Ever since Donald Trump won the 2016 election, there has been an undercurrent of confusion in some quarters about why financial markets have been so relaxed — or even enthusiastic — about what the president-elect will do once he is in the Oval Office. Many economists predicted a financial panic if Trump was elected — and that has not happened. Indeed, the incoming Trump administration’s protectionist trial balloons do not seem to have rattled markets the way so many predicted would happen during the 2016 campaign.
Pedro da Costa noted this oddity last week in Business Insider:
So far, markets have focused on the purportedly bullish portion of his broad-brush economic proposals — corporate tax cuts and loose plans for infrastructure spending. But they have largely neglected Trump’s potentially devastating approach to trade, one which scholars at the Peterson Institute for International Economics found could lead to a damaging, protracted trade war. …
But Wall Street’s base case has been to dismiss the prospect of follow-through.
Many people are in the habit of not taking Donald Trump literally, and that appears to include investors on Wall Street who have responded to Trump’s election with the sort of stock price boom you would have expected from the election of a completely orthodox free marketer like Jeb Bush or Marco Rubio. …
Wall Street certitude about this is a little difficult to understand. Trump certainly seems to be laying the groundwork for a serious effort to curtail imports into the United States, and nothing about his personality suggests that he’s likely to back down quickly in the face of countermeasures. The exact consequences of this are difficult to predict, precisely because nobody’s really tried anything like it in the modern era. But based on his picks and his clear belief that trade controversies are good politics, it seems much more likely than not that we are about to find out.
No wonder economists are so exasperated. Instead of the stock market crashing, the Dow Jones industrial average is approaching 20,000. The dollar is strengthening. So what the heck is going on? Even if the risk of a global trade war is only, say, 1 chance in 4, one would presumably expect such fears to affect the stock market, right?
I think there are a few different ways of trying to think about this apparent disconnect. The first way is to suggest that maybe, just maybe, the markets might be making an accurate assessment of the situation. The Trump administration is most likely to find congressional support for conventional GOP policies such as deregulation and tax cuts, which I hear businesses would like. It should not be surprising that financial stocks are driving much of the recent boom. Sure, a trade war would be bad, but maybe markets are putting a lower probability on that happening.
Don’t get me wrong: If Trump slaps a 5 percent border adjustment tax on imports, that would be bad, and markets have to know that. But it is possible that they think any trade war would be mostly symbolic in nature: Barriers would go up a little but not a lot, the global supply chain will not be interrupted, and for stockholders the benefits of tax cuts and deregulation trump the loss of protectionism. Maybe markets are right to be so chill.
The second way to look at it is that this is yet another example of the wonk dilemma that many policy analysts will experience for the next four years. On topics ranging from Russia to China to foreign economic policy, the incoming Trump administration is deploying rhetoric and ideas that a wide spectrum of experts think are really bad ideas. The failure of financial markets to punish Trump has left many of these experts flummoxed about why the world is not working the way they think it works.
Trump has not assumed the presidency yet, so experts might very well be right! But it leaves them in the odd position of rooting for the stock market to freak out, and this is not a good look for anyone. It is worth remembering that back in December 2015 and again in September 2016, Trump claimed that the United States was in the middle of a financial bubble and that it could pop at any moment. Many commentators criticized Trump at the time for making reckless statements about financial markets. Many of those same commentators are now decrying the lack of financial panic.
Then there is the way that I think political commentators should actually interpret the markets’ reaction to Trump: by acknowledging that markets are not the great predictor that some scholars have claimed. Social scientists have long assumed that investors have a powerful interest in understanding how politics works. Certainly, since 2008 more and more financial actors have invested in political analysis.
Actual political behavior can confuse them, though. Market participants are adept at identifying the economic pressures that could force politicians to act. Predicting how politicians will react to those pressures is where traders may fall down. In my conversations with investment bankers during the 2013 debt-ceiling showdowns, for example, they were constantly surprised at the political-bargaining failures that kept recurring. Politicians have different incentives than market participants — a fact that sometimes escapes for-profit actors when they think about the world.
It is also possible that asset managers care less about accurate political predictions and more about what their fellow investors think will happen. If financial managers care more about herd effects than anything else, then they will get a lot of politics wrong.
Full disclosure: I have been skeptical of the utility of markets as political predictors for some time now. But my main takeaway from the apparent disconnect between Trump’s proposed policies and financial markets is to appreciate just how much everyone — experts, investors and Trump — could be wrong.
Welcome to 2017.