The one thing markets and pollsters were not expecting, a Republican clean sweep of the Presidency, House and Senate, has happened. The disenfranchised industrial heartland of America deserted the Democrats and swung behind Donald Trump, even though the popular vote was close. The shock result sent equities and the dollar lower before closing higher. Long dated US Treasuries initially rallied and then sold-off as the market assessed the fiscal implications. The full implications of what has happened will play out over time but one thing we can be sure of is that US politics has got a lot more interesting.
Although the official handover of the Presidency will not happen until noon on 20 January 2017, the political logjam that has existed in Washington for many years will start to free up as the Republicans exert their influence. The more moderate factions within the Republican Party will probably act to limit some of the more extreme elements of President-elect Trump’s policy agenda, if he does not choose to do so himself.
In general, we can expect Mr Trump’s policies to be expansionary and likely to increase the budget deficit in the short term. His policy platform includes cutting taxes and increasing government spending, a lot. His conciliatory victory speech emphasized his plan to increase infrastructure spending substantially.
Such pro-growth policies would tend to favour equities over bonds. Increased bond issuance to fund the fiscal expansion will limit the potential for sustained bond rallies. Pro-growth policies should also see the US dollar resume its upward trajectory, as the Federal Reserve will eventually need to lean against the fiscal stimulus to reduce inflationary pressures.
In previous instances where Republicans have achieved clean sweeps, tax cuts have been substantial. Taken at face value, Mr Trump’s policy platform includes large, broad-based tax cuts. He wants to consolidate seven personal income tax brackets into three (10%, 15% and 25%), resulting in big tax cuts for upper income earners (always a Republican priority). Mr Trump also wants to reduce the top federal corporate tax rate from 35% to 15%, partially offset by the elimination of a range of business deductions, which would boost post-tax company profits and be positive for the US equity market.
On the trade front, Mr Trump has spoken in the past of removing support for the Trans-Pacific Partnership (TPP) trade agreement, of scrapping the existing North American Free Trade Agreement (NAFTA) and of imposing 35-45% tariffs on Mexico and China. He has also spoken of repealing the Affordable Care Act (Obamacare) in the health sector and of relaxing (if not eliminating) regulations for segments of the energy industry (in favour of fossil fuels) and in the finance industry. He has also spoken of increasing military spending and requiring allies to pay more for their own protection. A tougher stance on immigration has also been a hallmark of his campaign.
Concerns about global trade, which is already weak, becoming more restricted are alarming America’s trading partners. However, as mentioned, the more extreme elements of Mr Trump’s policy platform are likely be moderated once in office.
At the broadest level, the main thrust of President-elect Trump’s policies should boost US GDP growth, put upward pressure on interest rates, lift corporate earnings and benefit the equity performance of cyclical industries.
In 21 Presidential elections since 1932, the S&P 500 has posted inconsistent performance in the first month immediately after election day, rising on roughly half of the occasions. However, once the market has had time to digest the election results, it typically rises. In the six months post-election, the S&P 500 has risen nearly two-thirds of the time.
The equity market’s initial concerns are likely to be temporary. The positives for equities should outweigh the negatives, particularly if Mr Trump is seen to moderate his more extreme views that were always intended to help him win the election more than anything else. The return of US profit growth was already happening before the election. Now it looks set to accelerate.
There is a new sheriff in town and investors have the opportunity to take advantage of the exaggerated pessimism.