COULD THE STOCK MARKET BE SEVERELY OVER BOUGHT BY EARLY 2026
In Part 3 of a recent article, “The Unfortunate Connection Between Economics and Politics”, posted on www.georgeeconomics.com I discussed the actual realities of Trump’s tariff policy, rather than the bluster of his aggressive presentation and the overreaction of so many financial analysists and the stock market gurus. The point was made that the ultimate effect of the final body of tariffs on inflation and the economy would be based on the final tariff map, which was clearly going to be a dynamic moving target, and the price elasticities of the buyers and the foreign exporters, and not the hysterics of stock market analysts. Now that several weeks have passed between the original tariff announcement and the evolution of the tariff negotiations have brought down the original lofty figures, the stock market’s Neo Keynesian gurus have backed off their recession projections and the stock market has recouped over 75% of its tariff panic losses. Note that there are still some analysts pushing the recession narrative.
After reviewing the article, I referenced above, I was glad to see that I did not forget to point out the overriding importance of upcoming tax legislation and regulatory reform. How well the total of the ongoing trade realignment effort, the upcoming tax legislation, cost cutting and regulatory reform plays out, in terms of economic success, is entirely a function of execution. Theoretically, it all looks and sounds good and, if successfully executed, the economic results could be extremely positive. All of the Keynesian driven analysts, who fervently believe that tax cuts will only lead to greater deficits and higher interest payments, refuse to recognize Art Laffer’s theory that lower tax rates will result in greater tax revenues until the actual rate falls below the optimal rate. He poses that the existing rates are still above the optimal rate, and history has proven that his theory has merit. During the Reagan years and Trump’s first term, lower interest rates were followed by greater tax revenue collections.
It is highly likely that the proposed tax legislation and expected regulatory reforms becoming reality is high. By the time that the tax legislation is enacted (projected early summer), it is probable that the tariff noise will have been resolved, and when the news of imminent tax legislation passage breaks, the stock market gurus will start humming a bull market melody. And, in all likelihood, the stock market will follow its historical pattern of overreaction. Another wild card in the economic arena of action and reaction, however, is the “nonpolitical”, big government loving, Neo Keynesian Federal Reserve. Setting aside any political bias, which was exposed by a seriously out of tune chorus that sang “transitory inflation”, (directed by Federal Reserve Chairman Powell and Secretary of the Treasury Yellen during the Biden Administration),
Powell and the Fed’s blind adherence to Neo Keynesian concepts, such as the Phillip’s curve, gets in the way of growth friendly policies. The Phillip’s curve pushes the concept that inflation and unemployment are inversely related in the short run. Keynesians insist that supply side growth policies will lead to lower unemployment and, therefore, higher inflation, greater deficits and burgeoning debt. This did not prove to be the case during the Reagan Administration and the first Trump Administration and is not likely to be the case again during the present Trump Administration.
The Fed is a Keynesian animal whose tool box is restricted to demand side, economy crushing interest rate manipulation, and does not have even one supply side bone in its body. It will be interesting to see if and when the Fed will lower the target interest rate, given its theoretical belief that everything on the Trump Administration’s agenda will be inflationary sometime soon, even though current data is tame. It would be prudent for the Fed to bring the target interest rate more in line with the bond market and stop trying to lead the market. Along this line, however, note that the most Keynesian of analysts, Moody’s Analytics, just downgraded the US Sovereign credit rating which will put upward pressure on interest rates in the bond market. If the stock market takes off with the passage of growth friendly tax and regulatory legislation and the Fed is slow to react (late to the party again), then they may be forced to bunch up a number of rate reductions near the end of the year. Given that scenario, coupled with a Santa Clause rally, it is possible that the stock market could be severely overbought going in 2026. Hopefully, the stock market will be more orderly than its historical norms as Trump’s policies are rolled out and will stay within a reasonable trading range that reflects the timing of the impact of the Trump Administration’s pro-growth policies on GDP, employment, etc., in conjunction with the Fed’s actions or lack thereof.