Trump and Your Portfolio: A User’s Manual
Markets (not to mention voters) have now had a week to digest the reality of a Donald Trump Presidency. Doomsday warnings from a vast array of reasonably credible pundits even under-performed that same camp’s dire warnings for a Brexit aftermath (with Brexit, the markets at least nodded to the bears for 48 hours, which beats the Trump market sell-off by, well, 48 hours). Hedging against the fear of a macro event is one thing when that macro event never surfaces; it is another thing altogether when the macro event does occur, and the hedge is entirely unnecessary. But for now our focus is on analyzing the market environment ahead, and we will save discussion for the mistakes investors make time and time again for another time.
What is fascinating about the economic implications of a Trump presidency is how strange the bedfellows have become. “Right-leaning” politicos who are theologically opposed to inflation are now praising the idea of a massive fiscal stimulus bill even as the labor market has tightened dramatically. Left-leaning politicos are bemoaning Trumpanomics even after spending eight years pleading for a national infrastructure bill. The reality is that bond yields are moving higher for the very simple and unsurprising reason that the market believes Trump will get done much of what he wants to here, and what he wants here is, well, inflationary.
Is all inflation created equal? Put differently, is all growth inflationary? The productive growth that most market actors should desire is the kind that will come from a 15% corporate tax rate,
and from decreased energy regulation, and from a peeling back of some of the more onerous parts of Dodd-Frank, etc. The theme of foreign profits repatriation is not a growth theme to take lightly either. Foreign repatriation was clearly not priced into the market already since no one believed Trump was going to win, and since his opponent was totally opposed to such repatriation. So productive growth is predicted from many of these policy initiatives (rightly, I believe), and these policy initiatives are expected to make it through the halls of Congress. Beyond this productive growth, though, investors would be wise to watch out for various policy prescriptions that could be flat out contractionary (a trade war, excessive import regulation, etc.), or, could be inflationary yet not productive (a poorly executed fiscal stimulus plan, for example). This is what the market is, and will continue to be, digesting: The growth opportunity of much of Trump’s economic agenda juxtaposed against the fears of protectionist malaise.
The protectionism of candidate Trump has been a big concern of market pundits, and it should be no mystery as to why. China does have a large trade surplus with the U.S., but they do not have a large current account surplus, and their intervention in their own currency markets seems wildly over-stated, and frankly, may only exist in the opposite direction (meaning, they prop their currency up, not down). A labeling of China a currency manipulator may prove to be the same as when each of Trump’s predecessors said they would do it: All air. We would not rule out an impact on markets from mere protectionist rhetoric, but the very hard policies that could truly rattle markets are unlikely to surface, and surely would face substantial pushback from the right-leaning members of Trump’s own party who actually know better!
a theme for the foreseeable future. We will have greater clarity on what to expect from the Trump administration when we see his department heads and representatives (in commerce, treasury, and trade) announced. At press time no announcement has been made regarding Treasury Secretary, but Steven Mnuchin would be a more encouraging selection than Wilbur Ross for those who want to see supply side tax cuts take precedent over protectionism and a weak dollar.
Within the stock market, we know that some sectors have really monopolized this post-election rally (financials, biotech, defense, etc.), and others have not participated much (technology, managed health care, etc.). The bond market has taken on the greatest impact, as the ten-year treasury yield (already moving from a summer level of 1.5% to 1.8%) has run all the way to 2.25%, clearly in anticipation of greater spending, greater tax cuts, and greater deficits. The lesson from the bond market over the last week or so is not a predictive one (i.e. what it tells us that bond prices will do from here), but rather a useful and permanent reminder of how quickly the bond market can react to the things that shape it. Trends and baselines and ceilings are frequently re-drawn instantly when it comes to bond yields, and investors ought to consider the fact that we may now see 2% as a new floor in the ten-year yield, even if rates settle down here around 2.25%. Could we see a 3% level in the ten-year? In theory, yes, and that would certainly be more natural than the rates we see now, but the reality is that the European Union and Japan will continue to use every policy tool at their disposal to hold their own rates down, and should U.S. rates diverge too much we face a dollar rally for the ages that could offset all sorts of other effects. Bond market forecasting may not be much easier to do than election forecasting has recently proven to be, but our guess is that a 2% to 2.5% range for the ten-year seems likely. When rates find such stability, the dollar is likely to stabilize (it has finally gone into positive territory on the year after spending most of the year below its starting point), and when this happens we would expect emerging markets stocks and bonds to rally.
Within that stock market theme of “selectivity,” old tech may very well be a better play than new tech in a Trump administration because new tech is much more inflation-sensitive (with its wildly high valuations) than new tech (which is priced much more fundamentally and rationally). Furthermore, it will be older tech companies most impacted by foreign repatriation changes and certainly corporate tax reform.
The other sector where “selectivity” is the need of the hour is health care. Health care facilities companies (and managed health care providers) face significant headwinds from the impact of any adjustments made to ObamaCare (whether those adjustments mean repeal or just mere amendment). On the other hand, biotech names are likely to enjoy a less regulated environment, greater freedom for deal-making, and some suspension of the threat of government price fixing (the failure of Proposition 61 in California goes a long way here, as well). Many large pharma companies have big cash balances overseas and should be considered part of the list of beneficiaries of foreign repatriation too. How exhaustive the Republicans choose to be in taking apart from Affordable Care Act will make a big difference in how long it will take to get reform implemented, and what political capital will have to be used that may affect other initiatives.
One theme that has gotten some mention but perhaps not enough understanding is that of the midstream pipeline companies, particularly MLP’s engaged in the energy infrastructure sector. The anticipation is that drilling regulation relief is coming, and that the general lay of the land around imports and increasing American energy independence will become more favorable in a Trump administration. This expectation is legitimate, and the rhetoric of a Trump administration as well as the general intentions ought to be pro-energy infrastructure and pro-energy investment. However, there are complexities and nuances that may hold markets at bay. For one, until the November 30 OPEC meeting, is there really anything a Trump administration can do to speak to the overall appetite for oil investments, in general? Probably not. And should a Trump administration find itself in a trade war (or a trade war light) with Mexico, would their appetite for our natural gas fall off the vine? And finally, is it possible that in an effort to re-establish coal bona fides with the coal mining industry, there could be a dampening of demand for some of the natural gas that has replaced coal as an electricity-generator? Perhaps the clearest indicator of how enthusiastic a Trump administration will be to the plights of oil and gas infrastructure is what they do with the dozens of stalled projects around the country facing the potential for an imminent re-boot should regulatory impediments be removed. Midstream energy assets have question marks around them, and while the net-net ramifications are likely to be opportunistic for energy infrastructure, diligence and thoughtfulness should drive one’s exposures and allocations here.
The defense and aerospace sector has rallied hard since the election, presumably behind the likely accurate assumption that defense spending will grow under a President Trump. The reality is that defense spending was going to need to escalate next year and beyond regardless of who won the election, but the spending will now be easier to pass through Congress and will take on a larger Oval Office priority. Defense spending as a % of GDP is due to increase,
but the 15% increase Trump has proposed is substantial. We would be careful on loading up in this sector now, as the market has seemingly priced much of the expectation.
The Export-Import Bank faces a certain death next time legislation logistics will allow for it to be killed. Trump has not discussed it much, but he will create significant ties with the very conservative members of the House known as the Freedom Caucus if he lets it die. This is an issue that provides little real economic benefit and yet in killing it will really help Trump boast of populist bona fides (it would be hard to find a more classic case of crony capitalism than the Export-Import Bank).
Internationally, we not only believe emerging markets (debt and equity) will find their sea legs when the dollar rally inevitably pauses, but we believe the United Kingdom could be the big beneficiary of Trumpian policy. His administration has huge incentive to strike a trade deal right out of the gate (to validate Brexit), and the sterling pound has not depreciated in this latest round of dollar movement.
Our general viewpoint is that investors are caught in a tension right now between two forces, both real, both we believe somewhat predictable, and yet both on different timelines so therefore hard to predict in terms of how these things will play out. On one hand, interest rates are rising even as the global economy has been weak. And on the other hand, we really buy the argument that much of what we expect from the new political administration here in the states will be quite bullish for growth. The tension comes because the impact of higher rates will be felt immediately, while the pro-growth policies we are talking about out of Washington D.C. are months, if not a year or more away. We are watching how high rates go and may be compelled to take a larger position in bonds if we feel they become valuable on a price basis or as a recessionary hedge. We still believe growth is the likely outcome here in the states, but this timing tension is real and somewhat unpredictable.
Originally published on Forbes.