ROLL THE DICE, MR PRESIDENT
10 November, 2016
- Investors have decided that the Trump presidency will be good for US equities and bad for US government bonds. These trends support our view that bonds yields will keep rising as the developed world enters a reflationary phase.
- We expect a flurry of activity in the first hundred days after Trump’s inauguration on 20 January, because Presidential powers can be used to limit immigration, raise tariffs, cancel environmental regulations, etc.
- After that, the President will need to get the agreement of Congress to pass legislation on complex issues such as personal tax cuts, infrastructure spending, and higher budget deficits. Delays and disappointment will set in.
- Australia is not particularly affected by Trump’s policies. A trade war between the US and China, for example, will not impact our exports of coal and iron ore, despite what alarmists and journalists will tell you.
- The Arminius hedge fund does not make political bets, but our fundamentally based positions have performed well in November so far.
Investors voted with their money on 09 November. Equity investors identified which sectors would benefit – e.g. pharmaceuticals, construction, fossil fuels – and which companies would be harmed – e.g. car exporters, renewable energy, technology. Equity investors also remembered Trump’s remarks about specific companies: for example, that Disney shouldn’t use foreign labour at its theme parks, that Ford Motors shouldn’t have moved car production to Mexico, and that he would block the merger between AT&T and Time-Warner. On balance, the weight of money decided that Trump’s deficits and deregulation would be good for company profits. With European and Asian trading desks awake as the results of the election were made known, they sold down US equities, with S&P 500 e-mini futures falling by -5%, which triggered the exchange’s “limit down” triggers. Once American investors awoke and manned their trading desks, they bought the European & Asian panic-induced sell-off and drove their own S&P500 up to finish a monumental +1.11% up from the -5% down. US investors’ spoke with their buy buttons to move an US$18 trillion index by 6% in one day.
Bond investors, on the other hand, had listened to Trump’s planned spending increases and his remarks about repudiating government debt, so they dumped US Treasuries. Overnight, the yield on the ten-year Treasury rose 22 basis points to 2.07%, giving up its 2016 to return to a level last seen in January. Not only do bond investors want to reduce their exposure to US government debt, they also fear that Trump will bring higher government deficits, higher inflation and a lower US dollar. Bond markets typically display lower volatility than stock markets in the long run, until a potential global macro or geo-political event occurs. In which case almost all bond traders become bond sellers; all trying to squeeze through the same exit gate.
Donald Trump’s election victory is like the Brexit vote, only bigger, harder and faster. The Brexit implementation strategy (or lack thereof) has gone almost nowhere since June. It is now November and Theresa May is having trouble getting Parliament to buy into the “next step”. Financial markets acknowledged “President-Elect Trump” as a possibility, but did not expect it to happen. Once it had happened, no one knew exactly what it meant for markets, because Trump (like the pro-Brexit forces) had expressed differing views on what he would do. Trump’s policy statements are light on details, and they contain a lot of mixed messages because of the candidate’s history of off-the-cuff comments, which tend to stay accessible on YouTube forever. We think that the broad implications of President Trump are clear, but many of his specific policies will depend on what he decides to do once he is in the Oval Office, and what legislation he can negotiate with Congress.
The Republican Party controls both houses of Congress, but that does not mean that Senators and Congressmen will do what President Trump wants or that things will turn out for the best. After all, in 2001 George W Bush had Republican majorities in Congress and on the Supreme Court. Every President has to negotiate, bribe and horse trade to get their legislation passed, and Trump faces two additional problems.
His first obstacle is the iron law of campaign finance. Elected representatives need to satisfy not only the electors back home – much more importantly, they need to satisfy their major donors so that they can fund their next election. A President is very powerful, but he only has a four-year term. Big donors like the Koch brothers are there for life, so it is more important to retain their support than to please the President or the Republican leadership.
His second problem is that the Republican Party is an uneasy coalition of several different interest groups, and he has no strong ties with any of them. The three most influential groups are:
- the Tea Party, a vocal minority (with some billionaire supporters) which favours immigration restrictions, small government and balanced budgets. They are unlikely to vote for Trump’s infrastructure spending and increased budget deficits.
- the religious right, who will demand concessions on issues such as abortion and school prayers.
- the establishment Republicans of the East Coast. They served in the last three Republican administrations and have publicly repudiated Trump’s stance on national security issues. They are closely aligned with big business and many big donors.
Trump’s stated policy positions do not align well with any of these three groups, so he and his advisers will have to draft legislative compromises which satisfy enough people to pass. There are quite a few things they all agree on, but these things are mostly negative, such as personal income tax cuts, the repeal of Obamacare, the repeal of the Dodd-Frank banking supervision, and the end of clean energy subsidies.
Repealing Obamacare is one thing, working out what will replace it is another. Hospital stocks dived on the fear that the Obamacare revenues would simply vanish. Trump has also said that Medicare should be able to negotiate drug prices, a change which would be very painful for pharmaceutical companies. Despite what candidates say on the campaign trail, some economic problems are basically hard to solve. It is far from clear how Trump can create jobs in manufacturing or the coal industry, but it will be entertaining to watch him try. This was something that was visible throughout the campaign trail: one-liners and throw-away populist policy lines generated much media publicity for The Donald (and it was free – the more sensational the line, the more coverage he garnered). But people should not have been so alarmed by those “lines” because that is all they were. Spoken in haste for media exposure, almost impossible to implement, even at leisure.
There are countries which will be targeted by Trump’s policies – such as Mexico and China – but Australia is not one of them. Australia’s export dependence on China relates to the level of construction activity in housing, offices and infrastructure, not the goods which would be affected by US trade restrictions. China carries a lot of risk for Australia, but this risk is not likely to be exacerbated by President Trump.
Arminius does not bet on political events, but the fundamental positions which we took prior to Trump’s election are producing positive returns so far this month. Our investment strategies are based on long term history and simple economics. No US president has the power to repeal the laws of supply and demand.