Cheering For Record Dow Under Trump But Not Under Obama

Posted: Jan 17, 2018 9:19 AM
Cheering For Record Dow Under Trump But Not Under Obama

The stock market is making new highs every other day. Many investors think that the president’s policies are responsible, at least now that Donald Trump is president. Most believe that the rising stock market is a good thing. Let me tackle both of these beliefs.

First is the idea that the president has so much control over the economy that a good one causes markets to go up, and a bad one causes them to go down. Thankfully, America’s Founding Fathers did not grant the president so much power to move markets. Sure, he can promote and enact signature legislation—as Obama did with the so called Patient Protection and Affordable Care Act. But that does not necessarily cause stocks to react as one would expect. Here is a chart of the Dow Jones Industrial Average (“the DOW”).

The DOW went up 140% from the start of Obama’s term to the end (and other stock market indices went up more). I don’t think I have to argue too hard that this was not due to good economic policy. It also went up during Trump (at a faster pace in recent months).

Let’s look at another chart. This one is XLV, a healthcare sector fund. I have zoomed in to show just the time Obama was in office.

Even though health care stocks ran into some resistance at the end, they had quite a run. They went up nearly three times, more than the broader market.

Why is that? What policy specific to healthcare comes to mind during the Obama administration? The ACA is a terrible law. Yet these stocks rocketed up.

This leads us to the second point to debunk. We assume that regulation is bad for the companies it impacts. But it actually protects the largest companies from competition. Major corporations often lobby for—and help write—crony legislation. It’s the smaller companies who get hurt (and of course doctors and patients).

This is one reason why rising stocks are not necessarily a good thing. A move to freer markets might even result in a stock selloff. The massive, but often bureaucratic, incumbents who benefit the most from crony regulations may find they are vulnerable to more innovative companies who are now able to compete.

And there is another reason why stocks have risen so relentlessly: the Federal Reserve.

The Fed has been pushing interest rates down since Ronald Reagan was inaugurated in 1981. And by a variety of mechanisms, falling interest pushes up asset prices, most especially stocks. The stock market benefited from an unprecedented zero interest rate policy for most of Obama’s time in office.

The Fed began to hike rates at the end of 2015. If you look back at that chart of the DOW, you will see that the market stalls a few months before that. The Fed began to signal its intention to raise rates, and the market of course reacted to the news.

The Federal Funds Rate has risen more in the time after Trump’s inauguration than it did between 2015 and when he took office. The increased cost of borrowing will dampen corporate enthusiasm to borrow and buy back their own shares. It will cause some companies to struggle under their debt loads. It will reduce earnings, as interest is an expense that must be paid. Think of rising interest as increasing downward pressure on stock prices.

For most of Obama’s time in office, stocks had a powerful monetary tailwind. Beginning during his last year, and continuing under Trump, that tailwind has turned into a headwind. Government-blown wind is not good.

We should not have central planning of interest rates at all. Interest should be set in a free market. But so long as it isn’t, everyone should be aware of the consequences of changes in Federal Reserve policy.