We are seeing decent selling in today’s US equity markets, with the VIX up some 25%. Bonds are rallying. And most people are pointing to the Trump scandals. But this is only one day. What is happening with Trump – while negative – will not change the arc of the US economy and markets.
The markets. First, let’s remember that the market faces some headwinds based purely on the fundamentals. Large cap stocks are trading at relatively high multiples of earnings even on a forward-looking basis.
Source: Ed Yardeni
And the multiples for mid-cap and small-cap stocks are even higher than large cap ones.
Source: Ed Yardeni
So, absent continued multiple expansion and financial engineering, US equities are dependent on increases in operating earnings in an economy growing fairly slowly in nominal terms. Where 5% growth was a floor during an expansion, it is now a ceiling.
Source: St. Louis Fed
At this point in the cycle, and with historically high operating margins unlikely to increase, nominal growth is going to be the major factor driving market top-line growth and earnings. Moreover, while large caps can translate increased earnings from abroad into US dollars, I am skeptical about the ability of US companies to get organic growth without the aid of leveraging and multiple expansion. That limits upside.
The political economy. Given that backdrop, the delay and potential failure of Trump’s legislative agenda is negative for markets. That’s what I was saying last week, with my post on Comey’s dismissal. Moreover, given where we are in the business cycle, monetary policy is likely to offset a lot of fiscal stimulus that Trump had been planning, making the 3 to 4% growth he talks about close to impossible to achieve on a sustained basis. I think markets are starting to realize this and are adjusting to this baseline – but in the context of very positive near-term economic growth. That is supportive over the near-term but less so over the medium-term. That’s what I was saying this morning.
