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Expert Perspective

News, research and market insights from our team of experts.

Investment e.Perspective

Current Issue | April 27, 2017

Upset!

By: Mark M. Green, CFA, Chief Investment Officer and Oxford Investment Fellow


The stock market voted on Monday, surging higher on expectations of a Clinton victory after declining for nine straight sessions. The American people voted on Tuesday, in the only poll that really counts. And on Wednesday morning, we woke up to one of the biggest electoral upsets in modern political history.

Donald Trump is now the President-Elect. Moreover, the Republican Party maintained control of Congress and expanded its hold on state governorships. This may not have been a "wave" election with a clear mandate, but it was a solid electoral victory for Trump and a "hat trick" for the Republican Party in terms of expanding overall political power.

The global financial markets reacted quickly last night, once results began to come in. By midnight Eastern Time, Asian stock markets had tumbled, the S&P 500 futures contract had declined roughly 5% and US Treasury bonds rallied sharply in overseas trading. Just ahead of the normal market this morning, the equity futures had stabilized and clawed back some of their losses. The initial bond rally had evaporated and the yield on the 10-year US Treasury note was at its highest level since March.

Comparisons to the market reaction following the surprise Brexit vote last summer are inevitable, and some will be tempted to view this as a "buying opportunity" for global equities. And maybe it is, to the extent that the markets were caught off guard and are undergoing a short-term adjustment. Certainly there are similarities in the "animal spirits" that drove the election results. But the outcome of this US general election is far larger in its global significance than the British referendum to leave the European Union.

This entire campaign has been frustratingly difficult to analyze from a policy perspective, especially the potential longer-term impact of a Trump victory on the capital markets. Part of the challenge has been the lack of detail and specificity regarding his policy proposals. Taking President-Elect Trump at his word, however, and focusing on the direction rather than the detail of his policies leads to certain conclusions regarding his policy goals:

  • Tax rates will go down, especially on corporate and personal income.
  • Federal government spending will go up, especially on defense and "infrastructure" programs, while entitlement spending will likely remain untouched.
  • As a result, the Congressional Budget Office projects that the federal budget deficit will likely widen significantly.
  • The volume of Global Trade will decline, tariffs (taxes on imports) will go up and the likelihood of a trade war will increase.
  • Import prices will rise, for everything from food to automobiles.

These policies, if they come about, will have a very real and direct impact on the financial markets. There is a mix of deflationary and inflationary implications and it isn't yet clear which will win out or in what sequence they will unfold. Stagflation is a very real possibility. Other Trump policies, both foreign and domestic, will have less direct but also very real consequences for the markets, if only for the uncertainty they create:

  • US leadership in international political, economic and security arrangements such as NATO, OSCE, APEC, etc., will be called into question.
  • US military involvement in the Middle East will likely increase.
  • The independence of the Federal Reserve will likely be challenged.
  • Some form of regulatory reform is likely, including renewed efforts to roll back laws such as Dodd-Frank and to repeal ObamaCare.

How many of these policy goals will come about is an open question at this point. While the US Senate remains under Republican leadership, their majority is not filibuster-proof and the Senate Democrats can block most legislation. Moreover, there are very real policy differences within the Republican Party proper, which are now compounded by a Trump presidency. As with many populist political platforms, there are internal contradictions which belie a true governing philosophy. Political gridlock may remain in place well after the January inauguration.

From an investment and portfolio perspective, we continue to believe there are medium-term risks to the global equity markets. Valuations remain high and, at the margin, the risk of recession in 2017 has increased. The government bond market may rally on a flight to quality and safety, but the shift toward tighter US monetary policy and higher short-term interest rates will likely continue.

For some time now, we have advocated a modest underweight in US equity exposure, neutral weight to core fixed income and a slight overweight to certain alternative strategies. Based on the results of the election so far we see no reason to alter this advice. That said, more detail regarding the policy implications of the new Trump administration will emerge in the weeks ahead and our advice will no doubt evolve accordingly.

The above commentary represents the opinions of the author as of 11.9.16 and is subject to change at any time due to market or economic conditions or other factors.