Donald Trump has won the 2016 US presidential election, upending polls and market expectations, and will become the country’s 45th President……
Von Monica Defend, Head of Global Asset Allocation Research
Additionally, Republicans have retained control of the Senate – an outcome that was highly uncertain – as well as of the House, which was more expected. This suggests that Washington may have less gridlock on partisan lines going forward, although given that much of the Republican party establishment has opposed Trump during the campaign, it will not be in our view a smooth process in Congress by any means.
The highly volatile environment that characterized the build-up to the election, as well as the market’s initial violently negative reaction in Asia, as well as in the US based on the futures market, underlines the need for strong risk management to help preserve clients’ assets. At the same time, value opportunities may arise for active managers in the face of this broad, indiscriminate sell-off.
What is your view on this electoral result?
Donald Trump won the presidential race in a contest that showed a highly divided electorate along urban/rural, racial, and other demographic lines. Moreover, there is a great deal of uncertainty about his likely policies, as the campaign period was short on in-depth policy discourse and long on vitriol. Unpredictability and change generate concerns on the part of most market participants, as the reaction in markets around the world in the immediate aftermath of the election result becoming clear demonstrates. In particular, there are worries that Trump could start a trade war with China, or start to impose tax penalties on firms that try to shift business operations out of the US. However, we expect that some moderation from the Republican party could partially restrict his ability to enact many of his more controversial initiatives such as the ones related to trade tariffs, the rejection of all existing trade agreements, and a pull-back from the US’ historic support for NATO obligations (and what that would otherwise mean for stability in Europe). This might help to preserve the long US tradition of moderate and pro-business policy making. It is worth noting that Clinton had also intimated that she would have been less pro-free trade than President Obama as well as been tough on US corporations’ tax inversion strategies.
How do you assess the impact of the electoral result on US economy?
Trump’s victory could have a significant impact on the macroeconomic scenario, depending on what proposals will be implemented and whether the Republican congress may bring about more moderate outcomes than the ones suggested by Trump’s rhetoric.
While parts of Trump’s program (such as tax changes, full immigration reform and infrastructure spending) would require Congressional approval, the imposition of tariffs and the adoption of an extreme protectionist stance, could be enacted and have an immediate impact on trade balances and on confidence. The massive infrastructure spending announced by Trump and the potential for fiscal stimulus would probably end up being inflationary.
Given Trump’s critical statements on the Fed, it seems likely that he would push for a change of leadership as soon as Yellen mandate’s end on January 2018.
What are the implications for financial markets?
As expected, volatility rose in the days leading up to the election. Markets switched from a risk-off mode to a more euphoric stance as Clinton seemed to consolidate her advantage, with sentiment swinging back and forth several times, in the weeks leading up to the election. Markets have sold sharply as it became increasingly likely that Trump would win the day, and are likely to continue to do so in the short-term, at a minimum.
This affected equities but also some Emerging Markets (EM) currencies, with the Mexican peso in particular closely tracking the polls, ultimately selling off to record lows as a Trump’s victory became evident. We believe that a risk-off phase will continue in the immediate aftermath, until there is some more substantive visibility as to the policies of the Trump administration. Yield dynamics have been dominated in the last few weeks by expectations of a Fed hike in December and by reflation issues. In the short-term, the market could postpone the expectations of a hike should equity markets react in a disorderly way and Treasuries could benefit from safe heaven flows. Overall, though, we expect interest rate volatility to increase. On EM we would anticipate that export-oriented emerging markets, and specifically Mexico, China and Asian countries, may suffer sharp sell-off in their fixed income and equity markets. Russian bonds may, on balance, appreciate, on the back of Trump’s more positive relationship with Putin. Overall, we expect to see Emerging Market Bond Index (EMBI) spreads widening, eventually stabilizing around 50-75 points wider than current levels. We also see higher-yielding markets being impacted most, which are likely to underperform lower-yielding markets, suggesting that active fundamentally-driven security selection will be an important element to try to manage the current phase of market volatility.
And what are the implications for US assets?
We think that Trump’s policy agenda, to the extent it can be extrapolated, will be bearish for income-related investments, and could generate a steeper yield curve. The combination of greater stimulus to the US economy and rising debt should put upward pressure on Treasury yields. In response, this should prompt the Fed to tighten at a faster pace.
In the equity markets, the initial reaction has been quite disruptive and we expect volatility to continue at a highly elevated level. However, we believe that longer term movements will be driven by earnings growth rather than by who the President is. Sector-wise the Trump victory would be favorable for drug makers, financials, infrastructure, defense, coal and energy. Companies with a high reliance on exports could suffer significantly.
Volatility will probably remain high in currency markets. Historically, a more protectionist sentiment is a big USD negative as foreign investment flows tend to decline. Trump’s rejection of the NAFTA treaty may have a particularly negative effect on the Mexican Peso and the Canadian Dollar. On the other hand, safe haven currencies, such as the Euro, Yen, and Swiss Franc, have rallied sharply and will likely continue to be in favor.
What are, in your opinion, the implications of the US vote on the global macroeconomic scenario and on geopolitical risks?
Trump’s victory, we believe, represents the rise of populism and the spread of nationalism. These are global trends and are challenges that may be difficult to resolve, and are also reflected in European political uncertainty. The Italian Constitutional referendum in December is the next important event. Sharp divisions within Prime Minister Renzi’s party and the spread of anti-establishment attitudes could support the “No” campaign, potentially undermining the stability of the current government and slowing its agenda for reform. Brexit related uncertainty is further prolonged, following the high court ruling which requires the UK Parliament’s approval to start the two year Brexit negotiations. This will also likely weaken the UK Government and new elections cannot be ruled out at this point. So overall, we believe that the geopolitical risks are quite high and broadly extended.
What are the implications for a Multi Asset investor?
Ahead of the US presidential elections we have maintained a cautious approach on risk assets. In the run up to the election, given the rising possibility of a Trump victory, we have reviewed our short- term assessment of EM assets. This was not a reflection of a structural change of view, as we still favor Emerging Markets over the medium-term, but rather a short-term move designed to protect clients’ assets. EM assets would remain attractive from a medium-term perspective if we remain in a free-trade environment. If, instead, the US turns protectionist, the growth potential of regions like China (which strongly benefit from globalization) could be at risk. We will monitor the new administration’s trade policy stance to review our assessment regarding EM assets. Also due to the ongoing political uncertainty in Europe, we think gold could be a key structural hedge against potential spikes in volatility. We continue to believe that a focus on active management, quality of assets and downside risk mitigation will be crucial in the next few months