The Russell 2000 (RUT) continues to rally to unprecedented heights. This 13.5% rally is the largest rally since March 2009 which was the start of the bull market. The dollar index is also rallying again today. It reached 13.5 year highs. My leanings are against both rallies particularly the one in the Russell 2000. My best explanation for the rally is irrational exuberance. Some investors were caught short when Trump was elected and had to cover into the rally which ensued. I had believed the market would fall and then recover just like the Brexit. While this did occur, the entire sell-off was in the after-hours trading period.
Besides the short covering, some investors allowed their political preferences to take control and decided to buy stocks because they thought Trump would be pro-growth. For example, Carl Icahn bought $1 billion in stocks after Trump won. I’m not criticizing Icahn at all because he was correct in the short term to buy stocks as he’s made a lot of money in the past 2 weeks. The point I am making is presidents don’t control the stock market. I had the thought that President Obama would be bad for business when he was elected in 2008. If I would have shorted stocks based on this, I would’ve missed a massive rally. My inklings about President Obama’s policies were correct as GDP growth has been weak, but this factor was overridden by unprecedented dovishness by the Fed.
The entire 13.5% rally has been based on a lie which ignores basic math. I don’t know when the market will see reality since I wasn’t buying stocks at the start of this rally. The big lie is that Congress hasn’t been going through with fiscal policies to support the economy because there was gridlock between both parties. The real reason Congress hasn’t been going through with stimulus is because the government can’t afford it. By the end of the last recession the deficit as a percentage of GDP reached 10%. The Republican Congress was elected to have fiscal restraint, so they had the common sense not to spend even more money. Because there weren’t substantial spending cuts, the deficits were still out of control while the recovery was still weak. The Fed had to do QE 1, 2, & 3 to support the debt; the quantitative easing would have to have been even more massive if there was a stimulus, as no one else would backstop the debt which was at record low yields.
The dollar and small cap stocks are rallying even as Trump’s plan will bankrupt America if it’s enacted. As you can see from the chart below, Trump’s spending plan would increase the deficit by $5.3 trillion to 105% of GDP. I’m usually for tax cuts, but in the circumstance we’re in, we need spending cuts first, before we can think about enacting tax cuts. I understand tax cuts generate growth which can offset some of the gaps in the deficit, but it won’t be enough. Conservatives point to how Reagan’s tax cuts paid for themselves, but according to Cato it took 7 years for that to happen. It’s also worth keeping in mind that the economy is over-levered and weakening. Corporate debt is already at record rates and margins are falling; lower tax rates won’t make a difference.
The chart below shows the deficit as a percentage of GDP. According the Goldman’s analysis, Trump’s spending and tax plan would add 0.75% to it. The deficit is already increasing before Trump has even gotten into office because corporations can’t take on anymore debt. With interest rates potentially rising higher, the bubble economy is being pinched.
If you go back to when Obama got elected President, similar proposals were enacted. These proposals are partially why we saw the massive deficits after the recession ended. The government is starting at an even higher deficit to GDP than it started at prior to the last recession. Trump has less wiggle room to spend money with reckless abandon. The House GOP is proposing $7 trillion in spending cuts over the next 10 years. It will be interesting to see how quickly they jettison their frugality when the economy weakens and Trump calls for more spending.
I expect to see almost all Republican politicians ignore their principles and the reasons why they were elected in order to ‘save’ the economy. The reason I put save in quotes is because the packages never work. Recessions cannot be avoided no matter how much money is spent. Obama’s spending plan was enacted in February 2009 and the recession was already over in June 2009, meaning it enacted after the recession was mostly over. When the package was enacted, it was predicted that GDP would grow 4.6% in 2012 because of it. Obama’s entire presidency never had a single year of 3% GDP growth.
I’m expecting a similar scenario for President Trump. Because the economic situation is not as devastating as it was in late 2008, I expect a stimulus package to be enacted after a few months. The plan will have more tax cuts and less infrastructure spending because it will be done by the GOP instead of the Democrats. It will be passed and start effecting the economy after the recession is mostly over. It will add to the debt and do little to generate growth. The depths of this recession will be worse than 2008. I don’t know how the recovery will compare to this one.
Conclusion
Stocks and the dollar are rallying because of Trump’s economic policies, but they are more of the same failed policies of the past. Trump doesn’t care about the deficit much like Obama didn’t. Unless we have a reversal of economic policies away from deficit spending and reliance on the Fed to inflate asset bubbles, we will remain on the same path. The $825 billion stimulus package Obama enacted did not reach its goal of growing the economy by 4.6% in 2012. These Keynesian economic policies are what repeatedly create these massive recessions, so their solutions end up being equally as weak. There are still many more appointments Trump has to make to his cabinet. I hope he proves me wrong and makes great choices.