A lot of investors attribute the stock market’s post-election strength to President Trump, which is rather sad.
Fortunately for them, there’s much more to the “Trump bump” than Trump.
We learned that this week from the market’s reaction to Trump’s Obamacare reform failure on March 24.
Investors nervous about this setback unloaded shares at the open Monday. But it didn’t last long. The Nasdaq Composite Index COMP, +0.60% closed slightly in the green, and the S&P 500 SPX, +0.73% and Dow Jones Industrial Average DJIA, +0.73% came close.
That’s the market telling us the big post-election rally is about much more than Trump.
Zoom out and we get the same message. The S&P 500 rallied 7% from late June through Election Day. During that time, it wasn’t clear that Trump would win. So it’s difficult to give him credit for that rally.
With apologies to Trump supporters and the Donald himself, we can probably say the same for the 8% rally since the election. The bottom line is that the global and U.S. economies were doing fine before Trump came into office. And this economic momentum may be hard to break. This is good news for investors.
“A market dependent on proposed initiatives alone is far more fragile than one grounded on solid economics,” wrote RBC Capital Markets chief equity strategist Jonathan Golub in a note Monday called “Message to Market: It’s Not All About Donald.”
Here are four reasons why the Trump bump has less to do with Trump than you might think.
1. Global growth is solid
For much of the recovery, economic policies around the globe were out of synch. Europe and China were applying the brakes, while the Federal Reserve was in expansion mode. That changed a few years ago. Economic policies fell into alignment to boost growth. Now it’s working, and investors have noticed.
• The Citigroup Global Economic Surprise Index was recently at 47, the highest level in years.
• The global purchasing managers’ index (PMI) hit 52.7 in December, up from 50.9 in January 2016. Anything above 52 is considered expansionary.
This happened, in part, because China’s economy is solid. But troubled Europe has also been turning around nicely. The March Eurozone PMI stood at 56.7, up from 52.3 in January 2016. It was also a pretty solid 54.9 in December, shortly after Trump got elected.
“While there’s no reason whatsoever to believe that Trump’s election unleashed animal spirits in the eurozone, they are showing up in the region’s PMIs,” says Ed Yardeni, of Yardeni Research. Germany and France have been particularly strong. But Spain is providing some oomph too.
In short, the stock market’s strength has been underpinned by solid global growth. That makes it a lot less vulnerable to Trump stumbles in Washington than many investors think.
2. Solid U.S. wage growth will continue
Thanks to a tight labor market, wages were going up for much of 2015-2016, way before Trump was elected. You might have missed this because so much of the political-campaign propaganda was designed to make you think the Barack Obama economy was a mess.
But the truth is that wages were rising nicely last year, and that’s played a big role in continued growth in consumer confidence. This is very important for investors, because consumers drive so much of the economy.
A year ago, workers were getting 4.6% wage hikes, according to Automatic Data Processing Inc. ADP, +0.36% a company that handles payroll processing for many U.S. companies. The Bureau of Economic Analysis showed decent 3.1% gains, too.
Wage growth should continue, because the labor market is tighter than it was at its peak prior to the financial crisis, according to a recent survey of small businesses by the National Federation of Independent Business. Small businesses create most of the jobs in the country.
3. Inflation will pick up
Investors have been terrified of deflation for most of this recovery. But solid wage growth will probably bleed over into prices. This means deflation fears will go away and investors will be thinking a lot more about inflation. So will the Fed, and it will continue to raise interest rates.
All of this will be good for stocks, says Golub at RBC Capital Markets. This seems counterintuitive. We normally associate higher interest rates with the end of a recovery and bear markets. Higher rates make it harder to borrow and they eat into company profits.
But you need to consider the starting point. Abnormally low interest rates damage the confidence of business managers. They invest less. Reflation takes away those fears, and it may matter more than Trump, as it signals economic strength and creates an investor psychology that favors investment. “Pro-growth policies might be the icing on the cake, but a stronger backdrop is the cake,” says Golub.
4. Energy made a comeback
For much of 2015 and 2016, investors were fretting about an “earnings recession.” Perhaps the economy wasn’t that strong after all, they concluded.
But it turned out to be only an energy recession, according to Yardeni. Now that oil has rebounded, energy companies are back on their feet and spending again. So the group is no longer weighing down the economy and S&P 500 earnings.
“We’ve been arguing since last summer that the so called ‘earnings recession’ was really an energy earnings recession from mid-2014 through 2016,” says Yardeni. “It clearly depressed the earnings of the major stock market aggregates.” Not only that, weakness in energy company spending and employment hurt many other sectors, in a kind of a knock-on effect.
Now that oil prices have rebounded, this dark cloud over the economy is gone. Yet oil, at just under $50 a barrel, is still cheap enough relative to prices above $100 before 2014, to act as a “tax cut” that stimulates the economy. So we are sort of in a sweet spot, and investors noticed. None of this has anything to do with Trump, of course.
“We’ve been in an earnings recession, and it really felt like we were coming out of that even before the election,” says Eric Marshall, a portfolio manager and the head of research at Hodges Capital Management. “We’re starting to see a real pickup in earnings guidance and expectations.”
Trump fear plays
For investors, one way to play all of this is to buy stocks that have fallen hard on fears that Trump may not be all he was cracked up to be as president. Infrastructure-related stocks stand out, because they have suffered. Marshall cites U.S. Concrete Inc. USCR, +1.58% Eagle Materials Inc. EXP, +0.89% Martin Marietta Materials Inc. MLM, +1.39% and Vulcan Materials Co. VMC, +1.87%
He was buying those stocks on signs of improving economic strength way before Trump was elected. “These have all been beaten down, and it gives everybody another chance to buy them here,” says Marshall.
Marshall also likes economically sensitive companies as multi-year “holds,” in areas such as chips and electronic components, basic materials and shipping. In these groups, he cites Texas Instruments Inc. TXN, +0.10% Tower Semiconductor Ltd. TSEM, +0.43% Knowles Corp. KN, +2.15% Cliffs Natural Resources Inc. CLF, +0.12% AK Steel Holding Corp. AKS, +3.23% Commercial Metals Co. CMC, +5.87% and FedEx Corp. FDX, +1.52%
Not straight line up from here
Of course, even if Trump’s first big legislative setback is not the negative many pundits thought it would be, that doesn’t mean it’s back to the races with a market that goes straight up from here. Consider the following challenges:
• We may be due for a brief consolidation. “The last time stocks experienced a significant correction was nearly nine months ago, which is an unusually long time for a rally to persist without a pullback,” says Bruce Bittles, chief investment strategist at Baird.
• Some troubling “divergences” have emerged. Small-cap indices, such as like the Russell 2000 Index RUT, +0.73% and the Dow Jones Transportation Average DJT, +1.81% haven’t kept pace with the S&P 500. And they recently broke through their 50-day moving averages to the downside. This can be a negative sign for the market. Bittles thinks any correction will be limited because investor enthusiasm has fallen, yet corporate earnings are in recovery mode.
• The U.S. yield curve continues to flatten. This suggests bond investors don’t have a lot of faith in continued economic growth.
• Pundits have been eerily silent about that prospect of Federal Reserve Chair Janet Yellen being replaced when her term ends early next year. Once this comes on the radar screen it could be trouble, since Fed leadership transitions often shake up markets.
• The next great hope from Trump — tax reform — will be a challenge. Fiscal conservatives want revenue-neutral tax cuts. That could be tough since Trump wants to avoid cutting entitlements while boosting defense. Many conservatives insist on a wacky “border adjustment” tax on imports — a nonstarter for retailers and consumers.
The good news is that deregulation doesn’t require much help from Congress, because the president controls the federal agencies. This could explain a good bit of the post-election market strength — and the resilience after the Obamacare setback.
“The market probably figures that as uncertain as the prospects appear for this administration’s economic agenda, they have already moved on deregulation,” says Yardeni. “And the market may have more insight than us mortals on the beneficial impact of deregulation.”
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush is a Manhattan-based financial writer who publishes the stock newsletter Brush Up on Stocks. Brush has covered business for the New York Times and The Economist group, and he attended Columbia Business School in the Knight-Bagehot program.