WorldWatch
Donald Trump's surprise victory is a watershed moment that has important ramifications for many of the world’s financial assets. We consider the global impact of Trump’s potential policies, before outlining how we are positioned to exploit the opportunities created by his victory.
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It is the biggest political upset in living memory: Donald Trump will soon become the 45th president of the United States. The vote stunned pollsters, pundits and investors, who all predicted that Hillary Clinton would breeze to victory. Amid the din of post-event rationalisation, one fact stands out. Over the past 20 years, in real terms, the S&P is up 172% and US GDP has grown 66%, but median household income is flat. It was against this backdrop that Mr Trump tore through the Rust Belt and turned red a swathe of states that had not voted for a Republican presidential nominee in decades. This was America’s “Brexit” moment, a revolt of working-class whites who felt left behind in a rapidly globalising world. These voters helped to elect Trump on a promise of economic populism consisting of two main elements. The first is action to boost growth, notably infrastructure-orientated fiscal spending and tax cuts. The second element is trade protectionism. So how will these radical policy reversals affect economies and markets around the world?
The good
The answer depends largely on whether the main thrust of Trump’s presidency is action to stimulate growth or measures to promote protectionism. So far investors seem to be focusing on the prospect of significant fiscal stimulus, which is the area where Trump’s intentions are most clear. The president-elect has made a $1 trillion infrastructure investment programme one of his first priorities, promising in his victory speech to “rebuild America’s highways, bridges, tunnels, airports, schools and hospitals.” This seems reasonably sensible after a decade of austerity, particularly with interest rates still so low. It will create employment and should carry a greater ‘multiplier effect’ than monetary easing. That said, the case for fiscal expansion has weakened in recent months as global growth is improving and deflationary pressures have subsided. With the US economy now very close to full employment, it is difficult to see how more jobs can be created without stoking inflation.
In addition to infrastructure investment,
Trump wants to slash taxes, both at the personal and corporate level. According
to the Tax Policy Centre, these cuts could amount to 3% of GDP in Trump’s first
year. The case for lower taxes is not particularly compelling, especially if
they favour corporations and high-income earners, which tend to dampen the
fiscal multiplier by saving some of the windfall. Nevertheless, lower taxes
will boost economic growth, at least in the short run. They will also provide a
shot in the arm for US companies, with Citigroup predicting a 9% improvement in
earnings as a result. Perhaps the most sensible element of Trump’s tax plan is
a proposal to allow companies to repatriate the $2tn of accumulated profits
they have stashed abroad, without triggering a huge tax bill in the US. This
would encourage them to increase domestic capital spending as they would have
more cash readily available and subsequent profits would be taxed more lightly.
It would also boost M&A activity, share buybacks and dividend payouts.
The policies outlined above would almost certainly lead to faster US growth, larger budget deficits, higher bond yields, greater inflation expectations, a more hawkish Fed, and a stronger dollar. Faster growth in the world’s largest economy would normally be seen as particularly positive for Emerging Markets, which are often regarded as a levered play on global growth. Yet in the short time since Trump’s election, Emerging Markets have underperformed their Developed Market counterparts by over 6%. The reason is that higher US bond yields and a stronger dollar act like a magnet for capital, attracting money back to the US and tightening global credit conditions. This can be challenging for those Emerging Markets that are heavily reliant on foreign inflows to fund fiscal or current account deficits, as well as those with significant dollar-denominated debt. In our view, however, the potential for stronger global growth as a result of aggressive fiscal expansion more than compensates for the risks associated with higher interest rates. Moreover, Emerging Markets are far less vulnerable to rising rates and a stronger dollar than they were in the past: currencies are more competitive, current account balances are much healthier, and bad loan growth has slowed sharply. We therefore see the recent Emerging Market sell-off as a buying opportunity.
The bad
Of course, this assumes that global growth is not stalled by trade protectionism, the second element of Trump’s populist agenda. On the campaign trail, he pledged to tear up trade agreements and impose punitive tariffs on imports. Should he keep his promises, Mexico has the most to lose. Exports to the US account for 82% of Mexico’s total exports and 25% of its GDP. The country already has deteriorating public finances and a weakening currency. It also relies heavily on remittances back from the US, which may now be taxed or otherwise curtailed. Moreover, Mexico has consistently been the main victim of Trump’s antagonistic vitriol. This is partly because it is a relatively easy target as much of its export growth stems from the auto industry, where the US already has a deep supply chain.
China is another country that was explicitly targeted by Trump throughout his campaign. He has promised to label China a “currency manipulator” on his first day in office and pledged to slap a tariff of up to 45% on Chinese imports. This would be extremely damaging as the US accounts for 18% of China’s exports and 60% of its manufacturing trade surplus. Thankfully, such a draconian import tariff seems unlikely. US imports from China are relatively well diversified by category, making a blanket tariff difficult to implement. Moreover, the US lacks a deep supply chain in areas where Chinese exports are more concentrated, notably light manufacturing and electronics. Aside from China and Mexico, protectionism would be unhelpful for many other Emerging Markets, particularly those with relatively open economies that rely heavily on international trade and financing. But Developed Markets are far from immune. For example, while the US accounts for only 14% of the Euro Area’s exported goods, it is also responsible for 40% of the currency zone’s recent export growth.
The relative beneficiaries of any shift towards protectionism are the more insular economies, particularly those that can finance investment using large flows of domestic savings, and those that can rely on vast domestic markets to support aggregate spending. India ticks both boxes. Countries such as Argentina with reform angles should also fare reasonably well. In quick succession Argentina’s new president has lifted currency controls; settled a decade-long lawsuit that blocked the country from international capital markets; begun to compile and release accurate national statistics for the first time in a decade; and hiked heavily subsidised utility tariffs. We are confident that these changes will put Argentina on the road to economic recovery.
Clearly these countries are only winners in a relative sense. They will still be affected if Trump’s protectionist agenda prompts a slowdown in global trade. But one country that might actually benefit from a Trump presidency is Russia. When the news of Mr Trump’s victory reached the floor of the Duma, Russia’s lower house of parliament, the assembled politicians burst into applause. Such enthusiasm is partly due to hopes that Trump will adopt a more conciliatory stance towards Russia and perhaps even lift economic sanctions, providing a fillip to an economy that is already in recovery mode.
Of course, it remains to be seen whether Trump’s trade policies match his tough campaign rhetoric. In reality blanket tariffs will be difficult to impose as supply chains have become increasingly complex and globalised. For example, US domestic production simply does not exist for many component parts of technology-related products. Thus, the most likely outcome is a number of headline-grabbing tariffs on high-profile imports such as metals and heavy machinery, while more complex products emerge relatively unscathed. If this is the case, major exporters with substantial current account surpluses such as Korea, Taiwan and China should benefit from exposure to a stronger US economy, while largely avoiding the impact of a rising dollar and higher bond yields.
Even if Trump is able to pursue a full-blooded protectionist agenda, fears about Emerging Markets are likely to prove overblown. Indeed, such concerns are based on outdated perceptions of Emerging Markets as a one-trick pony with regard to global trade. While Emerging Markets undoubtedly benefit from the free movement of capital, labour, goods and services, the reality is that they also offer exceptional structural growth opportunities due to superior demographics and underpenetration in many large domestic sectors. These attractive qualities will endure, regardless of who is US president.
Portfolio positioning: coming up trumps
Even before Trump won the election on a promise of fiscal expansion, global growth was recovering and inflationary pressures were beginning to mount. Our view is that inflation expectations will continue to rise following Trump’s victory, and probably further than is currently priced in by the market. Against this backdrop, cyclical stocks should continue to outperform against defensives.
In our International, European and UK strategies we have been increasing exposure to Financials, Energy and Materials, while reducing exposure to bond proxies in the Consumer Staples sector. For example, we initiated a new position in GALP, a Portugal-based holding company engaged in the oil and gas industry. Whereas a lot of the big oil stocks are at the top end of the cost curve, the vast majority of GALP’s future production is due to come from Brazil’s Santos basin, which offers extremely low cost production. GALP has gone through a period of intensive capital expenditure, but this will start to tail off while production ramps up. Consequently, GALP should start generating a significant amount of cash.
With global trade in decline long before Trump’s victory, our Emerging Markets strategy has been skewed towards domestic stocks in countries with reform agendas. Indeed, Argentina has been our largest country overweight for some time. We have also been underweight Mexico, largely on valuation grounds, but also as a hedge in case of a Trump victory. In addition, we have been underweight China, primarily due to long-term concerns over excessive property inflation and insufficient recognition of non-performing loans in the Banking sector. Finally, we had recently moved overweight Russia, where the economy is showing signs of improvement. As such we were well positioned in advance of the election and only modest changes were required following Trump’s victory. In Mexico we reduced our exposure to an industrial Real Estate Investment Trust and bought a position in Grupo Mexico, a copper producer in Mexico and the US. With a peso-dominated cost base and a dollar-denominated revenue stream, it is a clear beneficiary of peso weakness, as well as copper price strength on the back of Trump’s infrastructure spending plans. The final noteworthy alteration was a reduction in exposure to the Indonesian Property sector, which could struggle against a backdrop of rising US rates.
Our Asia ex Japan strategy was also well positioned going into the election. We continue to have significant exposure to domestic-focused economies such as India and Pakistan. Both should be relatively insulated from any shift towards protectionism. Meanwhile, our largest country overweight is still Korea, where a substantial current account surplus should protect the economy from a stronger dollar and higher bond yields. Conversely, we remain underweight Taiwan, Singapore and Hong Kong. The former is a major exporter to the US and could struggle in a more protectionist world. Meanwhile, Singapore and Hong Kong look particularly exposed as they both import monetary policy from the US, either directly or indirectly. This is worrying as both are vulnerable to higher rates following a sharp rise in debt levels and property prices. Changes to the portfolio since Trump’s victory have been minimal. Most notable is an increase in Indian exposure following a significant pullback in the market. Here we bought HDFC Bank, the country’s highest-quality bank. It has a mix of corporate and retail business, but on the corporate side it is more exposed to short term working capital loans, which tend to be less risky. Consequently, it has largely avoided the asset quality problems that are plaguing other corporate lenders in India. HDFC Bank has maintained an ROE of 20% and has consistently grown both loans and profits by 20% a year for the past decade.
The ugly
Aside from the shock result, the US election was notable for the bitter and divisive manner in which it was fought. Though Trump has since struck a more conciliatory tone and called for national unity, his victory has undoubtedly polarised America like never before, especially after it emerged that Clinton won the popular vote. Similarly, by emboldening anti-establishment movements on both sides of the political spectrum, it has strengthened political centrifugal forces around the world, increasing the risk of further election upsets. This is bad news for the Eurozone, which faces several crucial votes over the coming months. Should Italy’s prime minister lose the constitutional referendum in early December, he will likely resign, plunging the country into political chaos. Meanwhile, a victory for Marine Le Pen in the French presidential election in spring 2017 would threaten the very existence of EU. Thus, the only certainty about Trump’s victory is that it has brought more uncertainty.