The optimism that has followed the election of Donald Trump has pushed the Dow Jones Industrial Average to the threshold of 20,000, a level that will be both a nominal record and a symbolic milestone. Although this is not the way most observers had predicted that 2016 would play out, most on Wall Street have become extremely reluctant to look a gift horse in the mouth...or to even look at him at all. The impulse is to jump on and ride, and only ask questions if it pulls up lame. But if this year has proven one thing, it is that predictions made by the consensus should not be trusted.
Back in the earlier part of 2016 the mood was decidedly darker. At that point most people believed that the Federal Reserve would be raising rates throughout the course of the year. While such hikes had been anticipated (and delayed) for years, most took comfort in the belief that the economy would be expanding nicely by the time the Fed actually pulled the trigger. But in late 2015, the already tepid GDP growth seen in the prior two years seemed to be decelerating. Investors also concluded that Hilary Clinton was a lock to win the election, thereby assuring that the anti-growth policies of the Obama years would continue. Many looked at these developments and concluded that the sins of the past decade, in which the Government and the Federal Reserve had used unprecedented levels of fiscal and monetary stimulus to prop up the economy and the stock market, had finally caught up with us. As a result, the Dow Jones shed more than seven per cent in the first two weeks of the year, its worst start on record.
But the year comes to an end amid a cloud of Trump-fueled bullishness. The markets fully embrace an unapologetic capitalist, and his team of billionaires, who promises to cut taxes, rewrite trade deals in America's favor, take a machete to anti-growth regulations, repeal Obamacare, and return America to its former industrial might. Many are making parallels to the Reagan Revolution in which a maverick anti-establishment Republican took charge in Washington and ignited an economic boom, a stock market rally and a surge in the dollar. But to make this comparison, boosters must jump over a more telling comparison to the last Republican president elected, George W. Bush.
The parallels to W. are striking. Both lost the popular vote, and will have taken office following the tenure of a two-term Democrat who had presided over a furious stock market bubble and a surging dollar. In the 4 years prior to Bush's election, the Dow Jones had surged approximately 60% and the dollar index had risen approximately 19% (1/2/97 to 12/29/2000). For Trump, the numbers are 48% and 24% (1/2/13 to 12/21/16). Then, as now, the U.S. was seen by investors as the only game in town. Clinton's second term was rife with global crises that both created safe-haven flows into the dollar and caused the Fed to backstop U.S. financial markets with cheap money (at least cheap by the standard that existed at the time). Both will have come into office promising tax cuts and regulatory relief following eight years of Democratic reign. As a result, the market gains of the Clinton and Obama years were expected to continue under their Republican successors.
But the optimists did not anticipate that the big, fat, ugly bubble that inflated during Clinton's second term, would burst early in Bush's first term (although the air started coming out of that bubble while Clinton was still in office). Given the ensuing recession of 2001, it can be argued that the only reason Bush was reelected in 2004 was that the Fed was able to inflate an even bigger, fatter, and uglier bubble in housing that postponed the pain until the financial crisis of 2008. That is where the similarities will likely end, as Trump will likely not be that lucky.
One of the pillars of dollar strength under Clinton was eight straight years of deficit reductions, culminating with a massive $236 billion budget surplus in 2000 (Congressional Budget Office). While the surplus did require some accounting smoke and mirrors and a stock market bubble to create, it nonetheless marked a significant achievement. At that point, many economists had assumed that the U.S. debt problem had largely been solved and that the country would ride a wave of permanent surplus. The only problem most could envision was a shortage of Treasury bonds once the national debt was fully repaid. No one is to worried about that "problem" now.
Similarly, Trump is taking charge at a time when official budget deficits have fallen consistently since 2009 (albeit from astronomically high levels). But 2016 is projected to be the first year since 2009 in which the deficit will have risen, significantly, from the prior year. The Congressional Budget Office sees a return to perpetual $1 trillion plus annual deficits in the early part of the next decade (The Budget and Economic Outlook: 2016 to 2026 report, January 2016), even if we have no tax cuts, spending increases or recessions over that entire time. Under the Trump presidency, we are likely to get all three.