Monetary Policy Drove Stock Market In Obama Years: Will Fiscal Policy Do The Same In Trump's Time?

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by: John M. Mason

Summary

During the Obama years, monetary policy was the support and justification for the record-setting stock market highs reached during that administration.

Now, the Trump administration is touting fiscal policies to stimulate the economy and the stock market has jumped on this hope to drive the stock market to even higher records.

The question is, of course, can Trump fiscal policies substitute for the monetary policy of the Obama administration and sustain the hopes of market investors?

The major thrust of economic policy during the Obama Administration was the belief that the monetary policy of the Federal Reserve would pump up the stock market creating a wealth effect that would drive consumer spending which would spur the economy on to more rapid growth.

The Federal Reserve engaged in three rounds of quantitative easing during the Obama reign and this resulted in the stock market hitting new historic highs creating a wealth effect that produced more consumer spending, but the rapid economic growth never materialized.

In terms of stock market performance through much of the Obama period, the consumer goods sector and the consumer services sector tended to be at the top of the leader board in terms of performers.

Now the emphasis is shifting. All that is being discussed in the Trump team is fiscal policy.

After so much attention has been given to executive orders over the past three weeks, focus is now being shifted to what the new Trump administration is going to do in terms of fiscal policy.

In particular, the press is honing in on Trump's National Economic Council head, Gary Cohn, a veteran of …you guessed it…Goldman Sachs Group. On Sunday the New York Times focused in on the man who "fills the void" in the Trump economic cabinet. On Monday, the Wall Street Journal highlights the "economic powerhouse" that is emerging within the Trump administration.

And, the focus is primarily on tax reform and tax cuts.

In fact, President Trump, on Thursday, noted that the new tax plan that was on the way was "nothing short of phenomenal."

The stock market took Mr. Trump at his word and jumped to new highs on both Thursday and Friday. On Monday morning, market futures were indicating that further new highs would be reached.

The shift in the leading sectors of the market?

At the top of the top sector performers in the market are Nonferrous Metals, Platinum and Precious Metals, Coal, Industrial Metals and Mining, Aluminum, Basic Resources, and Steel.

We have a rising market in the first four weeks of the Trump administration building on the work of the Obama administration, but there has been a major shift in the composition of the performance.

The question is, can fiscal policy continue to carry on the stock market performance in the place of the monetary policy of the Federal Reserve.

The mantra during the markets, especially during the tenure of Fed Chair Ben Bernanke, was "don't fight the Fed." If the Fed was pumping money into the economy, go with the flow and buy stocks.

Now, the basic feeling is that the Federal Reserve will be under attack. Already in Congress there is sufficient talk about weakening the powers of the Fed and forcing the Fed to go on some kind of policy rule, like the Taylor rule, that would put Federal Reserve actions on a guided path.

With the Republicans controlling both the Senate and the House of Representatives, there is real concern that events could move toward changing the very nature of Federal Reserve policy making.

Furthermore, there, there are two empty Board seats (out of seven) on the Fed's Board of Governors and as of April there will be a third Board position that Mr. Trump can appoint.

There could be real changes coming here, something we need to be very aware of.

The bottom line here is that the Federal Reserve might not be nearly so active over the coming four years as they have been in the past.

The emphasis, therefore, will be on fiscal policy and the possible stimulus that might be forthcoming in this area…and the possible boost such stimulus will give to the stock market.

Right now, and really since the election of President Trump last November, the stock market has responded very positively to the possibility that substantial stimulus would be coming from the new administration and that the efforts would show up on the fiscal side of the ledger, not on the monetary side.

And, the hopes here are that the stimulus would hit the industrial and manufacturing side of the economy and not the consumer side. Then, the economy would see more action in business investment expenditures that would put a spark into the productivity equation, which would cause the economy to grow at a faster pace.

The question is, however, about whether or not any fiscal stimulus can really "goose up" economic either in the near future…or over the next few years.

There are three areas of concern here.

First, as more and more talk about when such things like tax cuts, infrastructure spending, and regulatory reform, can actually be achieved. Like the discussions surrounding the reduction or reform of the Affordable Care Act, the actual achievement of such changes keep getting pushed back, further and further into the future.

Bottom line here: it just ain't gonna happen overnight.

Second, most of these changes, even when actually acted upon, have a lag-in-effect in terms of when the results of the actions will finally take place. With fiscal programs, the lag-in-effect can be quite substantial, so don't expect great results immediately.

Finally, there is a question about the ultimate ability of such programs to change economic growth much at all. Recent research on economic growth has re-emphasized the fact that the economic growth of an economy is dominated by the supply-side of the economy and the supply-side of the economy is driven by the growth of the labor supply and by the growth of labor productivity.

If the fiscal policy efforts do not impact these factors, then little or no additions to economic growth can be achieved. But, it looks like we may get a chance to see whether or not this is true.

So, there are a lot of unanswered questions about just what the Trump fiscal policy might achieve. Investors in stocks seem to be betting on the hope that the new fiscal efforts will take the place of the monetary efforts of the past eight years. And, right now, the new stock market highs seem to be based on this hope rather than any convincing evidence.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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