A Bank of America poll of global fund managers found that a Republican victory is one of the two great tail risks facing the markets. Investors are generally assumed to favor the Republican candidates, on the grounds that they favor a low tax, less-regulated economy. Interestingly, equity markets have tended to perform more than five percentage points a year higher under Democratic than Republican Presidents.
This time, the tail risk stems from the candidate himelf: Donald Trump. In some respects, his approach is line with Republicans; he favors tax cuts and reductions in non-discretionary public spending. In others, he diverges significantly, particularly on free trade. Most of all, the problem lies with his tone; he has made some wild statements about foreign policy, the Treasury bond market and the Federal Reserve. Hence Société Générale has found that Treasury bond yields tend to rise when Mr. Trump gains in the polls while emerging market currencies and the Mexican peso in particular tend to fall.
It is difficult to pin down Mr. Trump’s concrete plans. One reason is the fluid nature of his proposals, and his lack of academic “brains” that supported other candidates before him. The “make it up as he goes along” nature of his policy approach was shown in the recent visit to Mexico. When he talks about buying back Treasury bonds for less than face value, or muses about the political motives of Janet Yellen, he may simply not know what he is talking about. The benign interpretation of all this is that wiser heads will prevail once Trump is in office, either among the Cabinet members he appoints or in Congress. Another “benign” interpretation is that he does not mean anything he says.
A Trump victory would almost inevitably mean complete Republican control - the Senate and House are already in their hands. So President Trump would have quite a good chance of getting tax reform of some kind through Congress. That would mean lower tax rates for both companies and individuals in return for the abolition of some “loopholes” one aim would be to get companies to repatriate overseas earnings, for example. These plans will assume that these lower rates will lead to increased revenues via faster growth.
It is much easier to cut tax rates than to close the loopholes which are defended vigorously by lobbyists, just as it is easy to announce the intention to cut public spending in aggregate but much more difficult to eliminate specific items. The Committee for a Responsible Federal Budget, a bipartisan group, estimates that Mr. Trump’s savings plans will cover only a small part of his tax program. The deficit will likely rise; hence perhaps the weakness of T-bonds when his poll numbers rise.
When it comes to the dollar, the picture is mixed. Mr. Trump’s trade stance may well be bad for emerging economies. In foreign policy terms, his more aggressive tone towards China and in some parts of Middle East policy, combined with his dismissive attitude towards NATO and other alliances, mean that his election would lead to a surge in geopolitical risk. Paradoxically, such surges often lead to the dollar doing well, as US investors repatriate money from more risky places such as emerging markets. Other developed currencies such as the Swiss franc and the Japanese yen might be popular.
For the equity market, it seems likely there would be an instant sell-off on the news given the Bank of America poll. But there is a two-month gap between election and taking office and Wall Street may recover its equilibrium. The question would be whether “tax-cutting Trump” comes to the fore or whether “trash-talking Trump” on the foreign policy side took the helm. The former would be positive for share prices, at least in the short term; the latter uniformly negative.
We have never been a great enthusiasts for gold, but if there ever were an argument for buying bullion, a Trump presidency would be it.
Zurich 7th October 2016