The surprise US election result has generated confusion and volatility in financial markets. Comparisons are being made with Brexit, if only for the unreliability of public polling.
Financial markets swung wildly in response to unfolding developments. As the counting progressed and Trump’s chances improved, so equities, the US$ and bond yields all fell, while safe haven assets such as gold, Yen and the CBOE Volatility Index (VIX) rallied. The protracted nature of the count and the delayed announcement of the result just added to the overall tension. However, it seems the tone of Trump’s victory speech surprised the markets, leading them to quickly reverse the previous price action.
Adding to this change of view was the fact that the Republicans achieved a clean sweep of the Congress as well as the Presidency – something neither party was expected to achieve. The Obama Administration has been hamstrung by a Republican-controlled Congress, but that impediment is now gone. Or is it? Will the new President also find himself hamstrung by Republicans?
This is a difficult question to answer because the election campaign has been dominated by a tone and rhetoric not seen in living memory. How much of Trump’s bluster was for the sake of getting elected and how much does he really intend to do? How much will his own party let him do? Will he really be as wild and unpredictable as he was in the campaign? It is very hard to answer these questions now, but we suspect the reality of President Trump will be less wild than the rhetoric of Candidate Trump. There will be moments of surprise and worry, but it is still early days.
Trump’s campaign pitch included promises of:
- Greater fiscal stimulus through large tax cuts, repatriation of offshore profits and infrastructure spending programs;
- Standing up to other nations to put US interests first, with adverse implications for global trade agreements;
- Increased military spending, but not for the US’s allies – they should pay their own way;
- Less regulation and dismantling of Obama Administration healthcare and climate change initiatives.
These would have the following implications:
- Increased domestic spending and employment in the US;
- A larger budget deficit and higher levels of government debt;
- Higher inflation in the US;
- Potentially smaller US trade deficit with the rest of the world;
- More room for the Fed to lift the cash rate, but maybe not in December;
- Higher US bond yields and a stronger US$.
The reason why financial markets may have reacted more positively after the initial shock of the result is that these economic effects would likely provide the circuit-breaker the US needs to lift growth out of the rut it has been in over recent years. There is much talk of the ineffectiveness of monetary policy and that central banks can do no more to help growth - the best monetary policy can do is support the current pace of growth and inflation with some redistribution at the margin between countries via exchange rate movements. Fiscal policy is seen as the way to break this gridlock and lift the global economy to a stronger growth path. This is what Trump policies offer the US. Furthermore, the proposed business tax cut would boost corporate profitability and equity valuations.
However, there are some important caveats:
- We do not know exactly how much of the fiscal program will actually see the light of day;
- Cutting the business tax rate from 35% to 15% has Congressional Republican support, but preferably if it is deficit-neutral, which it is very hard to envisage; full implementation of the business tax cut policy has to be questioned;
- Similarly the size of his infrastructure program is likely to be watered down – a US$1 trillion program seems unrealistic;
- Also, even if his infrastructure plans are approved, there is always a long gap between passing legislation and starting construction;
- The US economy is much more open to international economic forces now than pre-GFC; this means that factors limiting US export growth – such as a higher US$ and rescinding trade agreements – will have a negative feedback effect on US growth, offsetting some of the domestic stimulus;
- Trump’s stance on trade agreements is one of his biggest challenges with his party and where Congressional Republicans are likely to try to limit his actions.
The essence of Trump’s policies are one thing, the size of them is another – moderate versions would be more pragmatic and digestible. Achieving this will be a challenge for Congressional Republicans.
The new Administration is not expected to interfere with the Fed, although they may move quickly to fill the two vacancies on the Board of Governors and Janet Yellen is unlikely to be re-appointed in 2018.
A combination of stronger US growth and a stronger US$ is potentially good for the global economy as a whole. This would amount to the US exporting reflation to the rest of the world, as long as Trump’s trade policies do not cut too far into global trade flows. European equity markets would likely benefit more than Emerging equity markets, which typically underperform when the US$ rises.
How might all this impact investors in Australia?
- Rescinding the Trans-Pacific Partnership Agreement would adversely impact some of our rural export industries;
- A higher US$ could relieve pressure on the A$, thereby reducing the RBA’s incentive to cut the cash rate again, while benefiting unhedged exposure to foreign investments;
- Resource stocks are being seen as beneficiaries of increased demand for coal and iron driven by Trump’s energy and infrastructure policies, as are construction companies with exposure to US activity;
- Infrastructure stocks and REIT’s are seen as underperformers because of the risk of higher bond yields;
- Interest rate sensitive US stocks would be adversely impacted for the same reason;
- The impact on the US’s security presence in the region and the potential implications for Australia are less clear.
It is far too early to know for certain how all these forces will play out. So far the markets have taken a more optimistic view, but we are still only a couple days past the election and there is still plenty of time for second and third-guessing of the situation. Surveys of global investors suggest the recent price action reflects tactical risk-on adjustments rather than fundamentally-based changes to portfolio allocations.
It will be important to watch what Trump tries to achieve in his first 100 days. More uncertainty and volatility are probably the most reliable forecasts to make at this stage. For the first time in US history, the President will be someone with no experience in governing or leading the military. Time will tell whether this proves to be a good or a bad development.