During the first quarter of 2017, the stock market (as measured by the S&P 500 Index) enjoyed a 6.07% total return. The gains reflect (1) the steady, persistent, non-inflationary economic recovery that has characterized the post-2008 period and (2) investor enthusiasm for President Trump’s pro-business, pro-growth policies. Moreover, when the Federal Reserve (the “Fed”) finally raised rates another notch in March, Chairwoman Janet Yellen stated that she expects monetary policy to remain accommodative “for some time.”

According to The Wall Street Journal (3/16/17), “Even with the Fed raising its benchmark federal-funds rate to a range of 0.75% to 1%, the real fed-funds rate – subtracting inflation – remains below zero, a sign of accommodative monetary policy.” As we have said before, stocks can do quite well during the early phase of Fed tightening because in this phase the Fed is raising interest rates in response to early signs of inflationary pressure but is still accommodative. It is not until later, when inflation heats up to the point that the Fed feels compelled to squash it, that the Fed tightens monetary policy so forcefully as to trigger a recession. In that environment, stocks usually do poorly. In our opinion, we are probably two years away from the second more aggressive phase of Fed tightening. Again, quoting the Wall Street Journal (3/16/17), “Economists in a monthly survey by The Wall Street Journal last month placed a 15% chance of recession within the next year, down from 22% last July.” In other words, a consensus exists that the economy should continue expanding, giving stocks further room to run.

In last quarter’s Investment Outlook, we discussed Trump’s pro-business and pro-growth policies, their likelihood of actually getting implemented and some of the potential consequences such as rising fiscal deficits if tax cuts are not offset with new revenue sources. We also discussed the risks associated with Trump’s bluster over trade issues if the administration takes actions that could ignite retaliation and spiral into some sort of trade war. Investors also need to focus attention on the potential economic effects of one of Trump’s non-economic policies, namely immigration reform. The concerns we raise are somewhat speculative at this point but are potentially disruptive enough to bear watching and monitoring.

Trump’s efforts to make America safe by imposing travel bans on potential immigrants from six or seven predominately Muslim countries, coupled with his “build-a-wall” rhetoric, have multiple ramifications. Some observers see a drop in foreign tourism, although our contacts in the hotel industry see no such effect yet.

A second potential fallout from these policies could be much greater difficulty in attracting foreign-born engineers and scientists, long a source of talent and innovation in Silicon Valley and elsewhere. Should this talent pool dry up, decide to work elsewhere or otherwise not come to the U.S., it could have a long-term impact on our ability to innovate and maintain world-leading creativity in technology and service. We have seen some anecdotal evidence of U.S. tech firms building research centers overseas. Whether Trump’s policies are causing this trend to accelerate cannot be ascertained at this time.

Third, the “build-a-wall” and “deport-the-illegals” message is clear: If you are from Latin America, it is going to be more difficult for you to come to, and work in, the U.S. Since Latino immigrants comprise a large portion of our construction (roughly 27%) and farm labor (roughly 23%), there are already reports of both construction and farm labor shortages. The latter could ultimately affect farmers’ abilities to harvest crops, thereby driving up the cost of such crops and adding to inflationary pressures both in the form of labor cost inflation and commodity price inflation. We have no idea how big a problem this could become or how significant the inflationary pressures might be, but it is clearly a trend that deserves monitoring. While we continue to believe that inflation will be subdued as the post-2008 economic expansion continues, changes such as a farm-worker shortage could alter the future trajectory of inflation, turning it upwards more sharply.