Look for Higher Growth, Risk of Higher Inflation

How much of the good news and higher expectations are already priced into asset prices?

November’s election results surprised both political and economic analysts. Investors quickly became more optimistic and repriced assets.

Bitcoin had the biggest move. On Nov. 3, its closing price was $67,811. On Dec. 5, it closed above $100,000 for the first time. That’s almost a 50% increase in about a month.

There also were powerful but less extraordinary surges in U.S. stock indexes and gold. Bonds and many foreign stock indexes initially declined, while commodities remained in a trading range.

Before the election the likeliest scenario for the next year or two was that the U.S. economy would continue growing at a modest rate and inflation would hold steady or creep to the Fed’s 2% target. Short-term interest rates were expected to decline a little while longer-term rates might increase.

After the election, an extension of most of the 2017 tax cuts is more likely, as are new tax reductions, a moratorium on regulations, and potentially some deregulation. There’s also likely to be fiscal stimulus from continued high federal spending and deficits.

But those positive factors for economic growth could be at least partially offset by a set of contradictory policy changes. Tariffs, mercantilism, and industrial policy are likely to reduce growth and productivity and increase the cost of doing business.

Analysts are going to have a difficult time for the next few years, because they have little experience analyzing the economic effects of those policies.

Another wild card is that winning an election doesn’t ensure that campaign proposals will be implemented. Even when enacted, it can take a while for their effects to be felt throughout the economy.

Those are good reasons for investors to wonder whether the markets are ahead of policy and that some asset prices reflect the best case even before a single policy’s been carried out.

As I cautioned before the election, it’s not a good idea to overhaul an investment portfolio or broader financial plan based on election results. Compromises must be reached for proposals to become law. Even after policies are changed, it can take a while for them to affect the economy and markets.

After the tradeoffs, I suspect economic growth will be higher than it would have been under previous policies. Lower taxes, higher federal spending and deregulation all should stimulate economic growth.

Those same factors make it less likely inflation will creep down to the Fed’s target. Indeed, inflation could be bumped higher.

There’s a good possibility the Fed will have to pause or reverse its interest rate reductions. International growth also is an important consideration.

China seems comfortable with growth well below the 10% rate the world expected until a few years ago. Since China is a major market for many countries, especially in the rest of Asia, slow growth in China could mean slow global growth.

Also, the promised trade policies in the United States could reduce growth in other countries and bring down the global growth rate.

There are a lot of moving pieces in the economic and market puzzle, and it’s not even clear we see all the pieces. That’s why I recommend that investment and financial decisions not be made on forecasts, speculation and expectations.

Instead, set a long-term strategy with balance and diversification. Make adjustments in reaction to actual events, whether the events are market moves, government policies or changes in your personal situation.