Global Policy Uncertainty and U.S. Stock Trends

The Financial Times has predicted that “the rise of Donald Trump may already be casting a shadow over the global economy.”

When it comes to the Trump Administration, the world is unsure what policies to expect. Trump’s positions on international trade and tendency toward nationalist policies are a concern for the rest of the world. However, the U.S. stock market is performing at record-breaking highs. Economic research has linked policy uncertainty to stock market slowdowns. If this is so, why is the American stock market responding so positively?

Policy Uncertainty

With President Trump’s unprecedented actions and unpredictable behavior, policy uncertainty seems like the only thing that is certain. With unbroken ties to his family businesses, casual use of Twitter, and frequent attacks on the media, President Trump is shaping up to be different than any president that America has seen before.

When it comes to policy, much of the Trump administration’s plans are unclear. Throughout his campaign, Trump took many different positions on major issues. For example, Trump claimed in multiple campaign speeches that the wealthy should pay higher taxes, saying “Right now they are paying very little tax and I think it’s outrageous.” However, in Trump’s August 2016 tax plan, the top 20 percent of earners would receive 67 percent of the overall individual tax cuts.

Whitehouse.gov also contains pages on high-priority goals for the Trump administration, such as the military, jobs and growth, and energy. However, it offers minimal details as to how the administration plans to accomplish these goals.

Uncertainty and Investment

Typically, we expect policy uncertainty to affect investment, reflected through stock markets and other economic measures. Moody’s Analytics explains that uncertainty theoretically raises the cost of capital, postpones consumer spending and creates an incentive for employers to slow hiring and investing.

Economists Lubos Pastor and Pietro Veronesi of the University of Chicago Booth School of Business developed an economic model that directly related policy uncertainty and stock prices. The model predicts that stock prices respond negatively to policy uncertainty; when uncertainty is large, the reaction is largely negative.

A study by Scott Baker of Northwestern University, Nick Bloom of Stanford University and Steven Davis of the University of Chicago found that policy uncertainty also negatively affects firm employment and investment. “Firms with greater exposure to government purchases experience greater stock price volatility when policy uncertainty is high and reduced investment rates and employment growth when policy uncertainty rises,” the authors explain. Citing household hesitations in spending, finance cost increases, and risk aversive behavior, and market rigidities/frictions as factors, the researchers claim that uncertainty can deeply impact decisions at a microeconomic level.

Nonetheless, scholars still do not completely understand the true effects of policy uncertainty on the economy. Moody’s Analytics found that “a sudden spike [in uncertainty] can have economic costs, but it can also be used as an excuse for weakness in the economy when there could be other clear causes;” this is especially true during presidential elections. The study asserted that policy uncertainty will likely remain high as the Trump Administration enacts new policies; however, the economic costs attributed directly to policy uncertainty will likely remain minimal.

Current Uncertainty and Economic Trends

Quantitatively, it is clear that global policy uncertainty is reaching unforeseen levels. In January 2017, the month of Trump’s inauguration, the Global Economic Policy Uncertainty Index reached the highest levels observed since the index began in the late 1990s.

The World Bank cites policy uncertainty as a cause for economic slowdowns in 2016-2017. Emerging market economies and world trade performance are both weaker now than in previous years.

When we focus in on United States, however, the narrative is different. The U.S. stock market has been

https://commons.wikimedia.org/wiki/File:Trump_address_to_joint_session_of_Congress_2.jpg

On March 1, the President Trump addressed a joint session of congress and the Dow closed at over 21,000 points for the first time.

performing relatively well since Trump’s election. Following an initial negative reaction on the morning of November 9, stock markets have reached new heights since November. On the first day of March, the Dow broke records by closing above 21,000 points for the first time, and in mid-March, the Nasdaq composite hit an all-time high.

Why has the U.S. Economy Responded this Way?

There are many potential reasons why the U.S. stock market has responded so positively in the face of high global policy uncertainty.

“Major international institutions such as the IMF, the OECD and World Bank have recently upgraded their forecasts of global economic growth largely due to expectations that tax cuts, rising infrastructure spending and a wave of deregulation will boost the US economy under the new president,” the Financial Times claims. All three of these proposals are good signs for the stock market. Trump’s intended timeline for these policies is unclear, but stock markets may be betting that they will be implemented eventually.

The stock market’s strong performance could also be linked to Trump’s approval ratings. A study by Ned Davis Research found that a low presidential approval rating corresponds with gains in the stock market. According to Gallup, Trump’s approval are ratings lower than any other president that they have tracked in 72 years. The NDR research only specified that there is a correlation between these two factors, but not causation. If there is any deeper causal connection between presidential approval ratings and stocks, then Trump’s low approval rating could explain recent trends.

Will it Last?

There is also a possibility that this boom is only temporary. Economist Larry Summers believes that this is the case. He cites future nationalist policies and increasing insider sales, among other factors, as the potential downfall of U.S. stocks. Along with this, Foreign Policy argues that the Trump Administration is taking the wrong approach to boosting the economy; most of the benefits will be enjoyed by the wealthy. Research shows that fiscal spending that focuses on helping low-income individuals/families has a more positive long-run economic impact. However, the Trump Administration is not placing much emphasis on these types of programs. Further, Trump has even suggested cutting large portions of programs meant to help low-income Americans.

Conclusion

It is too early to predict what the next four years will mean for the economy. Although news outlets and social media may make it feel as though unprecedented amounts of uncertainty to the United States, the economy does not seem to be responding to this uncertainty negatively, at least for now. In the short term, we can view this as a positive trend; nonetheless, we must be wary of any potential downturns in the future.
The author would like to acknowledge Dr. Russell Green at Rice University’s Baker Institute for providing the idea and framework for this post.

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