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LGT Beacon: Trump-rally is credible, but hold your horses for now

November 23, 2016

The financial markets reacted to Donald Trump’s electoral victory by instantly pricing in higher levels of future inflation and economic growth in the US. This initial reaction is fundamentally reasonable, and largely consistent with our in-vestment positioning. At the same time, the selloff of emerging market equities since the US election was overdone in our view. 

Long-term data shows that since the end of the second world war, US government expenditure growth has generally been higher under Republican administrations. Sarcastically put, Republicans seem to be fiscally conservative only when it comes to thwarting Democratic spending plans. Trump grandiose election promises to double the rival candidate’s infrastructure investment plans is therefore politically credible in principle.

Market conditions are favorable, as the US dollar is strong and interest rates are still at very low levels - even after the most recent surge, the ten-year US treasury bill yield is still hovering around the levels of December 2015, when the Federal Reserve decided to proceed with its first and thus far only policy rate hike. Furthermore, with most other major central banks buying back their national bonds, other liquid, low-risk government bonds remain in relatively short supply globally. In short, in addition to being willing to accept larger budget deficits, the US would also be able to borrow in its own currency. And when Trump’s first post-election statements sounded conciliatory, markets were immediately relieved. The expectation for more deficit-funded growth and inflation in the near future is credible for the following reasons in particular:

  • Effective and willing administration: The Republicans have secure control over the White House as well as both chambers of Congress, at least until the next elections in two years.
  • Protectionism: During the election campaign, Trump criticized existing and planned trade agreements and threatened China, Mexico and other countries with tariffs. However, comments by some Trump’s economic advisors suggest that a more pragmatic approach may ultimately prevail.  
  • Tax cuts: Trump is seeking to cut corporate and income taxes, and offer tax incentives for the repatriation of US corporate accumulated and held overseas. The plans seem realistic because there are precedents, and they also are largely compatible with the ideas of the Republicans in Congress.
  • Government and military spending: Trump has promised $1 trillion in infrastructure investments over 10 years. Even though the program may prove more modest in the end, public investment is now clearly being used as an important tool of economic policy, which is growth-friendly in principle. Military spending is also expected to rise.
  • Inflation-tolerant Federal Reserve: The plans can be effective in the short- to medium-term, as long as the Fed doesn't fully offset the coming fiscal largesse by tightening monetary policy. Over the past couple of years, when there was no credible pro-spect of significant fiscal expansion, the mere hint of possible interest rate hikes fanned deflationary fears. By contrast, under the assumption that Trumps plans will be implemented, the Fed’s current policy bias can be considered as too dovish.

Still, investors should hold their horses for now

Overall, Trumps election can be viewed as an unexpected easing of US monetary conditions, which naturally gave equities and inflation expectations an additional instant boost. At the same time, however, at least part of this de-facto easing was offset by the strong rise in US bond yield and the USD since the election. We therefore caution against chasing the markets. Instead, in the con-text of our existing tactical asset allocation, we would generally favor a more counter-cyclical investment approach. This is particularly true in the case of emerging market equities, which have been sold off too strongly since the US election in our view.

Read more in the LGT Beacon

Read about the resulting investment positioning changes in our portfolios in the LGT Beacon below. To subscribe to a weekly newsletter, go to subscriptions.

Note: The next LGT Beacon will be published on 14 December 2016.