This has been a long and emotional U.S. election cycle that has left investors with an unusual level of uncertainty over what type of leader the largest economy in the world has elected, and what policies he will pursue. The next several weeks are likely to bring more clarity. A famous U.S. President once said: “Trust, but verify.” The assessment of policy may call for the reverse: Verify, then trust.
In an election that was dominated by coverage of tweets, videos and emails, policy questions received surprisingly little airtime.
Donald Trump will be the next U.S. President, in a win that defied expectations and political convention. He won without a fundraising advantage or the support of many in his party’s establishment. He is a wealthy businessman who rode to victory with a historic swing of working-class Midwesterners. He ran a populist campaign and yet is likely to lose the popular vote narrowly.
Most remarkably, however, after three debates, two conventions and an election that seemed to last forever, a great deal of uncertainty remains over what type of president Trump will actually be. In an election that was dominated by coverage of tweets, videos and emails, policy questions received surprisingly little airtime.
Those questions are now crucial for markets. To a remarkable extent, investors we’ve spoken to both before and after the Nov 8th vote disagree on what President-Elect Trump will actually do.
The Reality of Trump
Many have told us, confidently, that they believe that, while he said some extreme things on the campaign trail, he is ultimately a moderate, pragmatic businessman—a dealmaker who will delegate policy to experts, lead with market-friendly (almost Keynesian) fiscal stimulus and, ultimately, avoid a large fight on trade.
Other investors take a less benign view. They say the President-Elect should be taken at his word and that, since the start of his campaign, he has defied predictions that he would moderate his tone or policy message. They point to the surrogates that surrounded his campaign. They point to Republican control of the House, Senate and Presidency, which means that there will be no check on policy. They worry more openly about the implications for foreign relations.
Which interpretation is correct?
During the campaign, Trump was a master at keeping both possibilities open, broadening his appeal. Like Schrodinger’s Cat, his policies existed in a state of being both pragmatic and radical, at the same time. His coming cabinet appointments offer clues to which interpretation is right. Until then, we will focus on modelling the different paths a Trump administration could take, and what it means for markets.
For macro, the Trump administration could mean big changes. Our narrative for 2016 has been “slow growth, slow reflation, and slow policy normalization.” A Trump administration could affect all three. When our U.S. economists and strategists attempt to quantify a “middle” scenario of looser fiscal policy, but only modest trade protectionism, GDP and inflation could both be 0.3 percentage point higher in 2017 and 2018. That boost could mean more Federal Reserve tightening and, potentially, an earlier end to the U.S. business cycle than we’d previously assumed.
Rate Volatility
This analysis emphasizes that other outcomes are also highly plausible. In a scenario where one takes most of President-Elect Trump’s proposals at face value, there could be a trade-induced shock of 0.6 percentage point to GDP in 2017. In a scenario where divisions in the Republican Party bog down proposals, our previous baseline may change relatively little.
Until we know which version of Trump we get, our market views have to be more tactical than we would like them to be. For now, we believe that low risk premiums and the potential for fiscal policy mean that curves will likely steepen and rate volatility may rise. Upside risks to the Fed path coupled with downside risks to global trade should support the dollar against low-yielding trade-focused Asia currencies, such as the yen, won and renminbi.
We believe that this supports equities in the U.S. over those in Europe and emerging markets, with the former benefiting from prospects for tax cuts and the repatriation of U.S. corporate profit held overseas. Meanwhile, emerging markets face headwinds from a stronger dollar, and Europe needs to deal with a heavy political calendar in 2017. For U.S. equities, this points to overweight industrials, healthcare (especially biotech) and credit cards, and underweight consumer staples.
Adapted from a recent edition of Morgan Stanley Research’s “Sunday Start” (Nov 13, 2016) series. Ask your Morgan Stanley representative or Financial Advisor for the latest market strategy coverage and reports. Plus, more Ideas.
