Washington’s Recent Policy Moves Are Driving The Markets

The epicenter of American business has long been marked by the giant bronze bull statue in the middle of Wall Street in New York City. The muscular creature is reared back, ready to charge forward, its horns gleaming in the sun. It’s an iconic symbol of our capitalist economy.

It might be time to move that gorgeous piece of art to Pennsylvania Avenue in Washington, DC.

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Right now, the White House is largely driving the markets. That was especially true in the tumultuous first quarter of this year. In early January, stocks soared on the implementation of President Trump’s tax cuts. But fallout from the President’s March decision to impose tariffs on steel, aluminum, and other imported products sent the market on the financial version of Mr. Toad’s Wild Ride, adding to market volatility fueled by concern over wage inflation.

The result: the once-promising first quarter of finished with markets down 1%.

But here’s the good news. Washington’s recent policy moves, taken as a whole, are a net positive for the market going forward. More importantly, the stock market is most influenced by investors’ collective sense of how the economy will fare in the near-term future; right now, that outlook is good.

Washington’s Impact

President Trump’s tariffs roiled the markets on fears of a global trade war. In fact, the international response has been mixed and muted, with China even announcing a reduction in tariffs on American automobiles. The relative calm has survived through President Trump’s recent public musings about adding even more tariffs on a wider range of foreign products. For now, at least, a trade war seems unlikely.

But the new tariffs aren’t harmless. The levies are expected to cost businesses and consumers $80 billion a year in higher prices for products. Some suppliers of steel and aluminum items raised prices just days after the tariffs took effect. But we need to put that $80 billion in perspective.

The GOP tax cut is expected to inject $200 billion into the economy. We’re already seeing companies use some of their cut to invest in facilities, boost training, and increase worker compensation.

As a result of changes in the tax code, corporations are also expected to return to the U.S. about $500 billion currently stashed in overseas accounts for – well, yes – tax reasons.

Finally, the new federal budget includes $100 billion in new infrastructure spending.

Those three items alone provide an $800 billion boost to the economy, ten times the drag created by the tariffs. And that doesn’t even factor in the economic activity generated by a $61 billion hike in military spending – 14 new Navy ships, 90 airplanes, dozens of helicopters, and pay raises for all military personnel. That money, by the way, must be spent in the next six months, by order of Congress.

So, bottom line, I don’t believe we should be overly concerned about the tariffs. Washington’s other recent actions have dwarfed them.

The Economy

The stock market doesn’t move in lockstep with the economy. You can have a good economy and a bad market. But rarely will you have a good economy and a terrible market.

We are living in the former. We have a good economy, but a not-so-great market. But as long as economic underpinnings stay strong, the markets generally avoid falling off a cliff.

Corrections happen. They are part of the market’s circle of life. We’ve seen the market drop lower than 10% on more than one occasion in 2018. Even if the economy stays strong, it doesn’t mean we won’t see another drop of 15% or 20%. But it’s difficult to stay negative if the economy remains solid and corporate earnings move higher.

That’s precisely what’s happening today.

We’ve now been in an economic expansion for 105 months – the third longest on record. There’s reason to believe we could set a record by extending into at least next summer.

Despite its length, the current expansion has been shallow in terms of real GDP growth. In fact, to reach the level of growth/expansion seen during the 1990s record, the US would need to grow real GDP another 25%. And here we are hoping to return to just 3% annual growth!

Still, at the moment, all is well in the U.S. economy. Consumer confidence sits at all-time highs, wage growth is steadily improving, and the unemployment rate of 4.1% is well below the historical average of 6.2%.

And the fundaments (stock earnings, and their ability to stay solvent, and expand) remain encouraging despite the extreme choppiness we’ve seen.

This year’s market has been unnerving for most folks. Nobody loves 1000-point stock market drops. But, think about it: what fundamentally has really changed? The economy continues to plow ahead, trade war threats are (for the moment) dwarfed in size by fiscal stimulus in 2018.

Here’s something else that doesn’t get a lot of press: Stock valuations and investor sentiment can get much more favorable during these pull-back periods.

  • The S&P forward multiple (valuation, the Price we pay for stocks, divided by what they earn as a group) now sits roughly in-line with its long-term average after being slightly elevated for much of the past year.
  • Investor sentiment, which was too frothy last year, is back to a pessimistic zone. When that happens, it’s a very bullish sign.

Bottom Line: when the market experiences a correction in an otherwise solid economy, stocks get cheaper in two ways. Yes, prices drop, but more importantly, lower valuations mean earnings are actually increasing.

We’re in an environment where stock prices have declined while earnings are still ratcheting higher. From where I come from that’s called a “good deal.”

But don’t get greedy. Stay diversified in many stocks. Stay balanced by allocating your assets properly across US stocks, international shares, a variety of bonds, and other main sectors, like real estate. If you follow this, you should sleep well at night.

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