Forget for a moment the pending Donald Trump presidency — the soaring promises of at once slashing tax rates and ramping up infrastructure spending, the vows to roll back regulations and revamp the federal government's role in health care.
Altogether, such sweeping change could fuel economic activity and loan demand, as well as lower costs for businesses of myriad stripes, including community banks. But, as investment strategist James Paulsen summed it up, nobody on the outside looking in really has a firm handle on how Trump will govern, whether his approach will prove effective and which policy changes will ultimately bubble up to the top of his priority list during the first two years of his administration, when the Republican is ensured of working with a GOP-controlled Congress.
Bank stocks have soared in large part on optimism surrounding Trump's pro-business ideas. The SNL U.S. Bank index has climbed more than 20% since the Nov. 8 election. But policy specifics are still in short supply from the president-elect, and bank industry insiders are starting to wonder aloud if investors are expecting too much from Trump. After all, no president gets all that he wants, and almost nothing happens quickly in Washington, D.C.
Of course, even after policy shifts develop in the nation's capital, it takes more time for such changes to make an impact. For instance, community banks' commercial clients could benefit from a far-reaching infrastructure spending effort — roads, bridges and more — that could lead to demand for their services and products. They could end up investing in growth of their own, and community banks, many of which specialize in business lending, could finance such expansion.
But if history is much of an indicator, that is not likely to prove a 2017 story, and the forward-looking equity markets may be getting ahead of reality on the ground, as Jack Ablin, chief investment officer at BMO Private Bank, suggested in an email.
What is more, Ablin added, Trump's vision of essentially doubling economic growth in coming years "runs the risk of major consequences if things don't go right."
In a report, he pointed to analyses from U.S. think tank the Tax Foundation, which advocates for lower taxation and a balanced federal budget, that estimate Trump's proposed across-the-board tax cuts could trim government collections by nearly $10 trillion over a decade. That, Ablin said, raises the prospect of "deep budget deficits," which many conservative lawmakers in Trump's own party loathe. And that could throw a wrench into the incoming president's agenda.
All of that noted, and any potential new laws under Trump set aside, there is still plenty to cheer about macroeconomic conditions and the operating environment for community banks, said Paulsen, chief investment strategist at Wells Capital Management. U.S. GDP gained momentum in the second half of 2016, he noted, and the job market continued to strengthen, bringing the country to essentially near full employment. The jobless rate stood at 4.7% in the final month of 2016, while employers added 156,000 jobs in December. On average, payrolls advanced at a monthly pace of 165,000 in the fourth quarter.
Manufacturing, a source of concern for many years, ratcheted up by 17,000 jobs in December. That followed a rebound in commodity prices, including oil prices, in the second half of 2016, which eased concerns about global deflation, Paulsen said. Additionally, he noted, average hourly earnings in December increased by 10 cents to $26.00, and wages for all of 2016 rose 2.9%, the best pace since 2009.
That points to strong demand for labor, which equates to a pair of big positives for banks, he said. First, it means that consumers will have more money in their pockets to spend on Main Street, boosting the fortunes of small businesses, which play a big role in job creation. When they are growing, they tend to fuel a virtuous employment and economic cycle, and these businesses tend to expand along with such cycles, drawing on bank credit to help finance their growth. And second, substantial wage and economic growth tend to put upward pressure on inflation. That would provide Federal Reserve policymakers reason to boost interest rates this year. The Fed would lift rates not to curtail inflation but to manage it toward gradual upward movement. Higher rates could make banks' lending more profitable.
Fed policymakers on Dec. 14 lifted their key benchmark rate by a quarter of a percentage point to a range of 0.50% to 0.75%. It was only the second time they boosted rates since prior to the financial crisis. But in projections for the current year, Fed officials indicated that they could follow last month's move with three more quarter-point increases.
"So I think there is a lot more to like here than just the election," Paulsen said. "The election is one piece of the bull case, but right now I think it's a small piece."