What Will Trump's Speech Do to and for Markets?
While the Fed may surprise us with a rate hike in March instead of June, the real suspense for investors is what specifically Pres. Donald Trump will propose in his address to Congress Tuesday night. What's already going on under the surface may surprise you as well.
By Vikram Rangala
Monday, February 27, 2017 - 00:00
Bond futures surged this week ahead of the president's speech, showing that traders now think the odds of a March increase in the Fed Funds rate are roughly 50%. This number has jumped 10 points since Friday. Plenty of analysts have countered that increased expectations don't mean the Fed will actually increase rates just two weeks from now. The Fed's 2 percent inflation target will probably just get reached this month, with home prices showing a big jump.
The main event, which has traders in a holding pattern today, is the president's first address before a joint session of Congress, in which he is expected to lay out his vision for the future and give specifics about his plans. So far, he has said he will boost military spending, cut non-defense spending, and repeal and replace Obamacare. He has said that he may not be able to outline a tax plan, which would be a blow to GOP fiscal hawks, until he knows the costs of his healthcare plan.
Investors will watch closely, but it's important to remember that while a lot of headlines say things like The Wall Street Journal's "Dollar Edges Lower Ahead of President Trump’s Address to Congress," that doesn't mean the forex markets are expressing their feelings about the speech. "Ahead of" doesn't mean "Because of."
That said, some markets are moving because of expectations. Infrastructure stocks (building materials, construction, and steel) have surged after a four-week slump based on earlier reports that building plans would be postponed until 2018. Trump then briefly commented that he was eager to start construction right away, and markets rebounded.
This ability to move markets with a tweet or remark can be seductive for politicians and newsmakers. Warren Buffett is famously cautious about commenting on stocks. And former Saudi Oil Minister Ali Naimi, who sometimes deliberately used the tactic, just announced that he's done talking about the oil market for good. While institutional traders, like banks and large funds, sometimes react to the news or trending topics, for the most part they have teams of economists and number crunchers to give them long-term forecasts. And they execute their buying and selling over days and weeks, sometimes months.
The rally above Dow 20,000 was not driven by those buyers, however. It was driven by small, individual investors, who often do trade the news. A report from JPMorgan Chase showed an $83 billion inflow into ETFs, index funds, and similar passive strategies favored by individual (retail) investors. At the same time, $15 billion has been withdrawn from the actively managed funds used by institutions. Some of that is people cashing out of hedge funds, which are actively managed. Some of it is institutions rebalancing their portfolios after a profitable run.
Passive funds trade differently than active ones, which means changes in buying patterns. One pattern could be a sign that investors are more nervous than the record prices and low volatility suggest, Last year, the stocks which led the rallies were in areas like finance and energy, which fluctuate depending on how well the economy is doing. If money is tight, people take fewer road trips and pull their money out of investments.
In contrast, people need their medicine and electricity no matter how well they're doing. Utilities and health care stocks tend to be less sensitive to economic growth and the business cycle—people always need the lights on. In the current rally to new record highs, it is these boring stocks which have led the market. This is unusual. It suggests that investors are moving their money to those sectors which will still be active even if the economy tanks.
In fact, it is the first time the Dow has made new highs over a three-week period while cyclical growth shares lagged and safer defensive stocks led, according to veteran research firm Sundial Capital Research. That switch to defensive buying began on the day the president promised a "phenomenal" plan to cut taxes. The problem is, he said more recently that his tax cut plan may have to wait until he knows how much the health plan will cost.
On Monday, when asked how he plans to pay for the 10% increase in military spending he proposes, Pres. Trump said he expects his policies to create so much economic growth that the tax revenue, even after tax cuts, will pay for the increased spending. Increasing revenue by cutting taxes to stimulate growth is a basic element of supply-side economic theory, first tried under Ronald Reagan and again under George W. Bush.
Neither attempt proved that supply-side works. While Reagan is remembered for his first tax cut, he went on to raise taxes six times and run up record deficits to achieve GDP growth. The success of Bush 43's attempt at supply-side is hard to gauge because it preceded and may have contributed to the Great Recession. Supply-side advocates will get another try, but they are unlikely to adopt all elements of supply-side theory.
Friedrich Hayek and Milton Friedman, the fathers of supply-side, also advocated, as have other conservatives, for a guaranteed basic income for all Americans to ensure a social safety net. Neither Congress nor the president is likely to push for that now. And that may be about the only thing investors can be sure of ahead of tonight's speech.
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