Broker Check

Animal Spirits?

OR GOOD OLD FASHION FUNDAMENTALS?

 

 

April 12, 2017

 

Even if you haven’t yet seen your quarterly investment statements, you probably have a pretty good sense that your investments have been performing fairly well since the middle of November.

 

The more important question at this point is where we are in the current market cycle.  What is likely to happen next?  The pundits, as is normal, are all over the lot, with some predicting a life-changing bust is imminent, and others who believe we are only in the opening innings of a “super-cycle” bull market, with perhaps years of above-average returns yet to be realized.

 

Many observers talk about “animal spirits”[1] and refer to recent performance as the “Trump rally”.  This theory assumes that recent gains are largely driven by expectations of the Trump agenda; health care and tax reform, infrastructure spending, elimination or reduction of bureaucratic regulation, etc.  If you accept this premise, the question is obvious:  To the extent that these expectations are “priced in” to the market, what will happen if the changes don’t happen?  It is a reasonable question.

 

I believe the Trump-rally theory misses a couple of very important factors.  In simple terms, there are a lot of good reasons why the market would be performing well right now, and the only reason it didn’t happen sooner – the reason why the market went no where for almost a year prior to the election – was because (1) of all the negativity around the election from both sides and (2) the uncertainty of the outcome and what it would mean.  Let’s face it, both Trump and Clinton brought significant concerns to the electorate about their economic policy (among many other things).  The markets hate uncertainty, and in this case the potential results were polar opposites.  It was impossible to plan or prepare for, or to hedge against one without creating significant risk if the other prevailed.  So as soon as the outcome was known, one half of those potential negatives were eliminated, and the other half could be planned for.

 

If you credit the Trump agenda for the gains, you must recognize that the dominoes have started to fall in the wrong direction.  Yet why was there only a mild reaction in stock prices when the health care vote was cancelled?  This week the conversation centers around potential delays in addressing tax reform, and without substantial modification of the Affordable Care Act, tax changes are likely to be far more modest than originally hoped for.  Yet the market yawned again.

 

I believe the market is recognizing (perhaps “it” knew all along?) that the achievements of the Trump agenda will be far more modest than the initial mania suggested.  But here’s the good news.  Perhaps the market is performing as it is, not because of “animal spirits” rooted in unreasonable expectations, but because of good old fashion economic fundamentals; improving corporate earnings, favorable interest rates, more people going back to work, favorable inflation trends. 

 

To be sure, the prospect of a more business-friendly administration in Washington can’t hurt.  But we’ve become far too familiar with gridlock in our legislative processes for our expectations to become too irrational, and the president can only speak so much into existence.  And I, for one, think that’s a good thing. 

 

As usual, your comments, amen’s and oh-me’s are welcome. 

 

Sincerely,

Jim Denton

James C. Denton, CFP®
Managing Principal

 

The opinions expressed in this article are those of the author and do not necessarily reflect the views of LPL Financial.  This is not intended to provide investment advice for any individual investor.  You should discuss any choices or decisions with your financial advisor before implementing any changes to your investments.

 

[1] In my opinion, the term, “animal spirits” is just another reference for good old fashion fear and greed asserting themselves.