Listen to this article
Since the election, US stocks have soared to new highs and helped all three major indexes end the year with solid gains. The Dow led the way, surging 13.4% for the year, while the S&P and Nasdaq returned 9.5% and 7.5%, respectively.
Who Led The Way
The rally was spearheaded by the financial, energy, and industrial sectors as investors expect greater deregulation, corporate tax cuts, and increased spending on infrastructure. Equity fundamentals also added to the rally as the S&P finally posted positive earnings for Q3, after five consecutive quarters of contractions.
These factors, along with a rebound in crude oil prices, pushed equity prices and valuations to all-time highs. And many analysts believe that this trend will continue in 2017 as Trump’s administration starts to implement its pro-growth agenda.
Nevertheless, investors should remain cautious of the impulsive ‘animal spirits’ that have taken control of the markets. Similarly, they must keep in mind the various headwinds that the markets face as Donald Trump begins to enact his agenda. With equities rallying for an eighth consecutive year, investors must question whether Trump can spur more economic growth or simply create volatility.
The first obstacle the market faces is the comparative price of the dollar to foreign currencies. The growing strength of the dollar will pose a serious risk for investors who believe Trump’s policies will generate a boom in US manufacturing. Growing optimism in the US economy has pushed the dollar to a 14-year high. Rising interest rates and higher expectations for inflation could drive the dollar even higher, especially if foreign central banks maintain dovish monetary policies.
The dollar’s rise against currencies such as the yen, the renminbi, the euro, and the pound will surely hamper reinvestment in US manufacturing plants. US exports will become more expensive for foreign purchasers, who may seek cheaper substitutes from Asia and Latin America.
Employment in the manufacturing industry will also suffer since companies will rely more heavily on automated processes and machine learning. Additionally, the wage differential between the US and developing nations will be too great to bring meaningful increases in domestic hiring.
However, a strong dollar could prove to be a net benefit for the economy because the US maintains a large trade deficit. The dollar’s purchasing power would cheapen imports and benefit consumers who spend more on foreign goods.
Corporations with exposure to foreign markets could also protect themselves against foreign exchange risk by using hedging strategies or derivatives to lock in more desirable rates.
Bark Vs. Bite
The biggest headwind to Trump’s economic growth plan may be his own unfiltered rhetoric. His use of social media is unprecedented for a president-elect. His rise in popularity can be attributed to the way he used these platforms to communicate directly to his millions of followers.
Trump’s use of Twitter to attack his opponents proved to be effective during the presidential campaign. But as president, his spontaneous use of the platform will only destabilise markets and aggravate world leaders. This became evident when Trump tweeted at Lockheed Martin and vowed to slash the cost of their F-35 fighter jet program. From this one tweet, investors began to question the profitability of the military industrial complex under Trump, and Lockheed Martin stock fell 5%.
A similar scenario occurred after Trump remarked that he “didn’t like what has happened with drug prices” in his Time magazine profile.
The following day, the iShares Biotechnology ETF fell 3% while all other sectors rallied to new highs.
Trump’s tweets have also drawn criticism from foreign governments. China’s official news agency, Xinhua, stated that Trump’s “obsession with Twitter diplomacy is undesirable.” Some supporters believe Trump’s messages are just a tactic to begin more accommodative negotiations. Others believe they pose serious risks to longstanding diplomatic relationships. Either way, his unpredictable use of social media will continue to unnerve investors and create volatility.
The Right Way Forward
There are ways Trump could instil confidence in the markets and grow the economy. He must move away from his extreme positions on immigration reform and adopt a more reconciliatory approach.
He should focus on constructive trade deals with the US’s allies and tax cuts for small businesses and individuals. In order to spur GDP growth, he must reduce regulations in government bureaucracies and allow corporations to repatriate overseas cash that can be used productively in the US.
In terms of foreign policy, he needs to develop a cooperative relationship with China and work with Russia to finalise a lasting ceasefire in Syria. A lot of things need to go right in order for Trump to be a successful president. He can easily double down on some of his harmful economic policies and create an even more divisive environment in America.