Rhetoric, reality

portraitA Donald Trump Presidency feels a bit like a defining moment. But, from a macroeconomic perspective, I have my doubts that the US is headed in an entirely new direction. A ‘TrumpQuake’ might have accelerated the collapse of the status quo, but the fault lines were already established. The dollar was strong, inflation expectations were intensifying, bond yields were rising and the Federal Reserve was poised to raise rates.

What has really excited markets though, in the few days since the election, is the potential for President Trump to deliver a huge domestic stimulus package; much more than was likely under a Clinton administration. Fiscal stimulus, by way of reduced taxes and increased spending, formed the core economic message of his campaign, including a promise to invest $550 billion (around 3 percent of GDP) to re-build US infrastructure so that goods can be exported, and people transported, ‘faster and safer’. Understandably, the shares of companies operating in the industrial metals sector, along with those in construction and engineering, have rallied hard.

Not surprisingly, financial stocks are rallying too. Banks look set to benefit twice over. First, profits on loans will be inflated by rising long-term interest rates and, second, Mr Trump has promised to ‘dismantle the Dodd-Frank Act’. The latter will effectively reverse the trend toward greater regulation in the US at a time when banks elsewhere are pressured by an increasing regulatory burden.

Of course, President Trump will not be unopposed. The Republicans have a thinner majority in the House of Representatives and Senate than they did under President Obama. And the Republican party is far from united. Both the Speaker of the House of Representatives, Paul Ryan, and the Majority Leader of the US Senate, Mitch McConnell, were equivocal in their support for Trump and his policy agenda.

Mind you, tax cuts will be easy to push through congress. Infrastructure spending will be less easy, since spending per se is not automatically attractive to most Republicans – certainly if it means more borrowing – but it is a boost that will attract support from Democrats. Trump’s trade policies are a different matter though; they will be opposed by elements of both parties.

International trade is one area of policy in which the ‘Grand Old Party’ (GOP) and Donald Trump are certainly not in a united state. Trump’s ‘plans’ to do away with the North American Free Trade Agreement (NAFTA) and impose a 45 percent tariff on Chinese imports are, surely, unlikely to ever see the light of day. The Republicans are pro free trade. Certainly, the Trans-Pacific Partnership is close to dead in the water already and the Trans-Atlantic Trade and Investment Partnership may well go the same way but the world will not miss what the world has not had.

All of this goes some way to explaining why the ‘TrumpDump’ lasted just a few hours, with stock declines rolled quickly into stock gains. Assuming I am correct in thinking that The Donald will be forced to shelve his trade plans (or water them down, or offer them as sacrifice in a deal on other issues), we are left with a tonic that quite rationally encourages stock market gains. Up to a point, at least.

The fly in the ointment might come in the form of inflation. I’m far from convinced that inflation will prove to be high and problematic in the short- and medium-term, but I see little reason to doubt that the Trump agenda will push it higher than would have proved to be the case otherwise. As Carl Weinberg, Chief Economist at High Frequency Economics, points out there is a risk that ‘if fiscal policies succeed in boosting US economic growth, they will collide with a Fed that has determined the economy to be at full employment already’. That implies a steeper increase in the likely path for interest rates.

As it stands, the CME Group estimate the options-implied probability of rate rise in December is close to 80 percent. Little has changed there; a December rate rise has been on the cards for some time. But at the longer end of the market, the chance of at least two rate rises by June next year has drifted higher from 30 to 40 percent over the last two weeks. Similarly, the yield attached to the 10-year US treasury bond has jumped from 1.85 percent on 8 November to 2.19 percent today having already moved away from its all-time-low of 1.36 percent in August.

So, what should investors do in response to last week’s election result? Well, as ever, the interests of retail investors are best served by a properly diversified portfolio with aggregate risks matched to the extent that they, as individuals, are willing and able to carry. By ‘properly diversified’ I mean one that is designed with a multiplicity of potential scenarios in mind, one that comprises both stocks and government bonds. A focus on the long-term, in the context of a clearly defined financial plan, is similarly key to success. If investors are positioned in accordance with that framework, my proposal is for inaction.

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