market will be smaller and have a V bottom implying it is short-lived. Those you can ride out. All indications are that you can, if you have cash, buy these dips until it is time to get out of the market entirely. I’ll let you know when I see that time approaching . . . possibly by this Spring or Summer.
January 23 update:
GDP growth is about to double that of the previous administration and we now have an actual economic recovery and expansionary business cycle phase for the first time in 10 years. Basically we have switched from a monetary stimulus bubble in the stock market caused by contradictory macroeconomic policies. These are an expansionary expenditure side policies (fiscal and monetary stimulus) versus contractionary supply side policies (i.e., regulatory overreach) under Obama that led to money growing into bank reserves and the stock market but not to loans and investment. Under Trump we now have consistent stimulative policies on both the expenditure and supply sides of the economy that create a real expansion that includes private sector investment rather than merely a stock market bubble. In other words, the tax cut plan will have a short-lived multiplier effect on the expenditure side of our economy and a longer run supply side effect through greater investment, growth, and jobs. Coupled with decreased regulatory compliance costs, another long-run supply side effect, the implication is to put cash to work. Continue to buy the dips.
