Rhetoric Transitions to Policy… President Trump Must Yield Results

by Jason Staley, CFA®

With the presidential primary and general election well behind the United States, Donald J. Trump is now the leader of the free world and at the helm of the world’s largest economy. President Trump’s trademark bravado mixed with his unconventional and, at times, unpredictable rhetoric fueled his forceful ascendancy to the oval office. Mr. Trump’s unconventional approach worked with much of the U.S. electorate; however, financial markets and their participants crave clarity and loathe unpredictability. In order to preside over the type of economy that achieves the economic growth targets stated during the campaign, Mr. Trump and his team will need to build broad public support that in turn produces a strong coalition that can push his legislation through Congress. Finally, Mr. Trump and his team will need to reassure the global markets and U.S. trading partners that, despite some of the strong rhetoric, the U.S. will remain a reliable and stable partner.

Most major U.S. equity indices appreciated from their pre-election levels after Mr. Trump’s victory. Investors were elated at the real prospect of significant and meaningful corporate tax reform, less-burdensome regulations, and a stronger U.S. Dollar with Republicans controlling both houses of Congress and the Presidency. The “Trump Rally” was based entirely on investors’ increasingly bullish sentiment that Mr. Trump would stimulate the U.S. economy from current levels (approximately 2% annualized GDP growth). Trump, however, will not be judged on the movements of the stock market over the course of 45 days; instead, Mr. Trump will be judged on the successful implementation of cohesive domestic policy agenda that stimulates productivity, wage and, ultimately, economic growth.

 

The above chart, produced by BlackRock Investment Institute, examines the potential impact of Mr. Trump’s fiscal policy and proposals on U.S. GDP[1]. While we find the inputs that factor into the potency of Mr. Trump’s economic plans interesting, as investors and asset allocators, the most illuminating part of this chart, in our opinion, is the bar on the far right.  This bar, labeled “Total,” shows the range of potential cumulative change in U.S. GDP of all of Mr. Trump’s policies over the course of ten years. The potential changes in GDP range from 3% to 23%[2]; the eventual outcome will depend on the implementation, efficacy and execution of these policies. At maximum effectiveness, GDP may hit 4%, but there are many variables and potential impediments that make achieving that number difficult. In instances like the above, where you have a wide range of outcomes, we would expect the global equity and fixed income markets (since much of the world trades off of U.S. economic sentiment) to experience increased levels of volatility. Adding further complexity is the fact that domestic equity markets are trading at elevated valuation levels with consensus for only modest returns in the interim; in order to drive markets upward, investors would need to be confident of economic growth, since significant multiple expansion is unlikely. If market participants get jittery or there is a hiccup in policy implementation, there is risk to the downside, such as was felt quickly after the executive order on immigration was signed in late January.

We have a less sanguine view of fixed income markets domestically. Whereas U.S. equities, despite some concerns surrounding valuations, have rollback of excessive regulations and an overhaul of the corporate and personal tax code as a tailwind, the U.S. fixed income market is afforded no such luxury. The U.S. Federal Reserve began a tightening of U.S. monetary policy in December, raising the Fed Funds rate by 0.25%; in addition to the interest rate hike, the Janet Yellen-led Fed indicated that three additional rate hikes were possible in 2017. The three-decade-plus bull market in bonds appears to be coming to a close after almost a decade of accommodative monetary policy following the U.S. financial crisis. In addition to the change in monetary policy is the prospect of a large U.S. infrastructure spending bill that has varied in cost from $500 billion to $1 trillion, depending on the source and proposal. This type of massive spending has the potential to stimulate the economy, increase worker productivity, and bring people currently not looking for employment back into the workforce (all very positive attributes). However, with a national debt that is approaching $20 trillion,[3] the interest expense, or the interest rate at which the U.S. Treasury issues debt, is likely to increase as investors demand more compensation for owning these bonds. The value of many fixed income investments trades in an inverse relationship to interest rates; as interest rates go up, the price/value goes down (and vice versa). For these reasons, our interim outlook on fixed income is that the broad market will remain challenging, especially the U.S. government/agency sections of the market.

Most people can agree that increasing worker productivity and investment, coupled with steady wage growth and low unemployment is a recipe for increased economic growth; the challenge is how to drive and implement policy to achieve those ends. Mr. Trump is now at the wheel, and financial markets and the global economy are not something that can be cajoled with a 140-character tweet. Shepherding the economy to greater prosperity will take a focused effort and attention to policy detail. Global investors, and more importantly, Mr. Trump’s constituents, will demand that his lofty rhetoric deliver the desired results. Mrs. Clinton and Messrs. Rubio, Cruz, Bush, et al. have been vanquished; Mr. Trump, has won, and he is now on the clock.

Disclaimer: Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as investment, tax or legal advice.  Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary.  The information provided should be relied upon when coordinated with individual professional advice.

 

[1] https://www.blackrock.com/corporate/en-us/literature/whitepaper/bii-2017-investment-outlook-us.pdf

[2] https://www.blackrock.com/corporate/en-us/literature/whitepaper/bii-2017-investment-outlook-us.pdf