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A series of electoral surprises helped shape the markets in 2016.  Voters in the United Kingdom decided by a narrow margin to take their country out of the Eurozone.  The election of Donald Trump in the United States ushered in an uncertain economic agenda that includes the prospect of tax cuts and fiscal stimulus.  Italian voters rejected proposed constitutional reforms, leading to the resignation of Prime Minister Matteo Renzi.

These unexpected political developments took place against a relatively positive economic backdrop, with both the U.S. and Europe showing improvement. In the U.S., unemployment is currently at 4.6%, and real wage growth is currently at 2.5%, having risen steadily throughout 2016.  In the Eurozone, the unemployment rate has declined by 2 percentage points from its high in 2013.  These improving labor fundamentals support household consumption, the key driver for the global economy.  Investors who took risks were rewarded in 2016.

In the U.S., Donald Trump’s election, along with Republican control of both houses of Congress means that the partisan gridlock that Washington operated under for the past six years is over.   After the election and through the beginning of 2017, markets rallied on  the likely simulative impact of corporate and personal income tax cuts, infrastructure spending, and deregulation.   We think this market enthusiasm may be overly optimistic, for a few reasons.

Pedestrians walk past the New York Stock Exchange before the closing bell in New York on February 16, 2017. Wall Street stocks finished mixed Thursday as a five-day streak of record highs finally began to show fatigue. BRYAN R. SMITH/AFP/Getty Images

Although there is broad agreement between Congressional Republicans and President Trump about the need to cut taxes and reduce regulation, there remain significant disagreements between the President and Congressional leaders on key aspects of any corporate tax reform.  This means that investors should be prepared for some delay and a scaling back of the size of the tax cuts.

President Trump’s ability to push his agenda on any subject, even among his own party, will depend on his approval rating, which has declined sharply since his inauguration.  Members of Congress, Republican and Democrat alike, are more likely to push back if the President is broadly unpopular.  Some Republican members are already voicing concerns about the long term fiscal impact of the President’s plans.

Even so, of all the proposed reforms, tax cuts remain the most likely. With respect to another of the President’s central campaign promises, being infrastructure spending, we see less likelihood of action.  Congressional Republicans have a limited appetite for higher government spending, and there is not even a policy outline from the White house on what an infrastructure bill will look like.   The lack of forward momentum on infrastructure policy so far in 2017 highlights the lack of urgency and planning .  Investors may be disappointed in the final outcome.

So far, the market does not seem concerned about the potentially contractionary elements of President Trump’s agenda.  Trade protectionism and a more restrictive immigration policy were core themes of the Trump campaign.  In both areas, the President can act much more autonomously than in matters of taxation or government spending.  Mr. Trump has already signaled that these goals are core to his governing platform.  When stymied by congressional opposition or burdened by poor approval ratings, Presidents have often turned to executive action to relaunch their presidency.   President Trump, perhaps even more than past Presidents, cares about  bolstering support among his core constituency, and may turn increasingly to the executive order to do so.