From the Federal Reserve chair on down, expectations have been building along with equity valuations. Forecasts and kudos have been handed out based on the S&P 500's runup. We see fresh monies in the hundreds of billions chasing flows into equities.
So what's conducting this cacophony? We believe it's the reflation trade.
Many have heard what they wanted to hear and declare the noise a symphony. We hear the noise and
We have seen the market rally since September 2016. Ironically, the pre-election rally was thought to be based on Hillary Clinton winning the presidency — but following the Donald Trump surprise, we have seen a four-plus-month rally boosting the S&P by 9 percent.
The rally is based on offers of lower tax rates for individuals and corporations. Reductions of up to 50 percent in corporate rates, mentions of estate tax repeal, cuts in capital gains and repeal of the alternative minimum tax float around. Export subsidies, tariff walls and $1 trillion in infrastructure spend are said to be on their way. Reflation confidence is based on extrapolation of campaign promises.
Meanwhile, mounting tensions within the Republican Party and setbacks on immigration and health care have not shaken confidence.
The usual macro suspects, like spiking wages and commodity prices, do not presently explain reflation expectations. Instead, the market appears to be working off the following assumptions:
1) Unpassed legislation
2) Phasing of effect from future legislation
3) Net macro impact from legislation passed
4) Effect of higher interest rates
5) No unintended effects that reduce growth and optimism
Unfortunately, these amount to conjecture heaped upon conjecture. Estimating compound political and economic effects out into the future and then properly discounting them back to the present is a fool's errand. We believe there is little reason — aside from optimism — to believe that we will see all that is hoped for and priced in from Trump.
Legislative processes are slow, opaque and subject to swings in opinion. Market price movements are opaque and subject to swings in opinion — but markets move quickly. Single party political rule in the U.S. was alleged to offer clarity on legislation. The recent misadventure in repealing and replacing the Affordable Care Act suggests otherwise.
Expectations remain elevated for policy-driven
Only time will tell if we are in an actual reflation cycle or just a
Story-based investment cycles, however, do not permit participants to write their own endings.