A round-up of the important issues around an impending Trump presidency:
- Republican Congress and White House may be good for growth;
- Impact on the Fed and rate hikes;
- Greater fiscal party emphasis with infrastructure spend;
- Uncertain future of Obamacare and his executive orders;
- Income and corporate tax reform; and
- Immigration issue subject to intra-party tensions.
As Election Day neared, we voiced our assessment that the outcome was essentially a coin toss. Turns out it was. In fact, as we go to press, although the count shows Hillary Clinton won the popular vote by a razor-thin margin, Donald Trump won the electoral votes and the presidency in a commanding victory.
Uncertainty has dogged us for months now—so much so that, in recognition of the fact that either candidate could seal the deal, we looked at the potential scenarios around both a Trump and Clinton win in the October and November issues of Capital Perspectives, respectively. If Trump prevailed, we noted, there would likely be significant market anxiety at least initially and, once he takes office, a probable “gap between some of his stated proposals and the less radical course of action” he would ultimately take.
And as expected, when markets realized we were headed for a Trump victory, they had a panicky, knee-jerk reaction, trading down about 5% in futures markets. However, two critical and surprising developments took place, which enabled markets to do an about-face, and then some. First, there was the quite unexpected result of party alignment in Washington created by the fact that Republicans now control not just the White House but both houses of Congress. Second, in Trump’s acceptance speech and Speaker Paul Ryan’s initial public statement, there was a clear determination to collaborate in order to achieve shared Republican goals.
To provide clarity at a time of extreme uncertainty and level-set expectations going forward, here is our outlook on how a Trump presidency might impact economies, markets, and portfolios.
Executive and legislative party unity bodes well for the economy. Along with just about everyone else, we expected a Trump or Clinton presidency would have to work in an environment of divided government and felt the need to compromise would likely persist. With the Republican Party holding onto its Senate majority, however, we have a unified government, which we believe will prove to be positive for economic growth on a variety of fronts. However, in our minds there is a fundamental tension within the party that is calling the shots inside the Beltway.
The tension exhibited during the primaries and the general election is now set to play out in public policy, between “establishment” Republicans (who have traditionally supported freer markets) and the populist wing of the party that Trump galvanized and led to victory. Indeed, some of the key populist-driven issues may pose risks to greater growth. Nonetheless, markets seem to be in the process of pricing in higher levels of GDP growth for the short to intermediate term, based on optimism around pro-growth policies that should enjoy support from both Republican Party factions. These include reducing regulations, infrastructure spending, personal income tax reform, corporate income tax reform, repeal of Obamacare, and an effort to repatriate foreign earnings.
Existing executive orders are likely to be overturned or altered. Many of President Obama’s actions in recent years have been accomplished through executive order, which may be easily reversed or changed without congressional approval. Again, these efforts could remove costly regulations for businesses and help to jumpstart economic growth. For example, his plan for his first 100 days in office includes lifting restrictions on energy exploration and development as well as on controversial planned pipelines.
Greater emphasis will probably be placed on fiscal policy. Infrastructure projects are likely to be front and center on the new president’s agenda as these projects will be pursued to stimulate growth, to aid in employing the constituencies that supported him, and to produce facilities that will be more productive, thus furthering economic activity. Candidate Trump indicated a desire for a large plan, though has yet to give very many specifics other than saying he favors public-private partnerships for such development and claims it would be revenue-neutral. The shift from monetary to fiscal policy initiatives will be an important feature in moving past fixing the financial crisis.
Tax reform is on the way. We also expect Trump’s proposals to dramatically reduce individual and corporate income taxes would be a boon to short-term economic growth as it would boost consumer spending and possibly business investment. However, we must reiterate our point from October’s Capital Perspectives that in the longer term, the current version of his proposals would be extremely detrimental to the path of the nation’s deficits and total debt, even with generous assumptions about higher economic growth. A tax cut package is made more feasible by Republican control of both houses of Congress, but there will be plenty of deficit hawks that we expect will be leery of accepting his proposal as is.
Obamacare is on the chopping block. The repeal of the Affordable Care Act has been a rallying cry for all Republicans since its passage in the early days of the Obama administration. Republicans of all stripes believe it is suffocating and expensive for businesses, especially small ones, and leads to slower growth. Whether it is fully repealed or just overhauled remains to be seen, but it will certainly be a focus in the early days of the Trump presidency.
Bring home expatriated bacon. An effort to repatriate the earnings of domestic firms with operations abroad via a temporary reduced tax rate is highly likely. This effort faces some support from both parties, but with a Republican majority, it is more likely to transpire without complicated strings attached (such as requirements to hire new employees or show proof that the earnings were used to invest). We are dubious that the effort will produce as much new capital expenditures as expected by proponents of this effort, but it would be beneficial to markets for firms to bring the earnings onshore and have the option to invest or reward shareholders.
The tensions will be around trade and immigration. There is a very fine line between creating tough but fair trade policies or going too far and falling into protectionist policies. One of Trump’s signature issues that may present a looming potential negative is international trade, the issue that galvanized the vote for him in former Democratic strongholds of Pennsylvania, Ohio, Wisconsin, and Michigan. High on his list of priorities in his first 100 days is to withdraw from the North American Free Trade Agreement (the agreement with Canada and Mexico), to withdraw from the yet-to-be-ratified Trans Pacific Partnership, and to label China a currency manipulator. Left off the list but prominent during his campaign was to place a 45% tax on Chinese imports and a 35% tax on some imports from Mexico. These policies, though popular with the electorate, are a serious risk to economic growth and market performance. The tax on Chinese imports would sharply increase the cost of many consumer goods, driving up overall prices and crimping household budgets. The possibility of starting a trade war could be calamitous for U.S. exporters. In 2015, U.S. companies exported $632 billion worth of goods to Canada, Mexico, and China. Those countries are the three largest recipients of U.S.-made goods, buying 42% of all U.S. exports last year. U.S. exporters are finally in 2016 recovering from massive declines in exports in 2014–15 that resulted from an appreciated greenback. We believe the approach to trade outlined by Trump could present a serious threat
Immigration very much a priority. An effort to deport millions of undocumented immigrants as well as more restrictive legal immigration will face resistance from both parties. No matter where one stands on how to handle the large population of immigrants here illegally, it is hard to argue that they are not integrated into the economy. Efforts to deport them en masse would be disruptive in the short term, even if there are long-term benefits. Some establishment Republicans have been involved in efforts to offer paths to citizenship, which is clearly at odds with Trump’s populist base.
Trump’s “A Team” could inspire confidence. We will be looking over the next several weeks for any sign of how Trump is dealing with the tension within his party. As suggestions are announced (or leaked) of those whom he is considering for important cabinet posts, the market will have much more information about which policies will be pursued first and most fervently. We will also be watching developments in the House and Senate. The former is riper for a change in leadership after Paul Ryan distanced himself from Trump late in the election calendar. Initial signs are they may want to work together, but Trump does not get to directly choose the important positions of Majority Leader and Majority Whip. Those positions will be elected by Republican House members and you can be sure the jockeying for positions has already begun. If a more populist representative gains steam as we approach January, we would expect a more populist agenda.
The impact on the Fed. The immediate question is whether it is still on track to raise rates at the December 13–14 meeting. Heading into Election Day, investors were pricing in an 85% chance of a hike and the Fed was talking up its desire to do so, making it a near certainty. In the wake of Trump’s victory, odds initially fell sharply but then rebounded to slightly higher than before the election. By the time the central bank’s committee meets next month, little of the economic data will have been affected by the election.
There will be a few more readings on inflation that will not be affected. There will be one more jobs report indicating how the labor market does in November. But unless firms dramatically change their planned hiring this week, that report will be unaffected. If business sentiment shifts in either direction it is more likely to show up in company surveys such as the ISM manufacturing and nonmanufacturing readings, due in the first week of December. We think the economic case for a rate hike will be essentially unchanged.
The path of the market over the next several weeks is more likely to influence the Fed. Everyone appears simpatico in the immediate aftermath, and the market is enjoying the prospects of the pro-growth policies outlined above. But if the mood turns for any reason, including the immigration and trade issues, the Fed would be facing some downside risks to its expectations for economic growth and inflation, which would affect their plan for hikes. Similarly, if the transition to a Trump presidency goes smoothly—and especially if the likelihood for stimulative fiscal policy gains traction—the Fed would be more likely to raise rates as the economy would (finally) have something else other than just low rates to lean on.
The other factor that may influence its decision is the de facto tightening of financial conditions in fixed income markets that is already under way. The immediate reaction in the Treasury market has been a steepening of the yield curve, with the 10-year yield hitting its highest levels (over 2%) since the start of the year, while the shorter end of the curve is essentially unchanged (after recovering from overnight volatility).
Fixed income investors may be reacting to the significant deficit spending plans outlined by Trump during his campaign, which would stimulate the economy in the short term but greatly increase debt down the road. The movement at the longer end of the curve is a tightening for anything that is priced in relation to longer-term Treasuries, including residential mortgages and corporate debt. This tightening of financial conditions in some sense achieves some of the Fed’s goals of reining in accommodative financial conditions in an environment of still-encouraging economic data. Should it decide to not hike, it will face a communication challenge of explaining the decision, given the economic data.
The future of other populist movements. First Brexit, and now America. There is simply no way to know for sure the limits of populist movements driven by dissatisfaction at the grass roots level. How much populism drives both domestic issues as well as issues in other countries such as the Italian Referendum on December 5 has yet to be determined.
The Investment Committee met informally to consider any possible changes to our portfolios and felt that our portfolios are prudently positioned and would best be left unchanged. Our recently increased international equity weighting and reduced domestic equity exposure provide a good balance of risk exposures globally.
We expect markets to be volatile as the uncertain, post-election environment is absorbed by investors. However, as we have pointed out, there are potential positives that should be stimulative for economic growth. Don’t be alarmed if portfolio values bounce around in the next few weeks. Our focus is more on the environment after this initial period, when our expectations for enhanced economic growth and prosperity may begin to take hold. In addition, we anticipate that the Trump-led government will provide support for sectors such as energy, financial services, industrials, and healthcare (as a result of a likely Obamacare overhaul), already reflected in the Wilmington Trust Sector Allocation Strategy®.
Our overweight exposure to Treasury inflation-protected securities should also continue to benefit us going forward, as we expect inflation to heighten in the face of an economy that continues to strengthen as well as labor markets that continue to tighten.
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