In a turnaround almost identical to the UK Brexit vote, the US confounded all the pollsters by electing billionaire Donald Trump as the 45th President of the USA. And just like Brexit, initial share market reaction was very negative as the probability of a Trump win increased during vote counting in Australian trading hours. At one stage the Australian ASX/S&P200 was down 4%, but clawed back performance to close down 1.9% on November 9. The Mexican peso was as good an indicator of any chance of Trump winning, falling as much as 11% versus the USD.
Other markets in Asia also fell, with Japanese Nikkei down 5.4%, the Hong Kong Hang Seng down 3.1% and US S&P500 mini futures down almost 5% in Asian trading. Initial reaction to the uncertainty of a Trump Administration saw interest rates expectations fall with Australian and US 10 year bond yields of 0.11% and 0.14% respectively in Asian trading hours on November 9.
The initial market reaction reflected the shock of the result relative to predictions, the uncertainty of a “loose cannon” President, plus expectations of the potential real impact of a Trump win. However, like our initial view of Brexit, we think there was an element of over-reaction in the initial market response. But what a difference an acceptance speech made. The Dow Jones and Europe rallied overnight, erasing initial knee-jerk falls. Yes, Donald Trump’s shoot from the hip statements offend many groups, and yes, he has some very strong policy stances but many of his economic policies are pro-growth, something the world currently lacks. We discuss some of the main potential economic impacts of a Trump Presidency below.
More protectionist trade stance?
The potential impact on global trade could be significant if Trump does amend or repeal US trade agreements and impose tariffs. Trump has discussed renegotiating or “breaking” the NAFTA (North American Free Trade Agreement with Canada and Mexico), and imposing tariffs on Chinese imports, and even withdrawing from the World Trade Organisation. From Australia’s perspective, the US is our second biggest trading partner after China but we import far more than we export to the US. Still, Australia’s exports to the US represent 7% of our total exports which is about twice of what we trade with the UK. Rescinding the Trans-Pacific Partnership Agreement (TPP) with the US (but not with other signatories), would rescind small benefits to our sugar, dairy and beef sectors but most benefits of the TPP came from improved access to markets other than the US. Therefore, we would expect rescinding the TPP with the US to be slightly negative and unlikely to impact many listed companies. However, should a more protectionist US trade stance herald in a more protectionist trade stance by other countries, then the impact could be much more significant. Beneficiaries of trade protection, such as US steel manufacturers, rallied significantly in overnight trading.
Trump’s plan is to lower tax rates across the board for US individuals and businesses, with the proposed business tax rate falling from 35% to 15%. Lower taxes, particularly business taxes, should stimulate growth which is something the world severely lacks at the moment. The catch is that such a significant reduction in taxes would likely significantly blowout the US federal budget deficit. The independent Tax Foundation group estimate that the tax plan would lead to an 11% higher GDP, 29% larger capital stock and 5.3million more jobs. However, this is “provided that the tax cut could be appropriately financed”. Lower taxes should be stimulatory and lead to higher after tax earnings for US companies, but higher deficits and higher growth will likely lead to some inflation and higher bond yields. Just like the stock market, US bond rates reversed their Asian falls, rising 20bp. Understandably, interest rate sensitive stocks such as REITs and utilities struggled in overnight trading.
More isolationist immigration stance?
Some of Trump’s most outspoken statements have been around curbing immigration, making Mexico pay for a wall and questioning Muslim immigration. Curbing immigration would likely have a longer term negative impact on US GDP growth since population growth helps grow the economy and generally immigrants provide cheaper labour for jobs that many US workers don’t want to do. Just like Australia relies on backpackers for cheap agricultural labour, the US agricultural industry has a strong reliance on cheap labour from new immigrants. Lower immigration may increase US wage growth which could increase inflation expectations.
In his acceptance speech, President elect Trump outlined plans to rebuild America’s highways, bridges, tunnels, airports, schools and hospitals. Infrastructure spending is stimulatory, but again Trump has not outlined how he would fund that spending. Stocks which are likely beneficiaries of infrastructure spending rallied strongly in overnight US trading.
The President is not all powerful
Even though Trump is the “commander in chief” with his fingers in control of the nuclear buttons, as President Obama has found, implementing change can be difficult. While the US President has the power of veto, significantly changing trade and immigration policies will likely need the approval of Congress and Senate. The Republican Party will control both US houses, but the Republican Party’s policies don’t necessarily match Donald Trump’s policies and getting Mexico to pay for building that wall will require a lot more than that. We expect President Trump might find it harder than he thought to enact significant change, but a number of his policies should actually be good for US economic growth. The flip side is President Trump’s election may herald the bottom of the current global interest rate cycle.
For Australia, higher US long term bond yields will most likely lead to higher Australian long term bond yields and a difficult period for bond-like assets such as infrastructure and REIT vehicles. However, we are not as convinced that higher US bond yields will translate into higher official cash rates in Australia in the foreseeable future. We expect official cash rates to stay low in Australia for some time and note that New Zealand actually cut its short term rate today by 0.25% (to 1.75%). Therefore, we believe that the Plato Australian Shares Income Fund, a well-diversified, sector neutral managed fund, will continue to meet its targeted income for Australian retirees in a President Trump world.
Contributed by Dr Don Hamson, Plato Investment Management: (VIEW LINK)