Can the Trumpflation rally last?

There has been a remarkable shift towards bullishness since Donald Trump's victory in the US presidential election.

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Stockmarket exuberance could be misplaced

Donald Trump has promised to make America great again. Wall Street is apparently so excited about this prospect that it has decided not to wait for his inauguration, says Kopin Tan in Barron's. All four key benchmarks, the Dow Jones index, the S&P 500, the Nasdaq Composite and the small-cap Russell 2000, hit a new record peak on the same day last week. That hasn't happened since 1999.

There has also been a "remarkable" shift towards bullishness, says Tan. A survey by the American Association of Individual Investors showed the bullish contingent jumping to 50% from 24% three weeks ago. A Bank of America Merrill Lynch poll of 177 global fund managers just after the election showed that 35% expect the world economy to get stronger over the next year, up from 19% in October.

Global inflation expectations have jumped to a 12-year high. The Organisation for Economic Co-operation and Development thinks that Trump "might be the man to spring the world's low-growth trap'", says Alistair Osborne in The Times. It thinks Trump's plans could cause global growth to accelerate from 2.9% to 3.6% in 2018.

The start of a new story

"Investors are exuberant to have a new theme, any theme, than watching the Federal Reserve," John Hussman of Hussman Funds told the FT. US stocks have struggled since the central bank stopped printing money to juice growth. Now, says the FT, "the narrative has changed to preparing for an era of tax cuts, deregulation and fiscal stimulus".

Trump's plans look promising for business. He's talked of spending $1trn on infrastructure; cutting income taxes; reducing environmental and financial regulations; slashing corporation tax to 15% from 35%; and encouraging firms to bring earnings piled up abroad back onshore through a tax cut for foreign holdings. The hope is that firms would spend some of this money on investment, not merely buybacks and dividends. US firms are holding a total of around $2.5trn abroad.

So the potential boost to growth is obvious. Indeed, the financial media is full of breathless comparisons between today and the early 1980s, when a fiscal boost coincided with the beginning of a long bull market (see below). But markets betting on "Trumpflation" may be jumping the gun. For starters, Congress often stymies presidential plans, and while Trump has a Republican House and Senate to work with, he may not have things all his own way. The odds of a significant tax cut "are pretty good", reckons Gerald Seib in The Wall Street Journal. But some legislators may baulk at estimates that Trump's fiscal plans will run up another $5.3trn to the federal debt over the next decade and push the debt-to-GDP ratio to 110%.

Ignoring the risks

More significantly, however, if Trump follows through on campaign promises to impose tariffs on Chinese imports and renegotiate the North American Free Trade Agreement, he will crimp growth and could "trigger a trade war that would cancel out any benefits from a stimulus", as Peter Thal Larsen notes on BreakingViews.com. In sum, says Tan, the stockmarket is "behaving as if Trump will fulfil only the promises it likes but conveniently break all the promises it doesn't like".

The strong dollar is a further possible headwind for stocks, potentially snuffing out the incipient earnings recovery: the S&P 500 firms make around 50% of their sales abroad. That in turn will focus attention on historically high valuations. None of this necessarily means the market will plunge the Fed will no doubt try to prop it up with yet more quantitative easing if things go horribly wrong but this bounce seems unlikely to be sustained beyond the next few months.

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The Trump bounce won't match Reagan's rally

Ronald Reagan's victory in 1980 ushered in an era of fiscal expansion, strong economic growth, and bullish stockmarkets. Indeed, it helped stocks embark on an upswing that ultimately stretched from 1982 to 2000, marking the biggest Wall Street equity bull market of all time. Today, exuberant investors appear to be betting on a repeat performance.

But "like 1980s haircuts, the market throwback looks dated", says Swaha Pattanaik on BreakingViews.com. A key difference is that the 1980s blueprint ignores the threat of protectionism from Trump; free trade and liberalisation were gradually spreading in the 1980s. Even without the possibility of trade barriers, however, the scope for a 1980s-style expansion is limited. When Reagan arrived, interest rates were 20%; inflation was 14%, and public debt was worth a mere 35% of GDP, say James Rickards in The Daily Telegraph.

"Rates and inflation had nowhere to go but down," and there was plenty of room for the federal government to borrow "without pushing the US into the danger zone of 90% debt-to-GDP." At that level, the debt load begins to undermine growth, suggests a key study by economists Carmen Reinhart and Kenneth Rogoff.

Today, America's debt-to-GDP ratio is already 104%, inflation is under 2% and interest rates are at zero. The economic cycle is also far more mature today, so a big stimulus now risks juicing inflation rather than growth, adds John Authers in the Financial Times. Meanwhile, stocks are far more expensive on a cyclically-adjusted price-to-earnings ratio of 26, compared with single digits in the early 1980s and a long-term average around 16. Don't count on a reprise of the Reagan boom.

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