Animal Spirits

Tuesday, March 28, 2017

If you are an investor in equities and have been paying attention, the indices that track different sectors of the equity markets have been on an upswing since the presidential election. The three major U.S. indices are all up by double-digit percentages since Nov. 8, 2016.

As of March 20, 2017, the Dow Jones Industrial Index is up 14.03 percent, the S&P 500 Index is up 10.93 percent, and the NASDAQ is up 13.63-percent.1, 2 It has left many investors puzzled because the so-called experts that were on television prior to the election were predicting a downturn in the equity markets if then candidate Trump were to be elected.

How could these experts be so wrong? What has changed economically in the United States since the election that could explain the rally in the equity markets? Has the GDP of the United States improved that dramatically? Have any of President Trump's economic proposals become law as of this date? Have the democrats joined in celebrating the election of President Trump?

The answer to these questions is that nothing measurable has really changed in terms of the economy. One thing that may have a changed though is an old economic theory described as "animal spirits."

Remember, for equity markets to rise there must be investors who are willing to buy. "Animal spirits" is a term coined by the economist John Maynard Keynes. The term was chosen to emphasize the importance of confidence and the "gut instincts" of businessmen on their future business prospects.

This can be described as a spontaneous urge to action rather than inaction and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.3 Consumer sentiment is at a 16-year high and the small business optimism index is near a 43-year high.4

The expectations of investors appear to be that the pro-growth economic proposals being pushed by President Trump will become a reality at some point this year. President Trump's message of buy American and hire American seems to have resonated within the business community and certainly the political base that elected him.

The possibility of lower taxes on business and individuals, the rollback of costly regulations, infrastructure spending, and rebuilding the military has historically triggered an increase in GDP. The GDP of this country averaged below 2 percent for the eight previous years. If the proposals of pro-growth become reality, a GDP number in the 3- to 4-percent range could become a reality and that type of growth would cure many of the challenges our country faces when it comes to jobs, deficits, and infrastructure going forward.

The real challenge will be if the party in power can deliver on the promises they have made over the last several years. President Trump appears to be keeping his promises. Only time will tell if the republican congress will keep theirs.

Don't be surprised if the pause in the upward move in the markets continues for a time. Congress has never been known to do anything quickly. Stay tuned and, as always, keep calm and carry on.

1 Marketwatch.com
2 It is not possible to invest directly in an index. Exposure to an asset class represented by an index is available through investible instruments based on that index
3 J.M. Keynes, General Theory (161-162)
4 NFIB March 2016 Report

Author

Wesley Lentz Wesley Lentz

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