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The Donald Trump US Presidency – Q4 2016

Wednesday 30th November 2016

As the dust settles on a bitter and divisive US presidential election, markets have begun the process of assimilating this new reality into asset price forecasts. The unanticipated nature of the Trump victory was expected to trigger a large stock market sell-off given his campaign-trail rhetoric. However, equity markets responded in a fairly measured way and instead it was the bond market that took the brunt of the selling, with global fixed income losses approaching $1tn in the weeks after the election. Prior to the election the yield on the benchmark ten year Treasury was around 1.8% and subsequently jumped to 2.25% in the days following. The reaction was quite a violent one and something not seen in the bond market for many years.

Since Treasuries are used as benchmark for many types of credit, such as mortgage rates, the ramifications of this move turning out to be more than just a short-term spike could be profound. Principally, it signals that investors have concerns about Donald Trump’s plans for the US economy and its increasingly large debt load. Given that inflation-protected Treasuries have fared much better than conventional bonds, there are fears that Trump’s plans could stoke inflation and cause the Federal Reserve to expedite the normalisation of monetary policy.

The challenge now for investors is to try and determine how much of Trump’s campaign rhetoric will finds its way into policy proposals and how much of it was pandering to key demographics by way of a protectionist agenda. There is also the question of how far a Republican-led congress will allow Trump to push them before they decide to reign him in (if indeed he pursues an authoritarian approach).

Thus far, the markets are making the following broad conclusions:-

  • Aggressive infrastructure spending of $1tn to take place over ten years, with significant public-private partnerships and private investment aided by tax incentives (Republicans blocked significant spending plans under Obama, however, this was seen by many as an attempt to hobble the Obama administration masquerading as a call for fiscal prudence).
  • Tax reductions and simplifications to the tax code. This, combined with the infrastructure spending plans are good for US growth prospects when considered in isolation. One caveat on the tax cuts is that they appear to be skewed towards the rich. Since the rich have a high propensity to save, this may not be as stimulative as it first appears.
  • Pickup in inflation due to a widening of the budget deficit and a corresponding steepening of the yield curve (this process has already begun).
  • Stronger dollar in the short term as growth picks up and interest rates rise (at a faster pace than previously anticipated). Also, a muted tax incentive for US corporations to repatriate cash held overseas could be supportive to the Dollar (although much of this is already in Dollars).
  • Relaxation or repealment of some regulations, namely the Dodd-Frank Wall Street Reform and Consumer Protection Act and a more accommodating US energy policy. Also, there could be a withdrawal from UN climate change commitments.

Should these predictions hold up then the main beneficiaries are likely to be domestically-focussed US companies, more specifically financials, energy companies and industrials.  Financials should benefit from a steeper yield curve (borrow short-term and lend longer-term, therefore, greater profit margins) as well as looser regulations. A looser regulatory landscape should also be good for parts of the energy sector as Trump is pro-fracking and has pledged to withdraw from the Paris Climate Change Agreement, dismantle the Environmental Protection Agency and undo Obama’s climate change policies.

Industrials that might do well under a Trump Presidency are infrastructure-related companies (those connected to the building of oil and gas infrastructure for example – Trump has already talked about restarted stalled projects such as the Keystone oil pipeline). Other industrial sectors such as automakers are already urging for a relaxation of emission standards. Globally, sectors that could benefit are industries such as the defense sector. Trump has been quite vociferous of his criticism of some European countries who have been gradually cutting their annual defense budgets, accusing them of getting a free ride off the US.  

The main losers from all this may turn out to be the so-called bond proxies (utility companies for example) which have benefited from a low growth, low interest rate environment for many years. Those that cannot justify these high valuations based on fundamentals alone may come under selling pressure going forward.   

The fact that the Trump campaign was fairly light on details regarding proposed policies has left markets playing somewhat of a guessing game, however, the agenda is set to be one of ‘America first’. Whilst, US-focussed efforts to stimulate growth have been taken positively, any measures that curtail the US’s involvement in global trade have the ability to cancel out any localised stimulus measures and cause damage to global growth going forward. There is also a risk that the potential move beyond easy monetary policy or an increasingly out-of-control budget deficit will be damaging longer-term.