Are financial markets ignoring the Trump risk?
11 November 2016A deeply divided nation has elected the maverick outsider Donald Trump to be president of the United States. Voters thereby taught the establishment of the political and professional class that they feel disenfranchised enough to experiment with a person and ideas that the overwhelming majority of subject matter experts regard as not just populist but outright dangerous to society and economy. Sound familiar? Well as we pointed out last week, for the event that Trump was to win the US election, we expected somewhat of a replay of the post-Brexit Referendum scenario – in the financial markets, as well as in politics. And so it unfolded. First an election night which felt like a déjà vu of the night of 23/24 June in the UK, with all the same failings of the pollsters as we had in the run-up to our referendum. The only difference perhaps that the defeated Hillary Clinton actually won the popular vote by a slim majority of 200,000. Donald Trump still won by a large margin of electoral college votes as he managed to get enough states behind him, which is how the US system has always worked. Second, a 6% sell-off in those stock markets that were open at the time – Asia. However, then similarities with the post Brexit scenario fast forwarded and financial markets decided not to spend another 3 days in a state of panic. When Donald Trump’s acceptance speech sounded far more sensible and conciliatory than anybody could have hoped, financial markets very quickly regained their balance. US stocks rallied, while bond markets sold off, jolting long term government bond yields upwards at a speed and to levels not seen since last year. Quite a bullish verdict by markets for the economic development of the US under a president D Trump? How is such a U-turn possible, when just a week earlier a majority of market commentators and analysts had predicted the almost exact opposite? Well, markets know no moral and are perhaps also sometimes prone to selective hearing. Financial markets clearly disregarded the painful division Trump had brought upon the American people together with the truly shocking deterioration of acceptable manners in public. They also discounted any success of him being able to progress his trade curbing protectionist promises or indeed cutting the US off the Global labour market. What I believe they focused on was firstly that Trump appeared to have turned from aggressive electioneer into political pragmatist, which meant that he would not pose an immediate risk to the current positive upward momentum of US economic growth. Secondly, they focussed on the combination of this Republican Party president elect coming into government with the US Congress also being Republican and his immediate policy focus on fiscal stimulus through infrastructure improvement programs to create well paid construction jobs for the lesser educated. Essentially, market participants seemed to assume that he would be able to get everything with potential to stimulate economic growth through Congress, where Obama had been deadlocked, but that Congress would prevent him from progressing anything truly detrimental for the US economy, like a trade war with the rest of the world. So, yes to sweeping tax cuts like Ronald Reagan and a New Deal 2.0 infrastructure program like Roosevelt, but no wall, no tariffs and no removal of illegal immigrants. The effect of such a Trump initiated policy shift would be accelerating economic growth and corporate earnings, while inflation would return as a consequence of wage pressures in the face of an already tight labour market and increased government borrowing. So while the educated western elites are still in shock over the demise of the bulwark of libertarianism and democratic etiquette, nothing changed or even improved in terms of the economy and investment returns? Well, just as with Brexit, nothing can and will change over the shorter term and in the absence of a nasty reaction from financial markets the economy just carries on. Additionally, the prospect of fiscal stimulus finally coming to the aid of monetary stimulus to re-deploy idle cash and rebuild business confidence levels is welcomed by markets from whoever may be able to deliver it. In the longer term, however, things are not quite as clear. Financial markets appear to have currently assumed little change to the geopolitical balances, which is somewhat unlikely given Trump’s deep rooted belief that the US should not attempt to mediate or intervene where humanitarian and democratic values come under attack. We also have to expect headwinds for the already lagging development of global trade and free movement of labour (and talent!). In summary, Donald Trump’s unexpected success to be elected US president has just like the UK’s Brexit vote been largely shrugged off by financial markets and as a result 2016 investment returns did not come under any significant downward pressure. However, contrary to the post Brexit developments, longer maturity bonds sold off considerably and this has sparked a wider debate whether bond yields, after falling steadily for nearly 36 years have now finally reached their inflection point, ending almost 4 decades of bond bull market conditions. Longer term bond yields have since the beginning of October risen more than we had anticipated, but while major central banks remain large scale buyers of bonds through their continued QE obligations, we see this as much of an overshooting to the upside as the summer’s yields’ plunge towards 0% proved to be an only temporary overshooting to the downside. Once the initial euphoria over the rediscovery of inflationary prospects ebbs away and the next economic worry appears on the horizon, bond markets are likely to moderate once again.