When President Trump comes into office, the whole world changes…. a new world order! Trump ran on the change from running the economy based on monetary policy to one of fiscal policy, much like Ronald Reagan did. Although both are used to pursue policies of higher economic growth and controlling inflation, make no mistake about it, and they are as far apart as the Hatfield's and the McCoy's, fire and water, Tom Brady and the evil Roger Goodell.
Right now, under President Obama, we are based on Monetary Policy.
Let me explain the difference between Monetary and Fiscal policy and how this is going to affect you and me:
Monetary policy is controlled and operated by the Central Bank or what we call 'The Fed". However, it is not one bank. It is a group of the 12 bank governors of the 12 Federal Reserve Bank districts. The group's official name is the Federal Reserve Board of Governors or the Federal Reserve System. It was created by an Act of Congress in 1913.
The Fed is a financial institution that works independently from the executive or judicial branches of government and its powers are derived directly from Congress. Alexander Hamilton was the first secretary of the Treasury in 1780. From what I hear, he couldn't sing or dance nearly as good as the Lin-Manuel Miranda, star of the new hit Broadway Musical. Although he was quite a lady's man and he did understand money.
The primary function of the Fed is adjusting interest rates and influencing the nation's money supply.
For example: The Fed may have an inflation target of 2%, as they say they do now. If they feel inflation is going to go above the inflation target due to strong economic growth, then they will increase interest rates. Higher interest rates increase borrowing costs and reduce consumer spending and investment, leading to lower demand and therefore lower inflation. If the economy went into recession, the Central Bank would do the opposite and cut interest rates.
Fiscal policy is carried out by the government and involves changing tax rates and levels of government spending to influence aggregate demand in the economy.
Under fiscal policy, to increase demand and economic growth, the government would cut taxes and increase spending. This of course will lead to a higher budget deficit. However, they would argue that increased economic growth will also generate higher taxes. To reduce demand and lower inflation, the government would increase tax rates and cut spending.
How will this affect the US Economy and how I invest?
Did you like all the Fiscal stimulus and Quantitative-easing programs of Ben Bernanke known as QE 1, 2, 3 and unofficially 4? Let's not forget the low interest rate policy continued under Janet Yellen. The market loved that too. Donald Trump just tipped everything upside down and knowingly or not handed us QE 5. That's right, his proposed $1 trillion infrastructure budget would make Blaze Starr cry, as it will be the equivalent of it raining money.
It's not like Obama didn't want to borrow while interest rates were low and spend on infrastructure projects. He floated the idea many times. Unfortunately, he and congress just couldn't get along. So, he controlled what he could - monetary policy. Now Trump has both houses of congress.
Pouring this much money on the economy will certainly raise GDP growth for the short term. However, it will also bring upon a much earlier return of inflation and higher interest rates. It will also likely keep the boom and bust cycle intact, with the next crash in a few years.
The new "fiscal" policy certainly has everybody excited, but will it really make that much difference to the economy? I'm not talking about you and me personally who will benefit from lower taxes. I'm talking about the overall economy and your portfolio. Investing in the next few years will be very different than the last few years, so put a plan in place to Trump up your portfolio!
Even though investors are exhibiting tremendous optimism, we have serious demographic challenges to contend with that will make it difficult. Let's face it, we have seen this strategy before. Just look at Japan. I devote a whole chapter to Japan's tireless effort to revive their economy in my book: Surfing the Retirement Tsunami - Your guide to staying afloat and retiring comfortably.
Japan has been trying a combination of fiscal and monetary policy for 25 years to no avail. The bottom line is that an economy simply needs more consumers to grow. Something that none of the developed countries will have for at least the next 5-7 years. Luckily we have much better demographics than Japan.
President Trump's economic vision calls for deep tax cuts for businesses and individuals and at least $1 trillion in new spending to rebuild roads, bridges and any other of America's crumbling infrastructure. Many people are calling this Reagan 2.0. Obviously, this will result in higher debt and budget deficits, though the new president insists that increased economic growth will pay for all of this.
The problem comes down to the country's debt problem. When Reagan took over, the U.S. debt was a fraction of what it is today. As bond guru's Hoisington Management wrote in their post-election update:
The economy is extremely over-indebted, turning even more so this year. In the latest statistical year, debt of the four main domestic non-financial sectors increased by $2.2 trillion while GDP gained only $450 billion. Debt of these four sectors (household, business, Federal and state/local) surged to a new high relative to GDP. This will serve as a restraint on growth for years to come. Also, the economy is in an expansion that is 6 1/2 years old. This means that pent-up demand for virtually all big ticket items is exhausted - apartments, single family homes, new vehicles and plant and equipment. Rents are falling as a result of a massive apartment construction boom. Reflecting a huge stock of new vehicles and significant easing of credit standards, the auto market appears saturated. Vehicle sales for the first ten months of this year have fallen slightly below last year's sales pace. New and used car prices are down 1.2% over the past year. The residential housing market appears to have topped out even before the sharp recent advance in mortgage yields, which will place downward pressure on this market.
Even if the new policy is successful, it will take several years to see and feel the impact. Hopefully we can get stocks to go higher in anticipation of future growth but rates staying low because we are still in a slow growth deflationary environment until 2023. That is the reason that bonds look attractive at these levels and are likely to come back strongly.
Most importantly, every portfolio should be tactically hands-on managed, never buy and hold, or what I like to call buy-and-hope. Be sure your portfolio manager is using all 6 asset classes: stocks, bonds, commodities (including gold), real estate, international and cash. Not just one or two. This is the way to achieve your objectives and the get the best returns with the least risk possible.
Stocks are on a tear, and likely to stay that way through the end of the year and into the first quarter of 2017. Money managers were caught with their pants down when Trump was elected, and it will take weeks if not months for them to Trump up their portfolios to. This is a buying opportunity for individual investors. Focus growth sectors such as "cyber-security" through Palo Alto Networks (NYSE:PANW) and the PureFunds ISE Cyber Security ETF(NYSEARCA:HACK). In addition, growth investors can buy Apple (NASDAQ:AAPL) at these low levels. China is just starting to show promise for them. Also, Microsoft (NASDAQ:MSFT), which is the staples for every computer made; Intel (NASDAQ:INTC), which is getting hit and a good buy at these prices; Google (NASDAQ:GOOG) (NASDAQ:GOOGL), which has had a nice rebound but still a great time to step in as their growth potential is in the stratosphere; Facebook (NASDAQ:FB), a social media staple and is winning over the older crowd, which are the people with money; and Amazon (NASDAQ:AMZN) which practically owns the online marketplace. For a broad-based approach, you can simply buy the market ETFs like the PowerShares QQQ Trust ETF (NASDAQ:QQQ) and the SPDR S&P500 Trust ETF (NYSEARCA:SPY). The WisdomTree Europe Hedged Equity ETF (NYSEARCA:HEDJ) is the play for a European resurgence as it is long EU stocks and short the currency. If you are cautious and want to play the downside, or want some portfolio insurance, look toward the ProShares Short S&P 500 ETF (NYSEARCA:SH) or the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX)
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.