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How Trump Is "Putting The Valuation Bubble In Equities At Risk"
07-19-2017, 01:02 PM,
How Trump Is "Putting The Valuation Bubble In Equities At Risk"
How Trump Is "Putting The Valuation Bubble In Equities At Risk"

<p><a href=""><em>Authored by Komal Sri-Kumar via,</em></a></p>
<p><strong>Donald Trump&rsquo;s appeal last November was linked to two factors. </strong>Both are now putting the valuation bubble in equities at <strong>risk</strong>.</p>
<blockquote><div class="quote_start"><div></div></div><div class="quote_end"><div></div></div><p><u><strong>The first factor was his emphasis on stimulus -- tax reform, infrastructure spending and fewer regulations -- that has pushed markets to higher and higher levels</strong></u>. The new administration was targeting at least 3 percent annual growth in real gross domestic product, well in excess of levels that the U.S. economy has experienced since the financial crisis.</p>
<p>Investors reasoned that properly directed fiscal spending would create employment and cause consumer demand to increase, while the reforms would validate a rise in market measures of valuation -- lower corporate taxes would be like valuing a company at 17 times earnings rather than 20 times, for example. Expectation of fewer regulations was a major factor in the increase in bank share prices.</p>
<p><u><strong>The second component of the Trump campaign presented the U.S. trade deficit as a sign that the country was being treated unfairly by its trading partners. </strong></u>The remedy was to impose higher tariffs on imports, with China and Mexico mentioned as specific targets.</p>
<p>Fear that the trade restrictions the candidate threatened during the campaign would dominate the incipient administration was the reason U.S. equity futures plunged during the hours immediately after the election results were known. Retaliation by trading partners to new tariffs would have slowed global economic growth and demand, resulting in a headwind for equities.</p>
<p><strong>In the first months of the Trump administration, the emphasis seemed to be on the stimulus front, and markets rose sharply. </strong>Trump was not going to name China a &ldquo;currency manipulator,&rdquo; and Commerce Secretary Wilbur Ross suggested that even if the North American Free Trade Agreement was canceled, the U.S. could have a new bilateral treaty with Mexico with similar terms as before. A 15 percent jump in corporate earnings in the first quarter compared with the first quarter of 2016 also helped propel equity valuations. Between the day of the elections and June 30, 2017, the S&amp;P 500 equity index had risen by 13 percent (chart below).</p>
<p><strong>The S&amp;P 500 Soars</strong></p>
<p><a href=""><img alt="" src="" style="width: 600px; height: 314px;" /></a></p>
<p>While equities have continued to rise to new levels in July -- the S&amp;P 500 index hit its 25<sup>th</sup> record on July 14 -- <strong>the Trump policy pendulum has swung away in the past few weeks from stimulus toward restrictions. </strong>Disappointed that Chinese authorities did not do enough to curtail North Korea&rsquo;s nuclear initiatives, U.S. officials have suggested that China may face increased trade action. There is also talk in Washington that Chinese banks that have business connections with North Korea could face sanctions. Almost certainly, such moves would provoke retaliation from Beijing.</p>
<p>And at the recent meeting of G-20 leaders, Trump reiterated -- even in the presence of Mexican President Enrique Peña Nieto -- that a wall on the U.S. southern border would be built and that he would get Mexico to pay for it. These measures are considered to be deeply demeaning by Mexico. The Trump statement came a few days after his decision to withdraw the U.S. from the Paris climate accord that was supported by all the remaining 19 nations in the G-20 group.</p>
<p><strong>Trade tensions with Europe have also increased. </strong>Trump criticized Germany in May for its large trade surplus and inadequate contributions to the North Atlantic Treaty Organization budget. The president was reacting to Chancellor Angela Merkel&rsquo;s suggestion that the European Union could no longer rely on the U.S. but had to take fate into its own hands.</p>
<p><strong>Equity markets continue to be pushed higher by positive earnings expectations, and earnings numbers for the second quarter suggest the trend will continue. But neither of the other two legs of the stock market tripod -- stimulus and economic reforms -- seems likely to be supportive.</strong></p>
<p>With the health care reform bill stuck in Congress,<strong> tax reforms, set to be next in line, seem like a distant dream. </strong>Weakening retail sales, and a falling inflation rate, are signs of an economic slowdown in prospect. If a trade war supplements the absence of stimulus, financial markets will face a double whammy in the months to come.</p>
<p>Fed Chair Janet <strong>Yellen recently cited &ldquo;somewhat rich&rdquo; valuations in U.S. financial markets to justify the central bank&rsquo;s intention to continue raising interest rates. </strong></p>
<p>The growing risk for investors is that delay in stimulus measures and the rise in global trade tensions could deflate the valuation bubble faster than Fed action can.</p>

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