It was well over a year ago that I looked at my children and told them that Donald Trump was going to be the next president. Then, the night of the election, I kept thinking, This outcome is not possible; how could I have been correct in my prediction?
Like most people, I was in shock when he did win. Since then, I can only say that, anecdotally, businesses seem a little more upbeat and hopeful about the economic future of the United States. Certainly, the 1,000-point rise in the Dow has made investors feel good, but at these lofty levels, where do we go from here?
Many proposals are being floated: Lower the corporate tax rate from 35 percent to 15 percent; impose less regulation, through removal of parts of the Dodd Frank and Obamacare legislation; and repatriate foreign cash holdings from our corporate conglomerates— these changes are all supposedly part of the agenda.
Certainly they would all help kick-start our stagnant economy. But there is also a price for these changes, which must be considered when we look at the year ahead.
2017 will be a bumpy, but okay, scenario for stocks, and a rough ride for bondholders.
At the time of writing, stocks are trading at roughly 21 times the average earnings for 2016 overall and about 17.1 times 2017’s estimated earnings.
In both cases, we are at levels much higher than the average norms. However, a reduction in corporate tax rates, from 35 percent to 15 percent, could add 20 percent to earnings. Then, if some regulatory costs were removed, and you added that to the bottom line, you would see an increase in corporate earnings of almost 40 percent.
This would lower the multiple on the markets to something in the range of 12 to 14 times earnings. That would make stocks much more attractive for the year. And it’s safe to say that this scenario is very likely, considering the make-up of the House and the Senate; but all this will take time to get done. Nothing happens quickly in the federal government.
Also, when you consider the posturing and arguments already occurring, the best case scenario is that this legislation will be done by the summer of 2017. And what if it all doesn’t go through? The above outcome may not be so smooth or attractive, so we should expect some volatility.
Now, there are downside issues with a quickly growing economy: Interest rates for one, will definitely go higher. Higher borrowing costs flow through every single economic market, and there are only two beneficiaries of higher interest rates: savers and the banks.
Both will welcome higher interest rates, of course, while the rest of us witness increases in the cost of, well, everything. On top of that, we’ll have an enormous debt hangover; and higher borrowing costs will make servicing our national debt a problem, with all new issuances coming in at higher rates.
Then there is higher inflation, which unto itself is not so bad, unless it starts moving too rapidly. This too will affect many people, as it erodes the buying power of our citizens. Inflation will also creep into the budget of the federal government, where salaries or growth of payouts are tied to inflation.
So, while most of this is welcome, our best guess is that 2017 will be a bumpy, but okay, scenario for stocks, and a rough ride for bondholders. In the long run, we must consider that we are still not in great shape with our debt, and it is expected to go higher.
What’s more, the debit issue alone could be a very dangerous situation, which, however, will not play out in 2017.
This article was originally published in the February–April 2017 issue of Worth.