U.S. equities are celebrating the election results. However, a meaningful fiscal stimulus may not come before 2018. Until then, policy uncertainty and tighter financial conditions could cap the market’s upside.
Investors believe the political regime shift will entail fiscal stimulus and a lifting in regulatory constraints that stir animal spirits and pull the U.S. economy out of its growth funk. The reality is that it is premature to make long-term assumptions. The political process could delay any meaningful fiscal stimulus until 2018.
Further, Trump’s anti-trade rhetoric and penchant for profligacy may dampen business confidence and increase policy uncertainty, causing delays in decision-making and investment. Policy uncertainty and confidence have been reliable leading indicators for valuations, and slippage would put upward pressure on the Equity Risk Premium.
Rather than get overly excited about the potential for a new fiscal spending impulse, it may be more appropriate to view the latter as truncating downside economic risks. Consequently, we still expect undervalued defensives to retake a leadership role from overvalued cyclical sectors and we also retain a domestic versus global bias.
It will be critical to monitor aggregate financial conditions. The Goldman Sachs Financial Conditions index has tentatively edged up. If corporate bond spreads, long-term yields and the U.S. dollar move much higher, financial conditions will tighten further and the odds of the broad market making further gains will diminish significantly.
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