What impact has the Trump victory had and is the market reaction rational?
When I woke up at 4am on Wednesday to the prospect of a Trump victory the equity markets were indicating a bleak future. The US S&P 500 equity index was about to suspend trading as it verged on the maximum move allowed by the exchange - 5% down. The FTSE looked like it would open over 4% down and yet most equity markets closed up on Wednesday. So why did Asian time read it so wrong and what can be read into the moves since the election?
The markets did not expect Trump to win, the opinion polls were close but the electoral college analysis predicted a Clinton victory. Markets do not like uncertainty and Trump is perhaps the least predictable world leader to emerge in my lifetime. His protectionist rhetoric is seen as anti-globalisation and anti-trade, pre-election this was seen as a potential drag on the economy.
Rhetoric on the campaign trail may prove to be little more than that. What is said on the trail may stay on the trail. Trump’s acceptance speech was, hopefully, the first sign of this. The ‘crooked Hillary’ of the campaign trail became someone we should be grateful to for their years of public service. A Republican president with a Republican majority in Congress and the Senate should be able to get things done. Some House members talk of being able to push through a Republican agenda but much of what Trump has indicated has previously been the antithesis of just such an agenda. In particular, ‘Tea Party’ Republicans were voted in over the last several years on a small government, deficit cutting agenda. Massive government-led infrastructure spending would require a huge volte-face on their part. However, the Republican Party is nothing if not pragmatic so perhaps this happens.
Getting back to market reaction we need to be aware that index moves can be misleading. Sector and stock returns have exhibited a very wide dispersion. Banks were up but utilities down, pharmaceutical companies did better but hospital and care home mangers did badly. So what drove these moves and what do we read into them?
Trump's acceptance speech was conciliatory in tone but made little mention of policy. The one promise he made was to spend more on infrastructure. This is seen as increasing the budget deficit and will likely to lead to higher bond issuance.
Whilst interest rates are only likely to rise slowly the increased supply of bonds is seen as weighing on longer maturities. As a result, bond yields have risen significantly since the election. This has led to investors selling equity ‘bond proxies’ with high and growing dividend yields such as utilities and food, beverage and tobacco stocks.
Bank stocks have rallied sharply as Trump has indicated he’s keen to reduce regulation on the sector and rising bond yields should boost their underlying profitability too.
The Republican Party definitely agree with their new president on repealing Obamacare and this is seen as one of the first actions he will take. This is damaging to much of the health care sector where yet more uncertainty after years of implementing Obamacare is inevitable. Hillary Clinton was vocal in her condemnation of drug price rises, so the lack of comment from Trump is driving the relief rally there – along with the failure of the Californian electorate to back a proposition to limit State drug prices.
So the reaction in bond markets and in individual sectors appears to be based on sound logic. However, we should be careful in extrapolating these reactions and will need to watch closely the relationship between the new White House and the establishment on Capitol Hill as so little of Trump’s policy is known at this point in time.
We have favoured inflation-linked Treasuries in our US dollar-denominated portfolios because we believed the expected rate of inflation was too low. We see the Trump’s protectionist policies and potential tariffs as adding weight to this view. If he is able to push through his infrastructure agenda, given full employment in the US economy this will only add to inflationary pressures. Within the US equity markets we continue to favour companies with long term growth stable prospects but also now see the attractions in smaller companies which have a greater domestic bias.
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