History has shown that presidential campaign rhetoric and promises do not always develop into actual policy. Much of that promised by President-Elect Trump requires working with and obtaining the approval of Congress. While it is true that Republicans have a majority in both houses, the use of filibusters has increased to delay contentious votes. In such a scenario, the Senate, for example, requires an affirmative vote of 60 to break a filibuster and bring a bill to a vote. The bottom line is that the “Art of the Deal” is going to require some negotiating.
We are watching for key developments in Trump’s policies, and three main themes to focus on thus far include: 1) Fiscal Stimulus, 2) De-regulation and 3) Trade. The first two themes were immediate positives for the equity markets as market participants are expecting these to drive future growth. With renewed fiscal stimulus, there is optimism around job growth and an improving middle class to drive the economy. Expectations are for this stimulus to come in the form of infrastructure spending like roads, pipelines and maybe even the “impenetrable wall.”
In addition, less regulation in financials, healthcare and energy-related companies are positive for corporate earnings. The latter theme of trade can have far-reaching effects on multiple facets of the economy and is more difficult to predict given the range of possible outcomes. Trump is clearly in favor of bringing jobs back to America and imposing penalties on companies which seek cheaper labor abroad.
With these assumptions on policies, there are clear winners and losers in the equity market. Less regulation should bode well for financials, health care and energy stocks. Construction, machinery and material companies would see a tailwind from increased infrastructure spending. Aggressive pursuit of defeating the Islamic State can benefit the aerospace and defense industry. However, losers include multi-nationals from all sectors that face an uncertain future of how they will conduct business overseas. Similarly, if Trump is successful in repealing Obamacare, hospital and managed care companies could see the tailwind experienced over the last six years evaporate.
While the stock market has generally cheered these possible changes, the bond market seems to have bought into the higher growth narrative, driving inflation expectations significantly higher. In addition to higher growth, protectionism fears and the added costs associated with it are also pushing inflation expectations higher. This directly impacts the yield curve with the 10-Year increasing from an initial bid to safety level of 1.71% immediately following the announcement of a Trump win, to over 2.10% less than 48 hours later as market participants digested the impacts of such a presidency. Long-term rates moved significantly higher as well, due to the prospects of fiscal stimulus increasing the national debt, therefore increasing the risk profile of the country.
If Trump is successful in creating growth (which could lead to inflation), it is reasonable to expect intermediate and long-term rates to increase. If this occurs, the Fed could be forced to play catch-up and hike short-term rates faster than anticipated. Also impacting possible monetary policy is Trump’s negative view on the current Fed policy of keeping the Fed Funds Rate artificially low. While we anticipate the Federal Reserve to raise rates in December, the ultra-accommodative stance could shift if Trump appoints Fed governors with more hawkish views. All of these factors do not play into bondholder’s favor during a transition period to higher rates.
Higher rates have their own impact on the equity markets, benefiting some areas while hurting others. The banking sector welcomes a steeper yield curve as it increases their net interest margin by providing loans at higher rates than what they are paying their depositors. Naturally, bond-proxy sectors like REITs and utilities will be negatively impacted with higher rates but fundamental growth can help mitigate downside risk within these sectors.
The following table highlights several areas that may be in focus by the Trump administration.We summarize the possible actions and impacts and suggested market positioning for both potential capital appreciation and protection.