Will the Post-Election Stock Rally Last?

Stock indexes staged a broad, post-election rally last week, as investors pushed aside their concerns about a potential global trade war and a clampdown on immigration, and instead bet that President-elect Trump’s promise of infrastructure spending would propel profits at large industrial companies and his tax cuts would boost the economy. (Irony alert #1: Congressional Republicans have argued that the financial crisis stimulus (the $787B American Recovery and Reinvestment Act) did not work and fought against subsequent infrastructure spending plans as a way to boost economic growth.)

While most believe that infrastructure spending would help the economy, the total impact would be largely determined by its size. At one point during the campaign, candidate Trump promised to spend about $550 billion over five years. If there is general agreement on the positive aspects of infrastructure spending, there is little consensus on Trump’s potential tax plan, which in its current form would disproportionately favor wealthier Americans.

According to the Tax Policy Center, by 2025, 51 percent of Trump’s tax reductions would go to the top one percent of earners (those earning more than about $700,000). Yes, the plan would raise the after tax income of middle class Americans by about 1.8 percent, but the top 0.1 percent would see a tax cut of more than 14 percent of after tax income. (Irony alert #2: The Trump tax plan would likely exacerbate income inequality that already exists and could be a surprise to those Trump voters who said that they felt left out of US economic progress.)

Economists caution that there are two other problems with the Trump tax plan: (1) rich people do not tend to spend their tax cuts; rather they redirect the savings into their investment accounts—that’s good for financial markets, but not so hot for the overall economy and (2) the tax cuts would cause a spike in federal debt levels – the plan would increase the federal debt by $5.3 trillion over ten years, according to the nonpartisan Committee for a Responsible Federal Budget. (Irony alert #3: Taken together, the spending and the tax cuts could balloon the national debt to more than 100 percent of GDP within a few years. How will fiscal conservatives make peace with that potential?)

Trump’s spending and tax cuts could help stimulate the economy in the short term, though the combination of those policies could also spur inflation and prompt the Federal Reserve to raise interest rates at a faster pace than currently expected. Under normal monetary policy, a faster rate hike cycle might snuff out a recovery. But some economists are more concerned that under President Trump, there would be a change in the composition of the Federal Reserve Board. (There will be a couple of vacancies next year and Fed Chair Janet Yellen’s term ends in February 2018.) A less disciplined Fed might accept more inflation, leading to higher long-term interest rates and a weak US dollar. A glimpse of how these policies could impact the bond was seen last week: more than $1 trillion was wiped off the value of bonds around the world.

Another area that could see big changes under President Trump is regulation. In addition to easing up on environmental rules, most expect to see a watering down of the Dodd Frank Wall Street reform, which had attempted to reign in the excesses, which contributed to the financial crisis. (Irony Alert #4: A populist President, put in office by an electorate that hates banks, would make life easier for the financial services industry. Financial sector stocks increased by 11 percent last week.)

Under Trump, the Consumer Financial Protection Bureau (CFPB), which was created out of the Dodd-Frank Act, will likely get diluted. In October, a federal appeals court ruled that the CFPB was “unconstitutionally structured” and as a result, the agency should be treated like others, where the president can supervise, direct and change the director at any time. Current CFPB chief Richard Cordray is unlikely to keep his job.

And finally, the big investment firms, which fought tooth and nail NOT to put clients’ interests first, are ready to resurrect their battle to water down the consumer-friendly Department of Labor Fiduciary Rule set to go into effect in April 2017.