Donald Trump elected President
Donald Trump is the winner of the US Presidential election, achieving a clear victory against the odds, confounding polls, forecast models, market sentiment, and our own expectations.
The Republican party has also managed to keep control of both chambers of Congress, maintaining a very large majority in the House of Representatives as well as a slim Senate majority. This outcome boosts the President-elect’s ability to govern, as he will now only need to reach intra-party agreement in order to get his chosen policy agenda implemented. We see the election of Donald Trump as a break with the status quo and we consider this outcome as one of the political events that financial markets will have to adjust to in the new political and economic environment.
The economic agenda of the Trump campaign was primarily focused on scaling back or restructuring trade relationships (in particular those with major trade partners such as Mexico and China), a strong opposition to immigration, deregulation (notably in industries such as energy, healthcare, and financial services), as well as a plan for substantial tax cuts – especially in higher income brackets.
Of particular relevance to financial markets is also the critical stance that Donald Trump has held against current Federal Reserve policies, and specifically against Janet Yellen. This has generated expectations that Yellen may be replaced as the Fed Chair when her term expires in 2018 (or even at an earlier date if she decides to step down) with a more hawkishly inclined candidate, in line with the prevailing Republican economic thinking. However whether the President-elect chooses to take this direction is an open question, as restrictive monetary policy would run counter to his stated goal of doubling US growth.
While lower policy visibility coming from a Trump Presidency might generate some volatility in financial markets in the short-term, over the longer term, the effects for risky assets are less clear-cut, as the pro-growth impact from economic stimulus and deregulatory policies that a Trump government may put forward will have to be weighed against the increased uncertainty caused by the less stable policy environment. One notable risk worth monitoring is that
an oversized fiscal stimulus through lower taxes and higher spending could generate inflationary pressures, which would pose upward pressures for the US rates curve and possibly also for the US dollar.
PORTFOLIO POSITIONING: REDUCING OUR US EQUITIES UNDERWEIGHT AND TAKING SOME PROFITS ON OUR EMERGING MARKETS BOND EXPOSURE
The potentially disruptive nature of this Trump presidency explains the shortterm risk-off reaction we are witnessing on global markets. From a portfolio positioning standpoint, it is important to distinguish the trends that are likely to last over the coming months –and thus that should trigger an investment decision- from the trends that should eventually prove short-lived.
The actual consequences will be highly dependent on the President’s ability to pass his most radical proposals. This Trump victory, associated with Republicans holding on to their majority in both the Senate and the House, should facilitate adoption of his main policy positions on fiscal stimulus and trade / immigration but there are still uncertainties around which proposals the Republican party will eventually enable him to enact. As such, today’s electoral outcome might question some well-entrenched trends such as yield-chasing and emerging market stabilisation. But some contradictory aspects of his program (pro-growth, protectionism and more hawkish monetary policy) make the assessment difficult to draw. So far, we put more weight on the reflationary and pro-growth domestic measures.
Equities: Halving our US equities underweight at the expense of European equities
Following an initial bout of market volatility, Trump’s proposed reduction of the corporate tax rate and expectations of a boost to the domestic economy should lead to an outperformance of US equities. In this context, we decided to halve our underweight in US equities at the expense of European equities. For the time being, we maintain our emerging market equity exposure unchanged as the reflationary trend we are experiencing could be reinforced. More evidence of dramatic protectionism measures would be required to really reverse this trend.
Sector-wise, the main themes of the Trump campaign suggest outperformance of big pharma (repeal Obamacare), financials (dismantle Dodd-Frank and steeper yield curve, see hereafter), materials (impose tariffs on Chinese steel and invest in infrastructure), traditional energy (support energy production and deregulate exports) and information technology (offer a repatriation holiday on foreign earnings).
Fixed Income: Taking partial profits on emerging local currency bonds
US Treasury bonds are likely to initially benefit from safe haven flows. However, in the medium-term, once the dust settles, there are many aspects of the Trump program that should drive US yields higher, notably a larger public deficit (with infrastructure investments and tax cuts not funded by a rise in tax revenues), the appointment of a more hawkish Fed Chairman to replace Janet Yellen, upward pressure on wages and imported inflation due to immigration and trade barriers. Both real rates and inflation break-even rates should thus rise significantly in the coming weeks leading to a marked steepening of the yield curve. For this reason, we maintain our underweight on government bonds.
Turning to credit, higher company financing costs are likely to be somewhat offset by a corporate tax cut. Despite high leverage, company coverage of interest expenses should thus remain sufficient to avoid a surge in defaults. We would thus maintain our preference for credit bonds, which are less sensitive to a rise in interest rates, whilst also likely to benefit from the fiscal boost.
When it comes to emerging market local debt, exchange rate volatility might be exacerbated especially in Latin America (Mexico) given the uncertainties surrounding the potential measures that could be implemented on trade.
Currencies / Commodities
Finally, on the currency side, the direct effects on the US dollar seem difficult to anticipate. True, the dollar tends to appreciate in times of uncertainty, but in recent weeks it has weakened as polls have shown a narrowing of Clinton’s lead. Trump’s planned repatriation holiday on foreign earnings should support the greenback but it will certainly take some months before these flows materialise. Still, the decreasing probability of a hike in December is likely to ease pressure on the US dollar. All in all we maintain a neutral view on the US dollar against developed market currencies.
It is also worth mentioning that the rise in US interest rates is likely to cap the current rally in gold sooner or later.
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