From ‘Trump Bump’ to ‘Trump Slump’?

3 February 2017

When the globally renowned weekly paper The Economist, runs the picture below with the title: "An Insurgent in the White House"...

then you know that many very thoughtful people have become very concerned. So against my own advice from last week to ‘Keep calm and carry on’, I am afraid the new populist man in the White House is back on the pages of Tatton’s Weekly’ and the agenda of our investment deliberations.

Reason for this is not so much that I fear for world peace, but instead that the stock markets’ post Trump election honeymoon of complacency to the short term damage he may inadvertently cause may be rapidly coming to an end. Over the past week, further, surprisingly strong US economic data and company results reports helped to hold things together. However, the US$ and the US stock market have continued to slowly weaken regardless.

Thus far US stock markets and the majority of corporates, chose to focus on the potential positives of ‘Trumponomics’ and discount the negatives of his more outrageous campaign pledges as bluster or negotiating tactics. Since the introduction of his travel ban on a number of Muslim countries this appears to be changing. Yes, he can sign lots of impressive executive orders, but – so the view so far – if they require funding the legislative checks and balances of Congress will stop the worst nonsense. So no ‘Wall’ unless he can find the funding – despite his executive order to build one.

While this is correct, he can nevertheless cause substantial damage, as the travel ban has shown, and clearly does not shy away from aggressively executing even those campaign promises we were told not to take literally.

This brings his misconception that global trade is a dis-benefit for the US economy into focus and the protectionist barriers he promised to erect at the US borders – he calls it ‘border adjustment’. Anybody who understands business basics will understand the impact of this plan to no longer allow non-US inputs to production, or non US merchandise, to be offset as costs against revenues. Under this plan, corporates would have to treat anything imported that becomes part of what they sell to the public as obtained at no cost. The effect is that in accounting terms their value turns into straight profit despite the money the company had to pay for them. This means that all imports would be taxed at the rate of tax for corporate profits, while the same would not apply to domestically produced inputs.

A game changer and, who knows, perhaps even successful in rebalancing global current account deficits and surpluses that economists have been warning about ever since the US economy first entered deficit status more than 50 years ago! But at what price for the US and global economy!? Integrated global supply chains of US companies that have taken decades to build would have to be undone and the resulting collapse in global trade would be very likely to cause a worldwide recession.

In my view this is still a highly unlikely scenario, because the Trump administration’s first and foremost objective is to boost US economic growth and not to kill it. But what if Trump is prepared to use the threat of tariffs (which he can impose without Congress) as a bargaining chip in a gigantic ‘game of chicken’ and after everything else he has done already, business and markets take him only half serious?

After very intensive discussions of Tatton’s investment team and with external research providers, we have come to the conclusion that the ‘Trump policy risk factor’ is not yet appropriately recognised by markets that have just overcome almost a decade of Armageddon paranoia. The high valuations the US stock market has reached over the last 2 years therefore appear very vulnerable to a renewed shock in business confidence. Having outstripped equity returns over the past 5 years compared to all other developed markets by approximately a factor of 3 (!), we believe it is now prudent to take some profits on our US portfolio positions and reinvest the proceeds in regions which are less highly valued and less exposed to the immediate ‘Trump risk’.

We have also decided to increase our underweight to the UK stock market whose valuations are likewise beginning to look vulnerable after the strong post Brexit referendum relief rally. Clearly, the political environment in the UK is not in any way comparable to the US situation. Nevertheless, we observe a not dissimilar market complacency about what may happen to the UK’s economic prospects in the shorter to medium term, should the now well-articulated plan of the UK’s government not achieve a mutually beneficial and amicable new relationship with the 27 remaining countries of the EU, but a ‘Crash-Brexit’ instead. Furthermore, the rising inflation pressures on consumer spending and stalling residential property markets are likely to cause market valuation concerns fairly soon.

Against these not particularly optimistic potential scenarios, we remain encouraged by the overall very positive and finally synchronised upward momentum of the global economy as a whole. This should persuade even the most radical and determined politicians not to frivolously risk what has taken long and hard 8 years to rebuild. We are therefore for the time being maintaining overall equity allocations across our portfolios in line with the long term allocations of the respective client risk profiles weightings. The now increased risk of at least a short term market tantrum as a consequence of Trump or Brexit upsets is in our view best reflected in a distinct underweight to the US and UK equity markets.