By Peter Mallouk, JD, MBA, President | April 10th, 2017
The stock market has been on quite a run of late, and while many are celebrating each time the market hits a new high, those same new highs create anxiety for others.1
The US market gained 8% from election day through the end of 2016, and large US stocks added another 6% gain through the end of March. Let’s break down some of the factors that play into this.
First, there is a portion of the gain attributable to the “Trump Bump.” During the election campaign, President Trump promised to roll back costly regulations and pledged to reduce corporate taxes, which would not only positively impact future earnings but would also lower taxes on cash coming back into the US that many corporations have kept overseas to avoid the US corporate tax. If you lower the taxes of a corporation, even if the corporation does not increase revenues by a dollar or reduce expenses by a dollar, their profit will automatically go up, simply because taxes have been reduced. The market quickly priced in all of these changes, expecting Congress would go along with this plan. Despite a fight within his own party over healthcare reform, there is no indication President Trump will find opposition with his general theme of lowering corporate taxes. Because stock prices are always a reflection of anticipated future earnings, this allowed for a very quick pricing in of the tax savings. This is the largest reason for the “Trump Bump.”
Independent of the Trump Presidency, unemployment declined from nearly 10% when President Obama took office to 4.8% the week President Trump took office. 4.8% happens to be the approximate point at which the Federal Reserve considers the workforce “fully employed.” This is considered an extremely bullish indicator, as at full employment, recovery tends to finally reach the middle class.
For those that are rolling their eyes at the former graph and prefer the much broader view of unemployment, the U-5 unemployment rate is similar to the traditional unemployment rate, but also includes those people who have stopped working because they believe that, due to economic conditions, no work is available to them, as well as people who would like to and are able to work, but haven’t looked for work recently. The addition of these different types of unemployed people increases the unemployment rate, but the main theme here is that the U-5 rate follows the same trend as the traditional unemployment rate, with the current rate the same as it was prior to the 2007—2008 economic crisis. Or, simply put, it is much better than it has been in nearly a decade, and heading in the right direction.
At first, when the economy is struggling, the Federal Reserve will often lower interest rates to encourage spending. Although fiscal conservatives and fiscal liberals disagree on the hangover effects, all agree that when interest rates drop, it becomes easier for people to buy real estate (with lower rates, you can of course pay more for a home or investment property), stock prices inflate (interest costs for corporations go down, positively impacting net revenue and there is cheap money to borrow for expansion), small business owners are able to borrow at a lower rate and hire more employees, and it becomes easier to make major purchases, such as cars. The issue is at the beginning of a cycle, the lower rates tend to benefit mainly the wealthy. 62% of Americans own real estate, including a home, and just 52% of Americans have an investment portfolio.2 The reduction in interest rates, combined with many other things, finally resulted in unemployment dropping to 4.8% as of election day.
At this level, the lower interest rates finally seem to benefit the middle and lower classes. The reason is at full employment, a business owner who wants to hire an employee usually hires that employee from another company, rather than off the unemployment line. To do this, the business owner will usually need to pay that employee more than they are presently earning. This creates wage inflation. When you finally have wage inflation, then nearly everyone begins to benefit from the recovery.
The Federal Reserve had to lower rates from the crisis to 2016 to continue to attempt to invigorate a slow growing economy. However, when the unemployment rate hit fu