Election shock as Trump becomes President
By Patrice Rassou (Head of Equities), Fred White (Head of Balanced) and Mokgatla Madisha (Head of Fixed Interest) at Sanlam Investment Management (SIM)
In his victory speech President Trump makes mention of increasing infrastructure spend and boosting growth. This would suggest the era of fiscal restraint is coming to an end, and long-term rates may start normalising in the US. Both Brexit and now Trump speak to a mercantilist agenda where free trade is likely to take a back seat to local interests. These have undoubtedly inflationary consequences and do not bode well for global trade, which has been growing at 6% p.a. for the past decade, outstripping global GDP growth.
The risk is also that Trump’s dissatisfaction with the Fed creates uncertainty as to whether Fed chair Janet Yellen will see her term through to February 2018. In order to create jobs for middle America, the Trump administration will have to reverse the trend which has led to offshoring of jobs to emerging markets and revive US industry in order to lift median household incomes, which have been stagnant for decades. Finally, aligned with the question of trade policy is the question of immigration. A Trump Presidency is expected to favour greater control over immigration. However, while not influential in the near term, demographics play a key role in the long-term outlook for economic growth. When population growth ebbs to the point where it eventually falls outright, the only means to promote GDP growth is through productivity gains. That is not easy to do consistently over the long term.
In the end, it is these decisions about free trade and the movement of people made today in the land of the free, which appear set to have significant long-term implications for the US and the global economy.
A knee-jerk reaction by markets
Markets initially braced themselves for Armageddon: The Mexican peso lost over 11% against the greenback, Tokyo traded down 4%, and Australia was down 3%. But not everything that gets bandied around in the US election necessarily gets implemented. And what does get implemented does not happen overnight. On average, the more radical a new policy, the longer it takes to clear the decision making/approval process. Throughout the process it gets steered “towards the middle” before it eventually passes. For this reason, any reaction in the markets post the result would always just cause a bit of noise in the markets, before the realisation kicks in that, in the short term, it doesn’t change anything. The markets would then start looking at the long-term implications and gradually start pricing that in.
The long term: what counts
The most likely longer-term impacts of a Trump presidency include slightly higher risk of inflation (due to tariffs and increased inefficiencies) and slightly better prospects for commodities (due to increased infrastructure spending in the US, but offset to some extent by a reduction in global trade). The medium- to long-term outlook for growth in the US should also improve a bit (due to tax cuts and spending stimulus), but probably at the expense of the longer-term growth trend thereafter (due to lower population growth via an adjusted emigration policy). In the medium term, this should play out in financial markets predominantly via gradually rising developed market bond yields and commodity prices.
The impact on local equity markets
On the JSE, there is a sprinkling of companies with operations in the US. Most prominent is Anheuser-Busch, which recently listed on the JSE after absorbing SABMiller. Both Mondi and Sappi operate mills in the US, while Naspers has an investment in Letgo, the online market place. Datatec also has a sizeable IT services business in the US, Old Mutual still owns a stake in its US asset management business, while Steinhoff International recently purchased Mattress Firm, the largest retailer of mattresses in the US.
As mentioned above, a more expansive infrastructure spend in the US may prove a windfall for resource stocks. Donald Trump may well use tax incentives to encourage private firms to expand their domestic operations, repatriate cash held offshore and create more jobs instead of focusing on share buy backs and dividends, which may provide a short-term boost to growth. In the long run, the US would need a productivity miracle to regain its place as a world-class manufacturer. Trump has threatened to renegotiate trade agreements, with the African Growth and Opportunity Act (AGOA) being one that has benefitted our exports of vehicles, while our poultry industry has suffered from dumping. We believe that it is highly unlikely that our plight will improve under the Trump regime.
The impact on local bond markets
Trump has promised to cut taxes, renegotiate free trade deals and spend money on infrastructure. He also lambasted the Fed for keeping interest rates too low. Should he fulfil his election promises, particularly on import tariffs, this would significantly increase US inflation. The US bond market has gone from pricing in only one hike in December to fretting about multiple hikes in 2017. Fed Chair Yellen is unlikely to be granted a second term by Trump. One can presume that her successor is likely to be more hawkish than she has been. Higher inflation and greater deficit spending argue for higher bond yields and a steeper curve in the USA. Higher US and global bond yields will reduce capital flows into emerging market bonds and South Africa has benefitted enormously from the carry trade. In the near term, local bonds could trade higher in sympathy with global yields but we expect the spread relative to US Treasuries to narrow because our bond yields, aside from local politics, are attractively priced.
Having said that, it is also important to remember that Trump will come up against fiscal conservatives within the Republican Party and therefore some of his plans on tax cuts and deficit spending may struggle to get passed. The current federal debt limit will expire in March 2017 and the negotiations ahead of this deadline will give a good indication on how Trump will work with the House of Representatives.
SIM is well positioned
By and large, our portfolios are well positioned for the most likely changes. From an asset allocation perspective we are underweight global bonds, and within the equity portions of our portfolios we are overweight resources. We believe this positioning will stand us in good stead as we take time to evaluate any other long-term impacts the US leadership change might have.