The 2016 US elections, Q&A with Blue Quadrant Capital Management
Donald Trump has won the presidency of the United States and financial markets in general have not reacted well to this development. What are the implications of this surprise event for investors and specifically, global investors?
Well, it’s really Brexit 2.0 isn’t it? It’s the same political dynamic and narrative, a growing protest vote against globalisation and immigration in the world’s mature developed economies. However, this time, potentially more serious over the longer-term given that the United States is still by far the world’s largest economy, and a key market for export-dependent economies, particularly in Asia.
Nevertheless, we need to appreciate that the United States (US) constitution was designed (specifically because the founders understood the risks of concentrating power in the executive) with numerous checks and balances. For instance, in addition to any new legislation, fiscal and/or trade policy agreements generally also need to be passed by Congress.
Even though the Republicans have maintained their control of the US house and senate, there are many Republicans who do not share Trump’s protectionist and anti-immigration views. As such, it is unlikely (at least in the short to medium-term) that Trump will be able (and perhaps want to) pass such extreme legislation or immediately terminate free trade agreements such as NAFTA nor immediately impose import tariffs on the likes of China and Mexico.
But surely the broader political narrative and the increased associated uncertainty will constrain business investment, and by implication, place a drag on economic growth?
Indeed, and in the long-run this may well be the case. In the final analysis, the unraveling of globalisation and the implementation of protectionist policy is stagflationary, not deflationary. Rising tariffs would lead to higher inflation in economies such as the US, even if growth remains weak. In an environment of rising commodity prices and wage inflation (caused by limiting inward immigration), the double whammy of an increase in import tariffs could severely impact profit margins for these companies.
This is not a great environment for bonds and will also be a negative environment for global multinationals, particularly consumer staple companies.
So in your opinion, the rise in populism and pushback against globalisation is clearly a major negative for fixed income?
Absolutely. Furthermore, the Republican sweep of Congress and the White House now opens the door to substantial tax cuts, including tax cuts for corporates, while Trump’s commitment to increased infrastructure and defense spending will likely ensure that the US fiscal deficit widens substantially over the coming years. A further negative for US bonds, is the risk of continued or even accelerated liquidation of US bonds by foreigners.
What about equities?
I guess we should probably distinguish between different geographies and sectors. As discussed, Trump has promised massive tax cuts, which with a Republican-controlled Congress are now likely to be passed. Beyond the very short-term, this is probably a major positive for the US economy and therefore US equities, although I would caution this view somewhat in terms of US multinationals and those with large-scale manufacturing operations in places like China and Mexico.
Equity markets in export-orientated economies such as China and Germany may fare less well, and in particular, in the case of China as well as other Asian exporters. Furthermore, rising interest rates will be a negative for those sectors of the market that have benefited from the “search for yield”, and again unfortunately this leads us to sectors such as consumer staples and the various larger multinationals in particular.
So there will be winners AND losers?
Which sectors are likely to benefit then from recent political developments?
Well, domestic-orientated or focused US companies will likely outperform, particularly those exposed to infrastructure or fixed investment spending. Higher interest rates or bond yields will also underpin support for financial companies, such as insurance companies, given that they have suffered considerably from the recent low interest rate environment. Finally, certain commodity companies, and in particular US energy companies also ought to do well.
But surely if interest rates rise too far, that is a negative for equities in general?
Yes, but it also depends on the Federal Reserve’s (FED) response and how short-term rates evolve. In a stagflationary environment (low growth AND higher inflation), the yield curve will steepen substantially, but there is no guarantee that the FED would actually raise rates or at least aggressively if growth is below trend. Also, given Trump’s character and authoritarian leanings, there is no guarantee that the FED’s independence will not come under threat.
This may impact negatively on real estate markets more tied to longer-term interest rates, but not necessarily shorter-term financing, at least not in the shorter-term anyway.
You seem somewhat sanguine about recent political developments, are there any major risk factors where investors would be better off running for the hills or loading up on Gold?
Look, don’t get us wrong, a combination of rising interest rates and protectionist policy will likely give us, at the very least, an “earnings recession” not just in the US but perhaps globally at some point in the future. But this risk is not an immediate threat and not a certainty either, given that there is no certainty that someone like Trump will be able to pass more extreme protectionist or anti-immigration legislation. In contrast, with a Republican-controlled Congress, it is now almost certain that major tax cuts and fiscal stimulus programmes linked to say infrastructure spending will get passed.
So it’s a case of wait-and-see, with perhaps counter-intuitively, more positives in terms of the scope for fiscal stimulus, therefore growth and by association equity markets?
We think so.
However, longer-term, there are clearly risks. The most significant and perhaps under-appreciated risk is geopolitical. Trump’s view with regard to Russia as well as NATO is sure to embolden Vladimir Putin. Should Putin and his party decide to move ahead with their desire to reconstitute the former Soviet Union, let’s say by taking more decisive control of the Ukraine and even perhaps invading the Baltic States, how will Trump respond?
Again, it is too early to say for certain how Trump’s foreign policy will evolve, but unless he exhibits a meaningfully different temperament and tone to that reflected in his campaign speeches, there are clear geopolitical risks from a Trump presidency. We have already seen how Turkey under Erdogan is becoming increasingly assertive and openly expressed a desire to reconstitute, at least, partly the influence Turkey enjoyed during the era of the Ottoman Empire. Again, how does Trump respond to these authoritarian regimes, when he himself has such strong authoritarian instincts?
In the final analysis or at least in our view, the risk of a major global conflict is probably the highest it has been since the end of World War 2.
Really, but surely such geopolitical risks were higher, say during the Cold War?
Perhaps, but let’s be clear Trump is not a normal US president. He has been elected on a nationalist and protectionist platform. US foreign policy in the past has generally been aimed at “keeping the peace” and promoting liberalism or democracy to some extent (yes, the conspiracy theorists amongst us will argue otherwise, but history in our view shows otherwise and we should forget which nation was ultimately responsible for defeating the fascist powers in WW2).
The risk we have with a Trump presidency is that we now have someone in the White House who truly (and openly admits it) has no particular desire to promote (or at a minimum defend) freedom and democracy or guard against authoritarian regimes, as long as they do not threaten the national interest of the US. If this “Trumpian” ideology becomes a key factor shaping US foreign policy in coming years, it will create a power vacuum globally, the likes of which we have not had since before World War 2. This power vacuum would embolden the likes of Russia and China seeking to reassert or grow their regional influences.
During the Cold War, we had two superpowers facing off against each other, but the US remain engaged and actively fought (in ways and measures not specifically tied to military action) to bring down communism. An Isolationist US foreign policy or worse, one solely focused on advancing Trump’s view of America’s “national interest”, is undoubtedly a major geopolitical risk.
But again these are not risks that can be predicted with any certainty, but at the margin probably do argue for some form of portfolio insurance, yes perhaps in the form of gold or physical commodities.
So in the final analysis, Trump may be good for the US, but bad for the rest of the World?
Trump may be good for the US economy in the short to medium-term, provided, he does not or is not immediately able to implement protectionist policy (such as import tariffs). In this regard, we think the Republican Congress will, at least initially, ensure this is the case. But again, make no mistake given Trump’s authoritarian instincts he also presents a clear and present danger to the US itself. We can think of no other previously elected US president (at least in the modern era) who has the ability and character to threaten the very survival of the Republic and therefore Democracy (in the US) itself.
Obviously such a development would take us back hundreds of years and not just decades and would likely lead to an unprecedented level of global turmoil in investment and financial markets. But this is an extreme outcome which as rational investors and fund managers we cannot or should not entertain seriously at this early stage of his presidency. Time will tell.Tags: politics, Trump, US, USD