10 November 2016

John Barton

Director & CEO

As we’ve now had just over 24 hours to digest one of the most unprecedented upsets ever seen in US political history, it is now time to take a deep breath and consider what the next four years could mean for the US, Australia and global markets.

Although going into yesterday’s poll a Trump win was seen as somewhat unlikely, it increasingly looked like less and less of a long-shot, and so it was. As expected the election of Donald John Trump Sr. as the 45th President of the United States of America has created a great deal of uncertainty surrounding not only domestic economic and policy outlooks for the US, but also the nation’s relationship with the world. This uncertainty will be with us for many months to come as details of his actual policy settings come to light and as his new relationship with the political establishment in the Congress develops.

Whilst increased uncertainty is now with us – the impending Trump presidency will also bring with it some of the biggest changes to existing US arrangements seen in decades. In areas as diverse as taxation, trade, social spending, healthcare, immigration and geopolitics we will see changes unfolding before our eyes.

 

Confidence within the US

On the back of a conciliatory acceptance speech markets have rebounded from their initial sell-off. More broadly, strong job gains and an emerging uptrend in wage inflation has sustained robust growth in consumption, in excess of income growth, in recent times. However, uncertainty over what a Trump presidency will mean for main street America is likely to see more subdued growth in this sector, particularly for purchases which depend on credit (such as motor vehicles).

Having seen a moderation of late (in activity more so than prices), housing in the US is also at risk of dampening GDP growth over the next 6 to 18 months as conditions are re-assessed by both households and construction firms.

For the corporate world, uncertainty over Trump’s agenda is yet another reason to hold off on further investment. Over the past two years, equipment investment in the US has been persistently weak, having suffered a cumulative decline of 2.6% with no viable reason to expect a return to growth much above zero anytime soon. Likewise, structures investment has fallen 7% over that period, partly the result of a weak energy prices, and should also be expected to remain low.

As it looks like the Republicans will hold majority power in Congress, there is a chance that Trump may be able to pass his intended policies (although which one are intended and which ones were campaign bluster remains to be seen). However as we’ve seen over recent months, there is always the possibility that some Republicans oppose the president-elect, causing delays and/or changes to planned policies.

 

Taxes

Some of Trump’s policies on taxation could definitely be supportive of growth. His mooted policy of lowering federal taxes – and reducing the number of federal income tax brackets from 7 to just 3 (12%, 25% and 33%) and potentially removing estate taxes – would aid households’ marginal incomes and wealth. A lower corporate tax rate should also incentivise investment in the US (subject to trade relations policy).

For individuals, the concern is that Trump has also said that lower outright tax rates would be compensated for by reducing deductions and loopholes, hence net boost to household incomes being relatively modest – albeit with simplified compliance. Also it is unlikely that his proposed cuts to estate taxes will fund greater marginal consumption in the short to medium–term. Instead, any tax saved is likely to be retained by households as an intergenerational wealth transfer.

For corporates, although the president-elect plans to significantly cut the headline tax rate from 35% to just 15%, he has also stated that he plans to remove the deferral of taxes on corporate income earned overseas. If this became a reality, it could result in US firms running down domestic cash stock piles to pay tax rather than increasing US investment so as to maintain their offshore capital. Clarity on this aspect in particular will be crucial in assessing the net growth impact of Trump’s overall policy settings.

 

Trade relations

In the weeks leading up to the election, both Trump and Clinton were vocal on their opposition to the Trans Pacific Partnership (TPP), an arrangement that has the potential to materially benefit us here in Australia.

Trump had gone a great deal further on international relations, floating the possibility of tariffs and the re-negotiation of already established trade agreements. Heading down this path is fraught with danger and would create lasting uncertainty for firms looking to invest in the US and export globally. Firms may also (rightly) perceive risks to aggregate growth in the US and therefore be unwilling to spend on expanding their domestic production and distribution capacity in the US. It seems unlikely that these existing arrangements could successfully be re-negotiated without significant harm to the US – only time will tell.

In addition, a number of well-publicised Trump policies, such as building a wall along the US/Mexico border; labelling China a currency manipulator; and deporting significant numbers of illegal immigrants (to name a few), have the capacity to inflame foreign relations and to be a net negative for domestic GDP growth.

 

Implications for China

Arguably, relations between the US and China is where the greatest risks lie for the global economy and for geopolitics.

Over recent decades, China’s development has proved advantageous for the global economy as a whole (and obviously for Australia in particular) – the efficient production of manufactured goods has helped to keep developed world inflation low; the greater availability of financial capital has supported liquidity in developed world markets; and commodity demand has provided a floor to GDP growth in exporting nations (again, such as Australia). Consequent gains for incomes in China have also seen the ongoing rise of its middle class, which has then brought further benefits for the global economy via increased services trade and financial integration. A persistent rise in diplomatic tensions between the US and China could put these drivers of global growth at risk, with potential losses to the US economy – and to ours.

 

Implications for FOMC

For some time there have been whispers that the US Federal Reserve (FED) has been positioning for a rate hike at its upcoming December meeting. However, following the result of Tuesday’s election and the uncertainty that it has created in terms of the US economy, it is likely the FED will now defer such a decision until it can more accurately assess the US economy’s likely growth profile.

The initial focus of markets on the Trump ascension will be on its implications for trade. Those implications are unequivocally negative which we can expect to persist until we see the results of his “first 100 days” in May 2017. Once markets have sufficient information to assess the likely extent of any perceived “damage” related to Trump’s trade policies, they will focus on the likely significant fiscal policy changes and whether such radical changes will get the support of the fiscally conservative Republican House and Senate.

Markets may flirt with the prospects of a huge increase in the deficit and a strong lift in inflationary pressures, but will likely be reluctant to price developments until there is more certainty around the new president’s capacity to push such changes through Congress.

 

Australia’s Growth & Policy Outlook

Clearly, the key issue for Australia will be the impact of potential trade policies on China. Fears about the direct impact on China of these policies in the US should not be overstated however. China is increasingly moving towards a service-driven economy and has ample flexibility, policy wise, to boost domestic demand to, at least, partially compensate any direct shock to exports to the US.

The impact of global uncertainty on markets as well as business and consumer confidence is a much more specific issue for Australia. Until Trump sets out the details of his agenda, confidence will falter in Australia.

 

Implications for markets

A Trump presidency has potentially seismic implications for global trade, geopolitics and the US economy, and markets are likely to trade on a heavy risk-adverse footing for some weeks, if not months, going forward. AUD/USD seems set to extend its decline to around 0.74, potentially lower, as markets position for severe clashes over trade between the US and Australia’s key Asian trading partners.

EUR should push higher in coming days to the top end of its 2016 ranges, 1.14 – 1.15 with USD/JPY likely to break 100 in coming days. Longer term, Trump is fundamentally a mercantilist and as such the strong USD policy – notionally held by many administrators – is likely to be abandoned. Against that, Trump is strongly in favor of another version of the Homeland Investment Act, potentially a significant USD positive as US multinationals take advantage of a temporary tax break to repatriate funds.

 

Your portfolio

So we wait and see what the coming weeks and months will bring – it’s certainly going to be an interesting ride. But whatever lays ahead it is important to retain a longer term view. It’s always true, but it’s particularly true right now, that knee jerk reactions are much more likely to hurt rather than help your portfolio’s performance over the medium-term.

It is a core belief of ours that in times of significant market uncertainty it is important to remember that attempting to finesse portfolios in the midst of sharp global moves is difficult and generally detrimental to performance – especially when emotionally driven.

We believe it is better to position portfolios based on the longer term fundamentals and valuation drivers while being prepared to react quickly if those sharp moves create particularly attractive opportunities consistent with that longer term view.

This article contains general information only and is not intended to constitute financial product advice. Any information provided or conclusions made, whether express or implied, do not take into account the investment objectives, financial situation and particular needs of an investor. It should not be relied upon as a substitute for professional advice. MGD Wealth, AFSL 222600.