Will the ‘Trump trade’ climax lead to the FTSE 100 sinking to 6,000?

The FTSE 100 has gained over 2% in 2017 to reach 7,300 points, yet its future is hugely uncertain. Investors have thus far been focused on Donald Trump’s economic policies, with higher spending prospects causing more bullish sentiment. However, this week has seen a pullback, and investors are now wondering whether the ‘Trump trade’ is over. If it is, could the FTSE 100 really slump to 6,000 points and therefore enter bear market territory?

Trump’s policies

The effects of Trump’s lower taxation and higher spending policies are a ‘known unknown’. However, history tells us that spending larger amounts on areas such as defence and infrastructure, while at the same time reducing taxes, leads to improved economic performance. Those policies are likely to create jobs, lead to higher consumer spending and business investment, as well as improved confidence in the future performance of the economy.

The reality is that implementing those policies is likely to be challenging. The process through which they need to go before they can put in place will take time, and there’s likely to be a further time lag of some sort before they start to make a material difference to economic data.

Furthermore, there are also risks attached to adopting a more relaxed fiscal policy. Higher inflation is becoming increasingly likely, although this may be kept at bay to some extent by a rising interest rate. Additionally, higher debt levels could lead to fears surrounding the sustainability of the US budget deficit, which may harm investor confidence in future.

Share price movements

Due to the lack of clarity regarding Trump’s policies and their impact on the US economy, investors are likely to face a prolonged period of uncertainty. In fact, the movements seen in the FTSE 100 since the start of the year could continue in the coming months. Although the index has gained over 2% in the year-to-date, it has also been relatively volatile, as investors have switched back and forth between bullish and bearish stances.

This volatility could mean that the FTSE 100 falls in the near term. Trump could face difficulty delivering on his policy aims, while investors may become fearful about the potential ill-effects of higher spending and lower taxation. This could create buying opportunities throughout the course of the year for long term investors who can accept that there could  be volatility over a sustained period.

Investment outlook

However, the FTSE 100 falling to 6,000 points seems somewhat unlikely. While it cannot be ruled out, the optimism surrounding such a major increase in government spending in the world’s largest economy is likely to mean that bullish investors ultimately overrun their bearish counterparts. This is likely to mean a rise in the FTSE 100’s level in the long run. And since sterling could weaken as Brexit talks commence, the outlook for FTSE 100 companies with international earnings could be even more positive.

The ‘Trump trade’ may not yet have reached its peak. After all, the new President has not yet put in place the ambitious fiscal policy he campaigned on. Therefore, the FTSE 100 seems more likely to gain, rather than lose, 20% (or 1,300 points) over the long run. This would make 8,600 more likely than 6,000, from today’s current level of 7,300, in 2017 and beyond.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.