The financial press has given a lot of attention to “animal spirits” and their impact on equity market returns. First of all, what are animal spirits? The famed economist John Maynard Keynes used the term to describe the human emotions that drive consumer confidence. If animal spirits are low, then the confidence level will be low; that may drive down a promising market even though the fundamentals of the economy are strong. Likewise, if spirits are high, confidence will be boosted and market prices can more easily move higher.
The current cycle of animal spirits has been fueled by consumer and business optimism due to Trump’s election, especially in light of his campaign promises to cut taxes and increase fiscal spending. So it would appear that the “Trump Trade” is for real. It follows, however, that should there be signals that the Trump administration will take longer than expected to lower taxes and increase fiscal spending, animal spirits could fade away. In the chart below, we compare the National Federation of Independent Businesses’ small-business optimism index against returns of the S&P 500 index. Although there is no perfect correlation, the chart shows that optimism and stock market returns can’t be completely separated.