The interview followed last week’s conviction of Paul Manafort, Trump’s one-time campaign manager, and the guilty plea of Michael Cohen, the president’s former personal lawyer. We asked three economists — M. Todd Henderson, Eric Zitzewitz and Larry Hatheway — to weigh in on how the market might react if Trump gets the boot.
Impeachment is already accounted for in stock prices
M. Todd Henderson is a professor of law and economics at the University of Chicago. The opinions expressed in this commentary are his own.
Political games in Washington typically don’t matter very much on Wall Street.
The fundamental value of a stock is based on the cash that the underlying company is expected to generate over its lifetime, discounted to present value. Therefore, the value of the stock market is simply the sum of the values of all the individual stocks (or, for an index, like the Dow, the value of the stocks in the index). If businesses expect to make more money, more investors will buy than sell, driving up stock prices.
What’s more, the probability of a political event like an impeachment is already baked into the stock price of every company. Markets (meaning buyers and sellers of stock) are constantly adjusting their estimates based on news of all kinds, whether it’s about consumer demand for a particular product, tariffs, the president’s latest tweet or even his impeachment. The prices of stocks today reflects these estimates.
Notably, markets didn’t move at all on the news of Manafort’s conviction and Cohen’s guilty plea. This means the market as a whole does not believe Trump will be impeached, or knows that Trump’s impeachment wouldn’t have a big impact on the value of American businesses. Investors could also think a President Pence with a Democratic-controlled House (and even Senate) might be good for business. Even if Trump is impeached, his tax cuts for corporations and the rollback of regulations are not likely to be reversed for many years should Pence become president.
Past stock market jumps and drops offer a clue
Eric Zitzewitz is a professor of economics at Dartmouth. The opinions expressed in this commentary are his own.
There was already a low probability that President Trump would finish his term, then get renominated and be reelected, according to betting markets at Betfair. So last week’s news of Manafort’s conviction and Cohen’s guilty plea caused his odds of finishing the term and of being renominated to drop even further (from 70.4% to 63.3% and from 70.0% to 60.6%, respectively).
But the stock market has seemed remarkably unaffected. When last Wednesday’s news broke, the S&P 500 was basically flat.
To dig a little deeper, we can look at stocks that are expected to especially benefit from Trump. The Trump Long-Short Policy Index is an index I designed in collaboration with Raymond Fisman of Boston University. It tracks the difference in returns between stocks that rallied when Trump was elected and those that fell at that time. When Trump met with congressional leaders Nov. 10, 2016 and confirmed his intention of pursuing a Republican agenda, it rose. When Manafort was indicted in 2017, the index saw a statistically significant drop, but rallied one month later when the Senate passed the tax cuts.
The index’s swings can be used to scale the importance of an event. For example, the fact that the index lost about 10% of its post-election gains when Manafort was indicted means that the markets estimated the indictment undid about 10% of the expected effects of Trump’s election, at least as it pertains to economic policy that matters for publicly traded firms. Conversely, the large index rally that occurred when the tax cuts passed indicated that these cuts were a significant component of what investors expected Trump to deliver.
In contrast to these prior events, our index barely moved on last Wednesday’s news. Not only was the increased probability of an early departure for Trump not a big deal for the aggregate market, it also appears not to matter much for individual stocks either.
Why? The explanation may lie in the fact that last week’s news also did not have much affect on Trump’s odds of reelection (which fell from 38.2% to 36.2%) or of the GOP keeping the House in 2018 (which fell from 35.7% to 35.2%).
Realistically, Trump is probably done passing most of his economic policy anyway. The key uncertainty now is how much of his policy will last. Ironically, while impeachment is clearly bad for Trump himself, if it divides the country, it may reduce the likelihood that a blue wave large enough to overturn the GOP and his policies will arise.
The economy was strong before Trump came along
Larry Hatheway is group chief economist at GAM Holding AG. The opinions expressed in this commentary are his own.
The most important driver of the US stock markets remains the US economy. The Trump administration’s achievements in delivering significant tax cuts and lighter-touch regulation clearly supported the S&P 500’s solid advance in 2017. But as much as any administration wants to take credit for solid economic growth and a rising stock market, the fact is that these trends were clearly underway before the 2016 election. For this reason, the simple act of impeachment won’t erode the fundamentals that have pushed the S&P 500 to record highs this year.
Since 2010, the share of US corporate profits in the nation’s gross domestic product has attained levels never before seen in the post-war era.
Low corporate borrowing costs courtesy of the Fed’s monetary policy easing since the 2008 financial crisis has cut debt servicing costs and boosted the bottom line. At the end of the Great Recession, profits jumped even more than usual, given that US firms shed far more jobs — and hence costs — during the recession than typical. That allowed firms to increase profits rapidly once sales began to pick up.
But other factors have been at work as well. The emergence of dominant players in key industries — like Apple, Google and Microsoft in the tech space — has created firms able to earn ‘supernormal’ profits. Lastly, various factors have diminished the bargaining power of labor, including globalization, labor-saving technologies and the long-term decline of union power.
As a result, wage growth has been tepid. And since wages and benefits make up over two-thirds of the total costs of the average US company, the diminished bargaining power of labor has been a key driver of historically high profits. All of this has helped cut costs and drive corporate earnings even higher.
Thanks to this rampant corporate profit growth, companies flush with cash have been hiring strongly for eight years. The US unemployment rate peaked at 10.1% in October 2009. By the end of the Obama administration it had fallen to 4.8%. Now it stands at 3.9%.
While Trump’s 2017 tax cuts have clearly provided a lift to the economy, the pace of job growth has slowed in the first two years of the Trump administration relative to the last four years of the Obama administration. In part, that reflects a more fully employed US economy — talented workers are not as readily available as they were five years ago.
But this combination of strong job growth and rising company earnings has made the US economy more resilient to all manner of shocks, even political ones.
So would impeachment — and removal — of a standing US president cause the market to crash?
Richard Nixon resigned from the presidency in 1974. It was during a time of increased economic uncertainty, thanks to rising inflation that led to a “lost decade” for US investors. In the 1970s, inflation had a far larger and longer-lasting impact on investment performance than Nixon’s resignation. Bill Clinton was impeached in 1998, but he was not removed from office. For investors, the tech bubble of the late 1990s was of far greater importance. Following the 1998 emerging market meltdown, equity markets surged as the Fed eased monetary policy and investors scrambled to buy Internet stocks. Clinton’s Impeachment barely caused a ripple.
We can draw lessons from history. Most importantly, the health of the economy and corporate profits largely determine how stock markets perform. Today, the greatest risk for investors remains a destabilizing escalation of trade conflict or an unanticipated surge in US inflation, which would force the Fed to tighten aggressively.
Politics matters, but to paraphrase political strategist James Carville: “‘It’s the economy, stupid.”
CNNMoney (New York) First published August 29, 2018: 12:30 PM ET