10 November 2016
The Economic and Market consequences of Donald Trump
Will they be dwarfed by other developments?
by Frank O’Nomics
Let’s be clear from the outset. It is too early to reach any definitive conclusions about what the new President means for the US and global economies, or indeed for asset prices in general. It would be difficult enough in normal circumstance, but it is more difficult still when faced with someone who has no track record as a politician, making it very hard to extrapolate his campaign slogans and speeches into likely policies. Leaving apart the obvious risks of having a volatile individual in command of the nuclear codes (if that goes wrong then all bets are off anyway), we have to look at the potential consequences for markets which had done little to factor in the risks of a Trump victory, despite press and poll indications of the possibility. It is no surprise that we see the standard response of a flight to quality as investors seek safety, with share prices falling and gold and safer currencies rising. However, whether this is sustained will depend on the extent to which Mr Trump can enact his policies. The position may also be reversed by potentially more important global factors, such as Chinese growth and the outcome of the Brexit negotiations.
In looking at how Mr Trump’s likely policy balance will impact, it is perhaps best to start with the budget deficit. Analysis of current proposals suggests that the deficit will be pushed upwards from both directions, by higher spending and reduced taxes. Concerns over the potential for a US recession are expected to lead to an increase in spending on infrastructure, while the blue collar workers, who came out in such great numbers to vote for Mr Trump, will need to see some cuts in their taxes. However, the extent to which a new government can successfully take this line is limited by its ability to get Congress to vote on increasing the debt ceiling. This is likely to prove difficult and may necessitate some moderation of ambition. From a growth point of view there is, however, a potential positive from the proposed tax holiday for US companies that repatriate some of the huge amounts of cash that they currently hold overseas. This is estimated to be around $1 billion (60% of which is held in dollars) and, if brought back onshore, could lead to a healthy rise in capital expenditure. Such a move may reduce the need for the proposed government infrastructure spending.
For US companies at least, there may be other positives from the protectionist policies, including trade barriers and import duties, that a Trump administration has threaten to enact. A renegotiation, or cancellation, of trade agreements could help domestic companies, particularly if the introduction of tariffs made them more competitive. However, the World Trade Organization has already warned of the “knock-on effects” such policies have on economic growth and job creation. Further, protectionism would be somewhat less helpful for the US consumer, who would face an inevitable increase in inflation.
There we have it – the “I” word. Inflation could be the biggest threat of Mr Trump’s policies, one of the major contributors being his policy on immigration. It is estimated that current immigration policies will reduce the US labour force by as much as 11 million, thereby making an already tight employment market much tighter. The result will be pressure on wages and, you guessed it, a rise in prices. From a growth point of view US immigration policy is also potentially a big negative, with GDP taking a hit over time of up to $1.6 trillion – a number that would make any benefits from a near-term increase in capex pretty paltry.
In looking at what all of this means for asset prices, one needs to look at the longer-term picture. In the near term, beyond the benefits from protectionism, and the aforementioned tax holiday, some sectors in particular will do well. Healthcare stocks will breath a sigh of relief over a reduction in the likelihood of Obamacare being extended, defence stocks will be supported by a more insular approach to foreign policy, and carbon producers may benefit from the possible repeal of some climate change laws. However, while the Fed may for now be reluctant to deliver the previously expected December rate rise, due to the level of market uncertainty, they are unlikely to stand by and watch inflation get out of hand driven by the factors discussed above. Bond markets risk being undermined by a combination of higher short-term rates and a steeper yield curve (given an increase in inflation and risk premia), together with the prospect of increased issuance due to the growing budget deficit. In turn this could lead to further yield rises as vast foreign holdings of US debt start to unwind. US companies could be left then with higher short and long-term borrowing costs, which in the longer-term would offset the short term benefits of lower taxes and higher margins. As for currency markets, it may well be that the Yen is regarded as a better safe haven than the dollar for now (the Yen has hit a record high recently), but the prospect of higher US rates will in time be supportive for the dollar.
In 10 out of the 11 election years since 1972, the S&P 500 has outperformed. This may seem somewhat surprising given that we are led to believe that markets don’t like uncertainty. Indeed, the only year in which the S&P, the MSCI world index and the FTSE all share index did not rise was 2008. Conventional wisdom has it that markets like a Republican win, given their supposed pro-capitalist stance, but, if you strip out 2008, the data points to markets doing better in a year where the Democrats triumph. As to whether markets do better over the full term of a Republican or Democratic government, there is no clear trend. This brings us back to the point about other global factors ultimately being more important. For now, the sell-off in equities looks justified in terms of the potential deterioration in the longer-term outlook for interest rates and inflation resulting from the US election result – but markets are likely to put this behind them fairly quickly and focus on the bigger, global, picture.
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