Why It Matters:
The so-called “Trump Trade” momentum appears to have hit a snag.
Transamerica Asset Management, CIO Tom Wald expects events in Washington to have a direct short-term impact on financial market activity.
Investors may want to focus on fundamental earnings profiles and the macroeconomic environment.
It has long been said that, if you want a friend in Washington, get a dog. With this in mind, one might surmise those seeking quick implementation of the new administration’s economic agenda may be looking for Lassie’s phone number about now.
These past six months or so have been one of the rare cycles in which the direction of financial markets have closely tracked the events of the political world. Usually following parallel tracks of occasional intersection, the political and financial worlds coalesced in November following the surprise election of Donald Trump, and as a result interest rates and the equity markets immediately headed upward and managed to keep that ascent on track all the way through the first day of March. During that timeframe the Dow Jones Industrial Average eclipsed 21,000 and the 10-year Treasury yield reached 2.61%, representing respective increases of +15% and +.75% from their pre-election levels.
That trajectory of stocks and market-based interest rates are believed to be linked, in some part, to the expectations of the Trump administration’s new economic policies. Focusing on tax reform and repatriation, deregulation, and enhanced levels of fiscal spending, markets quickly interpreted this agenda to be more pro-growth and inflationary than that of our current environment, hence the rapid move in rates and equity prices.
However, since the first week of March, the legislative path to achieving much of this policy agenda seems to have hit a snag, at least on timing, and this is reflected in the recent pullback of both stocks and interest rates. As of April 13, the Dow is off close to 3% from its early March high and the 10-year Treasury yield has fallen about .35% to beginning-of-the-year levels.
This recent market activity to some degree reflects a very difficult month-or-so the new administration has had negotiating the Washington legislative landscape. It began in early March when the White House attempted to garner a majority in the Republican-controlled House of Representatives to repeal the Affordable Care Act (also known as ”ACA” or “Obamacare”), and in so doing prioritized this legislation ahead of tax reform.
By almost all accounts, tax reform represents the single area of pending legislation that had the markets most excited and economic pundits most likely to raise growth forecasts. Giving it a backseat to health care was deemed by many to be a risky legislative strategy.
The decision to put health care first on the legislative docket most likely stemmed from the premise that by repealing the ACA, about $ 1 trillion in taxes associated with Obamacare would also be eliminated. This would in turn reduce the standard by which any future tax reform would be judged to be “revenue neutral,” a key criteria for many fiscally hawkish members of the House. To many, this might appear to be a simple game of Congressional fun-with-numbers, and in many ways that is a tough argument to take the other side of. Nonetheless, it was enough to make the White House put on an all-out press for health care passage in late March, and when the votes weren’t there, the path for tax reform on a timely schedule (as in, “by the end of 2017”) appeared to be in jeopardy.
At first, it was believed health care would be set aside and tax reform would move forward without it. However that assumption was contradicted on the morning of April 12 when President Trump confirmed the tax savings from new health care legislation would be necessary for any new tax reform. So in addition to confusion and frustration, more than a month was lost in the legislative process. When combined with the upcoming congressional August recess, tax reform in 2017 now appears to be at an underdog status. Such are the perils of Washington politics, where slam dunks can move to three-point shots in the blink of an eye.
So where does this leave the economic agenda and the markets as we look toward the second half of 2017 and beyond? A few points we believe to be important:
- By no means – in our opinion – have the pending economic policies of the new administration, or what has become referred to in the media as the “Trump Trade,” been the only, or even the primary, catalyst behind the move in stocks over the past several months. We believe the bulk of the argument for rising stock prices is attributable to what is expected to be a dramatic improvement in corporate earnings occurring incrementally throughout 2017.
- We believe it is also important to realize that delay in policy is not necessarily a denial of policy. As tax reform legislation will likely wind up being widespread and complicated in nature, far more than just adjusting tax rates, its ultimate conclusion could have a meaningful impact to individuals and corporations for years to come. Therefore a delay in timing into 2018 will not, in our opinion, have a dramatic effect on the long term economy.
- In addition to tax reform, we believe fiscal policy legislation, particularly pertaining to national infrastructure spending will likely also be on a 2018 schedule. If market weakness continues to ensue because of this calendar, we would likely view it as a buying opportunity, all else being equal, as we continue to expect earnings improvement as the predominant catalyst for stocks through the remainder of 2017.
- Finally, interest rates and bond yields have also seen a downward move during the past few weeks and now stand at or close to beginning-of-year levels. Part of that move, in our opinion, could also relate to geopolitical events, as there may have been a flight to safety following the firing of U.S. missiles into Syria on April 7. We continue to believe the long-term trend in rates remains upward, given overall economic and inflationary conditions.
In summary, we believe the events in Washington will likely continue to have a more direct short-term impact on market activity than has historically been the case. That having been said, we believe investors should focus on the fundamental earnings profiles and overall macroeconomic environment ultimately impacting stocks and interest rates.
What to Do:
Keep an eye on the big picture.
Transamerica Asset Management, CIO Tom Wald believes advisors should expect the long-term trend in interest rates to remain upward.
About the author
Tom Wald is responsible for overseeing the investment and mutual fund product development functions and sub-adviser selection process. He also actively publicizes Transamerica’s investment thought leadership and products to advisors, clients, and the media. Tom has more than 25 years of investment experience and has managed large mutual funds and sub-advised separate account portfolios. Tom holds a bachelor’s degree in political science from Tulane University and an MBA in finance from the Wharton School at the University of Pennsylvania. He has earned the right to use the Chartered Financial Analyst (CFA) designation.
Tom Wald, CFA® Chief Investment Officer, Transamerica Asset Management, Inc
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