Uncertainty Is Being Ignored

With the market rallying so fast, it is deciding that uncertainty is now bullish. In my years of investing, I’ve always thought uncertainty was a negative, but now the market just ignores risk and assumes everything will turn out well. That’s what I’m seeing when I see the Dow and the dollar rally 7 straight days and the Russell 2000 rally 12.5% to all-time highs. Trump’s presidency is highly uncertain and Fed policy is up in the air given Trump may replace Yellen in February 2018. The market participants are hell-bent on following each other off a cliff.

In my opinion, the biggest uncertainty with the Trump administration is whether we will see the fiscally conservative GOP Congress take charge or Trump take charge and spend money, increasing the deficit. Trump’s message generally was for increasing in spending because he stated he wouldn’t be cutting entitlements. Maybe that was a campaign promise he ran on, but decides to revoke when he realizes the debt the country is in. Trump was famous for saying he was going to halt immigration until he figured “what the hell was going on.” When he sees what is going on with America’s spending, he’ll be even more shocked. It would be disingenuous for him to be outraged by the trade deficit, but then ignore the huge budget deficit.

I have explained in my last post that Trump’s plan for infrastructure spending isn’t too expansive. The question is what will happen. The regulations and red tape being cut will allow for immediate spending which may spur growth. However, the $167 billion tax credit may not have as big of a bang for the buck as expected. These projects take time to orchestrate. If the economy begins to go south, I could imagine Trump getting more aggressive. It’s not that Trump doesn’t know what he’s doing when it comes to building infrastructure, but he may feel pressure by the angry voters who are impatient. Trump is not an ideologue, so he will listen to what the people want. The problem is when he may try to listen too much. Real leaders sometimes do what is right even if it is unpopular. I don’t think Trump has that quality.

Infrastructure stocks rallying after Trump is elected is working under the assumption that either Trump’s initial stimulus will work or that he will expand the program. He promised building public projects which won’t be covered under his private sector tax credit, so he may be adding to this package to get that done. It wouldn’t be the first time a politician ignores advice which calls for prudence in spending. The CBO constantly offers potential ways to deal with entitlements which are about to go out of control. Commissions are formed on how to cut spending and politicians ignore them. It’s become an American tradition to spend recklessly similar to watching Monday night football.

Trump made a reckless claim when he promised 4% GDP growth. It’s similar to when Sarah Palin promised oil prices would fall in the 2008 election. It’s ironic that the price of oil fell without her policies getting enacted. That’s because of market forces. Market forces control economic growth, not the government. Trump should temper his goal for growth and recognize that we don’t live in China. There is no way to control the economy, unless you want to have socialism or communism. When Trump makes such goals, it reminds me of 5 year growth plans in China. This implies Trump would incur deficit spending to achieve economic growth at any cost.

One key part of Trump’s contract with the American voter was to revoke the defense sequester cuts. This doesn’t make sense because Trump also campaigned on ending America’s involvement in the Middle East. With all of the money saved on spending in the Middle East, you would think defense spending would decrease. The GOP voted in favor of the defense sequester, so, in this case. Trump would be going against the Republican spending cuts.

The reason why I’m looking into Trump’s defense spending is because it may give us an idea about how fiscally conservative Trump will be. I think the best summary from the information we have at hand is Trump will have a disjointed economic policy which will lean more towards spending than the GOP Congress would like. The last Republicans president incurred massive debts, so it’s not unprecedented.

The effects on each category of assets are wide ranging. Bond yields should increase faster if Trump plans on spending more. The dollar should crash if he spends more money. The Fed funds rate will increase, but it won’t be able to catch up with inflation, so the dollar can still fall under this circumstance. Expensive technology stocks will fall in this rising rate environment. Dividend stocks will also fall as investors pull out of stocks and put the money in bonds which have higher yields. The entire reason for buying stocks at these expensive valuations was because they were the only game in town. Eventually, if bonds continue to sell off, it should negatively effect stock prices.

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