The day after a Trump triumph

If on 8 November 2016 Donald Trump is elected President of the United States, that day will go down in history as the first time a businessman with little political experience has won the US presidential election.

Much like the British public voted for change in leaving the European Union, the American people will have chosen Mr Trump to take on the tough decisions and work to fulfil his promise to “make America great again”.
Globally there has been much discussion and concern over the views and statements that Trump has made during this election campaign. Over and above those concerns, investors are particularly interested in his ideas for changes to economic policy and how these may impact financial markets. In fact, there is significantly more uncertainty about a Trump presidency than a Clinton presidency given Hillary Clinton’s support for many of the current administration’s policies. This article contemplates what the likely financial and market impacts might be over the short to medium term with President Trump at the helm in the US.

What’s next?
This is the key question that will create a great deal of uncertainty and could arguably be the making or breaking of a Trump presidency. Unlike his opponent Hillary Clinton, Trump did not spend his campaign creating a myriad of policies and proposals; so much of what will be implemented is up for debate. As Antoine de Saint-Exupéry said, “Perfection is achieved, not when there is nothing more to add, but when there is nothing left to take away”. Although there is much Trump must do to succeed in his goal as president, perhaps his lack of policy proposals will work in his favour as there is little he will have to go back on and take away from his plan.
The first and probably most important point to consider is the Democratic/Republican split in Congress. A Democratic majority in either the House of Representatives or Senate would restrict the more radical changes Trump has proposed and we could even see a stalemate on some issues.

However, it is highly unlikely that Trump would win without maintaining Republican majorities. Senate Majority Leader Mitch McConnell would stay in his role but is unlikely to preside over a large enough majority to run over Senate Democrats entirely. But if the election map in the next round of congressional races in 2018 favours the Republican side, we may see a shift as those trying to win or hold their seats jump on the populist bandwagon in a bid to gain the hearts of the public. Individuals like Paul Ryan (the current Speaker of the House of Representatives) are likely to stand their ground and temper any wilder policy proposals and keep a keen eye on the costs.

Secondly, markets will be eagerly waiting to see who will make it into Trump’s inner circle.
The composition of his administration will start to flesh out just how far-reaching Trump is intending to be and add some much needed expertise to manoeuvre through the political system.

What has been promised and how likely is it to materialise?
Setting aside the huge costs attached to certain ideas proposed during the Trump campaign, only a few key issues have been fleshed out in some detail, including tax reforms, trade agreements, immigration and healthcare. Although on the face of it the costs look unmanageable, Trump has said, “When I’m president, I’m a different person. When you are running a country it’s a different dialogue that goes and we can do that easily”. Perhaps then we can expect a more moderate approach going forward. The following paragraphs detail some of what has been said and the likelihood that it would become a reality.

Tax reform
Both Clinton and Trump stood fairly united on this issue, agreeing that fiscal easing through the reduction of taxes should be introduced to help the US economy. Therefore tax reform is the most likely to get through first.
The specifics, however, need to be hammered out, including how to offset lost revenues.

Trump’s official position includes:

• Simplify taxes for everyone and streamline deductions. Biggest tax reform since Reagan.
• Lower taxes for everyone, making raising a family more affordable for working families.
• Reduce income tax dramatically.
• Simplify income tax from seven to three brackets.
• Exclude childcare expenses from taxation.
• Limit taxation of business income to 15% for every business.
• Make corporate tax globally competitive and the US the most attractive place to invest in the world.
• End the estate tax.

The key point here is that Trump would like to see business-friendly tax reforms and the repatriation of offshore cash holdings at low tax rates, as he believes this is the way to get the US economy back on track and reinstate America as ”the best place in the world to do business”. The business tax reforms together with tax cuts for individuals are estimated to cost trillions. On 8 August, at a speech in Detroit, Trump announced a modification to the individual tax rates of his tax reform proposal. He proposes three rates: 12%, 25% and 33%. These changes would substantially reduce the cost of the plan but it is difficult to project the actual amount because he did not announce how the income brackets would be structured. Where these tax cuts fall will, of course, result in different outcomes for the economy. Cuts are likely to see high tax rate payers save more, while the middle class will spend more – boosting consumption and retail spending for the economy. For those in the low income bracket, tax cuts may trigger an increase in labour participation.

We have already seen Trump pull back somewhat to more achievable goals in terms of the actual numbers for tax cuts. As long as these slightly more conservative goals remain, there should be no reason why tax reforms in some capacity would not get the green light. However, if there were a move to force US companies to repatriate cash held overseas, then this could have significant implications for the US dollar.

Trade
Trump has been very clear that he is anti-trade, and he will actively pursue the repeal of trade deals and the introduction of new tariffs and trade restrictions. This all seems rather reminiscent of American isolationism in the 1930s and begs the question – are we seeing a trend, in the US and globally, to attempt to get back to the “good old days”?

The reality is Trump will have an uphill battle on his hands trying to repeal existing trade deals. However, imposing new tariffs and restrictions will be more achievable. If he were to introduce 35% tariffs this might help to address the US trade deficit. That said, the main focus for trade seems to be the current US-China trade deal, which Clinton also feels needs to be addressed. This is the issue America’s blue collar workers will be eagerly watching. Could this really revive the American manufacturing sector or will companies still opt to manufacture in China, taking advantage of lower labour costs? Trump is certainly thinking big with his intentions concerning China, including:

• Bring China to the bargaining table by immediately declaring it a currency manipulator.
• Protect American ingenuity and investment by forcing China to uphold intellectual property laws and stop the practice of forcing US companies to share proprietary technology with Chinese competitors as a condition of entry to China’s market.
• Reclaim millions of American jobs and revive American manufacturing by putting an end to China’s export subsidies and lax labour and environmental standards.
• Strengthen negotiating position by lowering the corporate tax rate to keep American companies and jobs at home, attacking debt and the deficit so China cannot use these as leverage against the US, and bolstering the US military presence in the East and South China Seas.

Only time will tell how much can realistically be achieved in a four-year term, and perhaps the focus should start at home first. Navigating the inner workings of the House and Senate will be tricky enough – arguably using force to get China to bend to Trump’s will is a step too far for now. It is much more likely that a renegotiated agreement could be reached.

Immigration
Similarities with the isolationist period do not end with China and are most pointed when it comes to Trump’s views on immigration, including his proposal to “compel Mexico to pay for a wall”. Throughout history walls have been built with the intention to segregate and/or protect regions and they have had varying degrees of success. However, one of the common outcomes is that at some point they become almost redundant with people finding ways around them.

While legal immigration is to be encouraged – the US would never have been great without it – illegal immigration needs to be controlled.
This is an issue where Trump’s rhetoric has softened somewhat through the campaign and if he can manage this issue appropriately the US economy could benefit in the long run. The risk in the short term, however, is that certain sectors that rely on cheap labour such as retail, construction and agriculture will be hit. Disrupting the labour supply cannot be beneficial to the economy and are there US workers willing to take up these jobs? For now many have suggested that the way forward is investing in Mexican cement and building companies, though surely the wall he is talking about is not going to be made of bricks and mortar, but rather a mound of trade agreements and visas.

Healthcare
Healthcare has been another hot topic in the run up to the election. Trump has been adamant that the Affordable Care Act (ACA) should be repealed and replaced. With a $400bn price tag, the chances that he will get the backing for this
are slim. It is more likely that the “Cadillac tax”
that is an additional more generous private healthcare plan will be scrapped. Nevertheless, uncertainty around the future of the ACA may impact hospitals and managed care if treatments they provide are no longer covered. Conversely,
the pharmaceuticals and biotechnology sector
has a sunnier future as Trump backs the government negotiating drug prices under Medicare Part D and he is supportive of drug importations and aggressive tax reforms.

Economy and markets – ‘There is no such uncertainty as a sure thing’ (Robert Burns)
Historically, Republicans have been stock market friendly with pro-growth, pro-defence, pro-big pharma, anti-regulation and balanced budget stances. As discussed above, Trump has shown that his views are a little different, favouring tax reform, anti-trade and anti-immigration policies and a desire to unwind the ACA. In some ways this could be good for business and the domestic economy as a whole. However, it is said that “there is no such uncertainty as a sure thing” and with Trump’s unpredictability it is likely to bring uncertainty to the markets. As already discussed we know little about Trump’s views in many fields and his instinctive and mercurial nature is sure to make for jumpy markets. Or the counter may be true, and in these globally uncertain times, markets may become complacent and wait and see what is delivered rather than jumping to premature conclusions.

A Trump win will likely lead the US dollar stronger initially in a risk-off, buy dollars move. But it is also bullish for the dollar as protectionism reduces potential output and leads to higher inflation and a more aggressive Fed relative to baseline, for a given level of growth. This is coupled with the population close to full employment and a big fiscal spend to build infrastructure, pushing wages and inflation higher. Conversely, if there is an implosion in growth elsewhere in the economy there may just be a big shift in employment towards construction.
A big concern will be if Trump’s comments on bringing back the gold standard carry any weight. Trump is quoted as saying “Bringing back the gold standard would be very hard to do, but, boy would it be wonderful. We’d have a standard on which to base our currency”. One can only hope this was a throw-away comment. Can Trump have missed the recessionary economic environment the world has been in for almost a decade? The pros of a theoretical gold standard that ties the US dollar to the price of gold would be: preventing excessive printing of money by the Fed; keeping inflation low and so slowing the increase in consumer prices; stabilising oil prices; and, of course, gold retains value which is recognised across the world. However, much of this is made redundant by the current economic environment. Arguably, without the ability for central banks to print money the global financial crisis would have been more dire. Indeed, the reason the US economy seems to be turning around is partly (if not entirely) due to quantitative easing. Moreover, the economy is crying out for inflation with levels at all-time lows, so the idea of reducing inflation is absurd.

Trump’s memory does seem to be rather short in this case, as you need only look back less than 100 years to see what a disaster the implementation of the gold standard was.
It lasted just over a decade before order was restored.

Impacts on equity markets will be mixed. The obvious winners will be infrastructure, with a focus on roads, bridges, airports and sectors that would benefit from M&A and industry consolidation, which Trump is particularly enthusiastic about. Financials will benefit from loosening of the Dodd-Frank regulations. Furthermore the defence sector is likely to thrive. Other sectors likely to do well include consumer discretionary, consumer staples, telecoms, energy and mining.

A Trump win is unlikely to be great news for the US bond market as inflation break-evens rise.
In particular, his proposed policies would lead to substantial budget deficits, steepening the curve somewhat. Additionally Trump has made some disconcerting comments regarding a lack of commitment to debt repayments.

If a substantial global event like the financial crisis were to occur again, this may mean domestic debt is paid while foreign debt remains outstanding. Could this deter investors?
This would be particularly unfortunate as Treasury issuance is likely to increase significantly in order to fund the various costly proposals as the US racks up larger deficits.

Currencies
There are three areas that could affect the US dollar:
1. Repatriation – a repeat of the 2004 Homeland Investment Act is more likely under Trump given previous talk of a one-off 10% tax on repatriation (although this does not appear in the “economic vision” section of the campaign website). The amount mooted to be held by US companies overseas is $2tn but this would only be dollar positive if:
a) the money came back.
b) the money was not held in US dollars,
dollar-denominated or dollar-hedged assets
and therefore had to be converted.
Data is patchy given companies tend not to disclose composition. However, the bulk of what is disclosed is held in US dollars so the amount of relevant repatriation would be significantly less than $2tn, although a potential positive for the dollar, nonetheless. HIA 2004 saw 2%
of GDP repatriated.

2. Trade – there is likely to be an increase in protectionism through tariffs. The most obvious result will be a reduction of the trade deficit and with it the current account deficit. Traditionally, this would be associated with currency strength. The narrowing of the current account deficit would also reduce the amount of dollars available abroad, which would put pressure on economies with large dollar-denominated liabilities. This would be a double negative for countries with high levels of exports heading to the US and dollar-denominated liabilities, so we would expect the dollar to perform extremely well against the likes of Mexico and China. However, the counterpoint to this would be the reduced attraction of the US as a destination of capital and investment that a Trump presidency would bring – the likes of the Euro and the Yen are likely to outperform against the US dollar. Broadly, Trump’s trade policies would come at the detriment of currencies that primarily export goods to the US (mostly emerging markets) and to the benefit of countries that export capital/investment (ie developed nations). From a historical perspective, this was what we saw in the early 2000s when steel tariffs were imposed on Europe and in the mid-1990s with auto tariffs imposed on Japan.
3. Fiscal expansion – globalisation appears to have increased trend growth, so it would be reasonable to assume that the imposition of trade barriers would do the opposite. With Trump’s proposed fiscal expansion, a lower trend growth in an economy already close to full employment will likely cause a sharp uptick in inflation and a response from the Fed. This would lead to a higher US dollar, which would also benefit from the rise in long-dated yields that would come from a fiscal expansion of that magnitude.
In reality, Trump is likely to be hamstrung by not having control over Congress and therefore not able to implement all of the above – or at best he will implement it in an extremely watered down fashion. We would likely enter another period of policy stasis in the US with policy uncertainty keeping the Fed at the side-line. This would
lead to a weaker US dollar and a risk-off
episode in markets.

Conclusion
No major legislation is likely to reach the finish line for 12 months as the victor takes power in January and needs to appoint and gain confirmation of agency heads, including a new justice at the US Supreme Court. However, conventional wisdom holds that a President’s important achievements should happen within the first two years of the term. Any later than that and legislating becomes much more difficult as the next presidential election cycle looms. Of course, the first two years of a Trump term may be dominated by punishing the losing side and members of Congress proving their conservative credentials, but there is a space where a Trump president can make real changes that will be reasonable and tempered. We will have to see.

Mark Burgess – CIO EMEA and Global Head of Equities – Columbia Threadneedle Investments