Why has the stock market been going bonkers, even as interest rates have begun to rise?
CNBC sums it up in two words: “animal spirits.” Wall Street types aren’t talking about the ghosts of dead puppies when they use the term “animal spirits.” It’s a reference to human exuberance based on expectations.
The term was a concoction of John Maynard Keynes, the guy who has been revered by liberals everywhere because of his notion that government spending is good for the economy. Of course it’s not — when government spends, we pay — but politicians, journalists, academics and even many economists who should know better like to be called neo-Keynesians, so they follow along.
Coming up with the term “animal spirits” to describe human behavior is perhaps Mr. Keynes’ second worst offense.
Any time an alleged expert makes a reference to “animal spirits,” he or she gets quoted, since it sounds like deep thinking to most journalists and at least it’s more colorful than saying “consumers are feeling more confident about the economy, because their employers are no longer being regulated into bankruptcy.”
Used in a sentence: John Canally, chief economic strategist at LPL Financial, explained the latest jobs report, which was more positive than expected, by saying, “There’s been a burst in animal spirits since Trump was elected.”
In other words, the White House has become Animal House. Hopefully, no goats have been sacrificed to keep the animal spirits rising.
Of course, crediting “animal spirits” for the ongoing market boost is an over simplification, but journalists are not economists and few viewers or readers have the attention span to go much deeper.
So what’s really happening? In place of CNN’s two-word summary, we would use three words: Reality has flipped.
The Republican Party, given up for dead (at least by the media), now controls the White House, Congress and most governor’s offices and state legislatures. The Democratic Party, in spite of dominating media, academia and California, controls very little.
That means investors expect fewer new regulations to hamper businesses and the removal of many of the regulatory constraints that have been added in recent years. Of course, tax reform would be nice, too.
The reality flip goes beyond that, though. Republicans have become protectionists and Democrats have become advocates for states’ rights. The Democratic Party, which might have been considered to be soft on Russia (e.g., the reset, the Syrian agreement, etc.), now accuses the Republicans of being soft on Russia.
Some of these changes may be good for the economy, others may be bad, but there’s another reality flip that’s getting little attention, even though it’s positive for the economy: the Federal Reserve Board is no longer in charge of the economy.
As a result, the Fed can now raise interest rates without tanking the stock market. It wasn’t long ago that even a hint of monetary tightening would send the stock market into a near free fall. Remember the “taper tantrum?”
Higher interest rates can be toxic to the stock market, because higher borrowing costs typically mean lower corporate profits and less discretionary income for consumers. Higher interest rates also make risk-free saving more competitive with stocks.
But the promise of deregulation and tax reform more than counter the 0.25% or 0.5% interest rate increases we’re seeing.
The CBO Scare
Then again, the Affordable Care Act continues to befuddle — and it could kill off the animal spirits. While there’s general agreement that the ACA must go, “repeal and replace” is turning into a Herculean challenge.
Estimates by the Congressional Budget Office last week predicted that a proposed Republican substitute for the ACA would reduce the federal deficit by $337 billion over the next decade, but would also result in 24 million Americans lacking health insurance by 2026.
The result, of course, is headlines like this one in The Huffington Post: “Devastating CBO Report Exposes The Empty Promises Of Obamacare Repeal.”
But why would so many people lose coverage? Because the federal government would no longer force people to purchase health insurance.
“The CBO attributes ‘most’ of this initial coverage plunge to ‘repealing the penalties associated with the individual mandate,’” The Wall Street Journal reported. “If people aren’t subject to government coercion to buy insurance or else pay a fine, some ‘would choose not to have insurance because they chose to be covered by insurance under current law only to avoid paying the penalties, and some people would forgo insurance in response to higher premiums.’”
We should note, too, that the CBO has a history of overestimating (apparently, failing to take “animal spirits” into account). The CBO predicted that, as a result of the ACA, the individual market would enroll 26 million by this year. Instead, enrollment is just 10 million.
The CBO analysis has many in Congress wavering in their support of repeal and replace. But unless Congress acts, the majority party could be replaced by a whole new animal.