Some are celebrating. Some are stunned. Others are scared. Following the announcement that Donald Trump has become the 45th president of the United States, we have formally concluded the highly publicized and arguably most controversial and unconventional U.S. presidential election race in history. And many, including financial markets, are awaiting the impending implications of his protectionist policies, anti-immigration sentiment, and unclear foreign policy rhetoric. As the markets and the broader global economy digest the election of Trump, the question is: should we brace for impact or stay relaxed as the next few months and years unfold?
My thoughts? While I don’t think the markets are going to crash (ala 1929 or 2008), I do expect a significant amount of volatility as we navigate this uncertainty. The markets expected, and had priced in, a Clinton victory. A Trump win, our new reality, is similar to looking in your rear-view mirror and realizing you are about to be rear-ended. What’s your instinct? For most it’s to reduce the chance of injury and pain associated with the impending impact. Science even agrees with this approach, with research showing that those who brace for impact have better long-term outcomes and less injury (free car safety ‘lesson-of-the-day’). And this common reaction is exactly what we anticipate from the markets. Looking specifically at fixed income, we expect the following:
- Risk off: This will likely occur in various iterations, led by a rally in U.S. Treasurys. In addition, it is likely we will see a weakening of the U.S. dollar as developed-market currencies, such as the yen (and to the lesser extent euro, pound, and franc) rally as investors flock to safe haven assets, while debates over the USD reserve currency standing also weigh on the greenback.
- Yields will fall, but then will rise: Similar to the aftermath of Brexit, we expect to see yields, notably the 10-year and 30-year yields that have experienced recent highs as a result of growth many attributed to the optimism that Clinton would take office, fall. The bright side? These losses, similar to what we saw post-Brexit, should be recouped after the dust settles and more information on what a Trump administration looks like is garnered. This is due largely to Trump’s stimulus plan that includes tax cuts and infrastructure spending, both of which should push yields back up and steepen the yield curve.
- Emergence of a possible bear bond market: The late stages of our current credit cycle were already underway and some investors will be seeking safe haven and moving away from riskier products, notably equities and emerging market debt, but also from spread products, which could take a hit in the coming weeks/months. In some ways, investors were already prepared, moderately reducing positions given the recent high total returns and fear of an impending burst of the credit bubble as central bank accommodation is removed.
- More of ‘lower for longer’: We know Trump is not a fan of Chair Yellen. What we don’t know however is how he intends to approach a possible chair nomination in 2018. Although he has very little influence on monetary policy, he has warned of the negative consequences of rate hikes but has also espoused that rates have been low for too long. Translation: We will likely see Trump nominate a new Federal Reserve chair within the early years of his presidency but until then, the Fed may hold off on increasing rates as it tries to stabilize a global economy that has found itself adjusting to a new regime.
So what’s the good news, if any? While the adjustment period may take longer for emerging markets and global trade partners, there are potential bright spots – although it is likely that the market will need a full recovery from any sell-off before such news can be realized. It is highly probable that we will see healthcare, pharmaceuticals and biotech firms appreciate in price. Previously these industries suffered price losses or muted growth as concerns over increased regulation, which would have accompanied a Clinton win, permeated the market. There is also the increased possibility of repatriation of offshore earnings if Trump’s proposed reduction of the corporate tax rate takes hold. If it does, this means we could see the balance of offshore capital, which currently sits around $2.5 trillion, return to the U.S. And as previously mentioned we will see increased spending on infrastructure projects, many of which are backed by deficit spending.
In closing, the initial post-electoral impact will likely be fear. And as history has shown, fear can cause people and markets to do unpredictable things. However, our stance, as it is in all volatile market environments, is to brace for impact and remember that with volatility comes prudent risk management and many times buying opportunities. Actively managing and repositioning portfolios with an emphasis on security selection will be important in the coming months as we navigate a new opportunity set. And as science also shows, early treatment post-impact reduces the likelihood of pain down the road- to us, this should be no different.
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