Why are markets rejoicing at Trump's win? The incoming president may not be good for the economy in the long run.

Author:De Rugy, Veronique
Position::ECONOMICS
 
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ON THE EVENING of November 8,2016, as it became clear that assumptions about Hillary Clinton's certain electoral victory were wrong, investors began to squirm. Dow futures dropped by more than 700 points that night, and the liberal economist Paul Krugman wrote at The New York Times that "if the question is when markets will recover, a first-pass answer is never."

The next morning, however, the stock market completed a stunning reversal to end at a record high. What some have called a "Trump rally" has continued ever since, with the Dow Jones Industrial Average hovering just above the 20,000 mark at press time.

One explanation for Wall Street's seeming euphoria is that investors believe they're now less likely to see the continuation of tax hikes and micro-regulation desired by the Clinton campaign.

True, it's impossible to know what Donald Trump's win heralds on the policy front in the long term. But at least for now, the market appears to be betting that the new president will make good on campaign promises that businesses expect to be good for their bottom lines. The Republican sweep could pave the way, for instance, for a long overdue reform of the individual and corporate tax codes.

Right now, explains Cato Institute researcher Chris Edwards, corporations keep just $65 of every $100 in profits they earn, after taxes are taken out. "Trump is saying they will get to keep $85," he says. "If the profit stream increases by 30 percent ($85 vs. $65), so should the market value." After all, "in theory, stock valuations are the present value of future after-tax net profits to companies. So when you cut the tax rate on profits a lot, the [present value] of the net profits--the net cash--to the shareholders rises a lot."

The S&P Financials Index returned 16.75 percent from Election Day through year end, compared to 5.98 percent for the S&P as a whole. This suggests markets are bullish about the possibility that Trump will loosen Wall Street-specific regulations such as those in Dodd-Frank. Multinational companies may also have concluded they'll be allowed to repatriate some of their foreign cash holdings to the U.S. at a lower cost than they could have under Clinton.

None of which means the markets are right. Andrew Hofer, the head of Taxable Fixed Income at Brown Brothers Harriman & Co., thinks markets may be overcorrecting for a...

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