History is bunk – Michael Wilson contrasts the chaos of the Trump administration with strong USA stockmarket performance

Henry Ford knew what he meant when he declared a new historical paradigm, says Michael Wilson. But could Donald Trump say the same?

It sometimes seems impossible that it’s only just over a year since Donald J Trump was elected President of the United States.  Those twelve short months have seen the arrival of what Mr Trump calls a “modern presidential” style, and what most foreigners would call a completely chaotic pattern of administration.

A tumbling carousel of top-level dismissals, which recently included his chief of staff Reince Priebus and his own chief strategist Steve Bannon, has left the President painfully short of allies and his staff battling to keep him from further blunders. Trump’s recent Twitterings against his own Secretary of State (foreign minister) Rex Tillerson, who he accused of “wasting his time trying to negotiate with Little Rocket Man” in North Korea, prompted a highly conspicuous non-denial from Tillerson to the media claims that he had called his boss a moron.

And all the time, the special prosecutor’s office has been quietly subpoenaing the President’s circle into giving evidence on the “Russia thing” which has already claimed the careers of more senior figures than fell during any administration since Nixon.

Trump’s performance on the world diplomatic stage during those ten short months has first confounded, then amused, and finally horrified a world which is now coming to terms with the damage that the President is doing to America’s international standing. His direct threats of nuclear annihilation to North Korea have been timely and appropriate, to some reluctant ears. (Even a clock that’s running backwards is bound to be right twice a day, they say.) But Trump’s failure to abolish Obamacare, to build the Mexican wall, to nominate more than a thousand key civil service personnel, to or to keep his own industrial think tanks from disbanding themselves in disgust, all suggest that the President’s grasp of leadership is deficient to put it mildly.

This time it’s different

Which is why it’s odd that Mr Trump’s latest plan to reform the US tax system by abandoning the principles of budget balancing hasn’t hurt the American stock markets. (Although its impact on the bond markets may yet prove to be a different matter.) The first nine months of the Trump Administration’s tenure at the White House saw the S&P500 rising by nearly 14%, at a time when the Footsie was struggling to hold onto a 2% increase and the Nikkei made 7% against a sharply depreciating Japanese currency. Among the major market centres, only the German DAX (up 11% on a much stronger euro) would have made a sterling investor more money than the US.

And all this in the face of US company valuations which are, by some measures, verging on the suicidal and unsustainable. At least, by the standards of the traditional Shiller ten year p/e, which takes a decade-long average of prices and earnings and presents them as an inflation-adjusted average. The Shiller average for the S&P500 at 6th October was running at 31.03 – the second highest level ever, apart from a ferocious blip in 2002 that was destined to end in tears, and just a nose ahead of Black Tuesday in 1929.

“History is more or less bunk. It’s tradition. We don’t want tradition. We want to live in the present, and the only history that is worth a tinker’s damn is the history that we make today.” (Henry Ford, 1916)

Structural issues

What’s that all about? America’s popularity might be simply happening because of the US dollar’s traditional role as a reserve currency. In which both oil and gold are denominated, remember. Not even George Soros ever betted successfully against the greenback – and at a time when political and economic uncertainties are troubling the markets in Asia, Latin America and (of course), in Britain, there are sound reasons why foreign capital should favour the solidity of the United States.

We’ll come back to that possibility in a minute – there are, after all, a number of reasons why the dollar’s momentary weakness might indeed be attracting interest from long-term players. But for the moment let’s focus our gaze on two of the key factors that brought such a strong stock market welcome to Mr Trump when he first came to office.

The first, as you might recall, was a commitment to sink $2 trillion into improving America’s gently rotting infrastructure. For decades, the country has been dogged by poor quality highways, awful regional airports, and trains that only the poor feel inclined to use – America does have a long-term problem with investing in public plant and equipment – and Trump’s determination to reinvigorate the communications structure proved to be one of his best electoral lines. But where is it now?

In truth, it might be better to ask where it has ever been. Trump never made it entirely clear whether he intended to fund that $2 trillion out of the public purse, or whether he would float new bond securities specifically for the purpose, or whether he would effectively privatise the infrastructure by turning over major projects to the private sector – either through private finance initiatives or through actual commercial ownership of the public facilities.

What we can say at the moment is there’s not been a peep from the White House about what’s proposed. It seems very unlikely that the public purse can afford to stick the cost onto the federal deficit bill (see below) – but where are the tenders for new public works? Where is the enthusiasm from construction companies for the infrastructural bonanza that will underpin the country’s promised explosive economic development? Why is the USA’s average broadband speed slower than Belgium’s or Romania’s? (And only a nose above Russia’s?)

Tax reform and “wealth-fare”

Again, you might well ask. But that’s because the bigger unanswered question is how the Administration intends to manage the fiscal purse, full stop.

You’ll be aware that on 27th September the President announced a long-promised tax reform that was bold in its language, but about as detailed as the one-page health statement he issued before his election. It promised a doubling of family income tax allowances, and a drop in corporate tax rates from 35% to 20%, and a repeal of death duties – but, as of mid-October, there was no word as to how that huge handout would be paid for.

How huge? $6 trillion, according to one Reuters estimate. That would be about one third of the current accumulated federal deficit. So could it come from cuts to other government departments? Will the President aim to claw some of it back by abolishing deductions that are currently allowed? (We know that there’ll be a one-off levy on businesses’ accumulated offshore earnings, and that personal deductions for state and local taxes will be disallowed.)

Or will the simplification of personal tax rates (from seven tax bands currently to just three – 12%, 25% and 35% – be accompanied by a detrimental downward shift in the income brackets to which those bands apply? We might know more by the time that you read this article, but all that seems clear at present is that the axing of estate duty would save wealthier citizens around $20 billion a year – of which, says Bloomberg, the President himself would account for $564 million. Small wonder that the term “wealth-fare” has become a media ‘thing’.

Nor are we really allowing for the fact that the vast majority of US companies don’t pay 35% tax on their earnings anyway. According to broadcaster NPR (using Congressional Budget Office figures), hefty deductions and rebates mean that the actual rate paid by US corporations is 18.6%, just behind Britain’s 18.7% – but still much more than Germany’s 15.5%, France’s 11.2% or China’s 10%. There’s plenty of scope here for a bit of sleight of hand.

Deficit, schmeficit….

And that in turn doesn’t begin to tackle the question of how those $6 trillion of Trump tax breaks can be financed. The Congressional Republican Party has been pleading with the President all year to limit his posturing about ultra-right-wing demonstrators and Obamacare and Chinese currency manipulation, and to start focusing on the tax reforms that have underpinned most of the stock market’s enthusiasm this year.

In theory, then, the President’s plans ought to have received a warm welcome on Capitol Hill. Instead, however, the knives are out well in advance of the necessary cuts being implemented. The best estimates at the moment suggest that Trump will either have to find $4 trillion of savings (or augmented revenue), or else to grow the deficit.

Now, it looks as though Trump can reclaim about $1.3 trillion from the abolition of tax deductions for local and state taxes, which would be a start. The problem is that both New York and California have set their faces against allowing this to happen; indeed, the once-faithful Trump ally Republican Senator Bob Corker (Tennessee) has said he will lead a congressional rebellion against anything that leads to an increase in the federal deficit.

Reasons to be cheerful

Does any of this matter, given that Trump has more than three years left in which to get what he wants past Congress? There are those who point toward next year’s mid-term elections as a defining moment – the moment when individuals’ tax bills will be either rising or falling, and when both senators and congressmen can expect to get the full blast of public opinion in their faces. That, it seems to me, will bring an element of sanity to this matter.

But in the meantime, there are several good enough reasons why this year’s Wall Street surge might still prove to have been an entirely rational development.

  • The weak dollar has brought in speculative money from abroad, which has found US stocks to be unusually cheap. Rather like the way that London benefited from the Brexit vote in the second half of 2016.
  • The likelihood of higher bank rates in the new year will probably hit corporate profits in consumer industries, but it will strengthen the dollar, which will underpin the value of any US equities that are bought now.
  • Conversely, higher bank rates will probably inflict considerable damage on the US bond markets, which are currently super-sensitive to every twitch in the yield and which have a long way to fall if the worst happens. That could probably drive enough money toward equities to keep the S&P 500 bandwagon rolling.
  • We mentioned earlier that the Shiller ten-year p/e ratio has been running at a near all-time high over the last year, and that this would normally imply that a major correction was on its way. But optimists say we shouldn’t forget that the ten-year anniversary of the 2008 crisis is now approaching – which ought to mean that the worst year of the ten-year Shiller run is about to roll out of the calculation.
  • Let’s not forget that US inflation and unemployment are both at historically low levels – which suggests, in turn, that there’s no sign of overheating.

And finally

Let’s conclude with two very generic observations. Firstly, that the United States has not just one of the world’s most dynamic and entrepreneurial cultures. It also has probably the youngest demographic of any developed nation. And yes, the fact that this is mainly down to Latinos and illegal border-hoppers is just something that America may have to take in its stride. Compare America’s demographic position with that of China or Japan, and you’ll see what I mean.

Secondly, let’s remember the wise words of US perma-bull Ken Fisher, the founder and Executive Chairman of Fisher Investments, who told us a year ago that Trump’s election wasn’t going to crash the US stock market, or even dent it. As he told the Financial Times back in January:

Betting on what Mr Trump will do is wrongheaded. Even if you guess right, presidents can do little on their own. Big change requires legislation and Congress is an undrainable swamp. Republicans have just 52 Senate seats to Democrats’ 48, yet 20% of Republican senators didn’t endorse Mr Trump. Intraparty squabbling will be a new source of gridlock. Budget hawks will probably block huge tax cuts and major new spending. Republican leaders are pushing back on “The Wall”. Whatever you fear or hope happens probably won’t.”

Full marks, Mr Fisher.

Michael Wilson is Editor-in-Chief at IFA Magazine.

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All figures correct as at 01.02.2018.