Highlights:
· In a result that was generally unexpected, Donald Trump was elected the 45th President of the United States.
· Domestic equity markets have responded positively to date in anticipation that President Trump’s pro-growth policies will outweigh his stance on free trade.
· The level of federal debt outstanding and various constituencies within both parties of Congress are likely to keep tax cuts and infrastructure spending in check.
· President Trump will be taking office at a time where the domestic economy is strengthening and the Fed has started to raise interest rates. A rising interest rate policy by the Fed could be an additional impediment to President Trump’s growth agenda.
Commentary:
“No one will emerge as a winner in a trade war. Pursuing protectionism is just like locking one’s self in a dark room. Wind and rain may be kept outside, but so are light and air.”
The above quote does not necessarily characterize the events of the previous year, but the person who said these words certainly does. This quote did not come from a Federal Reserve governor, an ambassador or famous CEO. Instead, it was President Xi Jinping of China, the leader of the world’s second-biggest economy, in a speech to the World Economic Forum. It does seem to explain much of the global state of affairs when the leader of the largest communist government in the world lectures the economic policy makers of the free world regarding the benefits of trade.
On November 8, 2016 Donald Trump was elected the 45th President of the United States. Regardless of one’s political affiliation, the result of this election was generally unexpected, as most of the polls and political pundits projected democratic candidate Hillary Clinton as the virtually certain winner of the election. Ultimately the same themes that arose during the Brexit vote – economic security, jobs, and immigration – played a major role in the outcome of the U.S. presidential election.
On the night of the election, equity futures markets hemorrhaged at negative levels not seen since the panics of 2008 and 2009. This was understandable as markets generally respond unfavorably to ambiguous political situations, and uncertainty in general. In this case, however, by the opening of markets the following morning and generally since then, U.S. equity markets have reacted quite positively. This is apparently due to an investor belief that the new president’s policies will have the propensity to improve economic growth, kick start inflation, lower corporate taxes, ease bank regulations and increase infrastructure spending. Additionally, although it may be posited that President Trump’s stance on free trade poses the biggest danger to the U.S. and global economic growth, it appears investors perceive this stance as only tough talk and negotiating tactic.
The pro-growth rhetoric of the new president has thus certainly provided some positive momentum to domestic equity markets. The issue coming into the current year, then, would have to be whether it can persist. In this regard, we believe this would be contingent on whether much of the talk can be turned into action. In this regard, we see two major impediments to the implementation of some of the overhauls on which Trump has campaigned. The first of these is the level of debt and the second is the composition of Congress.
As referenced above, President Trump’s tax proposals are certainly pro-growth and that may be seen as somewhat of a breath of fresh air compared to the policy stalemate seen over the last several years. Trump has emphasized increased domestic infrastructure spending. This is definitely expansionary, however, where the funding to pay for it comes from will be a critical issue. This will immediately force the president to rely on the Republican majority in Congress to find a way to fund such programs. There is a still strong Freedom Caucus within the party which may preclude the expansion of any further debt for these purposes. A tax increase also would seem unlikely as another major part of the platform is tax reform and reduction. This leaves reducing domestic spending in other areas of the budget and both parties of Congress have a terrible track record when it comes to gaining consensus on such budgetary matters. It would take very little Republican crossover to allow the Democrats significant opportunities to curtail any such budget cuts in social programs. If Congress has proved they can to one thing very well, it is to gum up the works. Although we would prefer to remain optimistic, broad based economic budgetary reform may be more difficult for the new president to achieve than he currently realizes. Thus, the result may be a somewhat watered down package of tax cuts and domestic spending.
As also mentioned above, many have expressed concerns regarding President Trump’s anti-immigration and perceived anti-free trade positions. Clearly, the latter could have some profound economic ramifications. However, Trump has made clear that he favors global trade, just on more favorable terms. Nevertheless, these agreement are extremely complex and they have been negotiated by experts over many years in attempts to balance a host of conflicting and intertwined interests. A number of existing domestic industries could be adversely impacted in the process or renegotiation and their interests will be made known to the president. Thus, it is unlikely the president will just cancel such trade deals; rather, more traditional negotiation will likely be employed. Again, we remain optimistic that some benefits can be achieved, however, they may be more difficult to come by than currently reckoned by many.
President Trump will be greeted by an economy that is growing and finally starting to see upward inflationary pressures, strong corporate profits, improving employment and wage growth statistics, a resilient U.S. consumer that has less debt and continues to spend at a reasonably strong level, American banks that are much stronger than they were eight years ago, and a real estate market that has mostly returned to pre-crash levels in many parts of the country.
Citing many of these factors, the Federal Reserve raised its benchmark interest rate in December for just the second time since the financial crisis of 2008. The Fed also signaled that it expects to raise rates more quickly next year to prevent the economy from growing too quickly. A less accommodating Fed would serve as a counterweight to fiscal policy oriented toward faster growth. The Fed’s assessment that the economy is growing at a healthy pace and is not in need of stimulative government tax and spending programs is clearly at odds with the president’s campaign message that job creation has been terrible, economic growth has been anemic and his promise for a 4% growth rate, double the 2% since seen since the recession. Furthermore, President Trump has indicated in the past that he prefers low interest rates and some of his plans like infrastructure investment would be easier to fund if rates remain low. Rising interest rates would be a sign of a stronger economy, which bodes well for long-term growth prospects, but in the near term could begin to increase borrowing costs for consumers and businesses and put further pressure on corporate profit margins that are already near historic highs and are likely to be squeezed by higher labor costs as the job market continues to recover.
We don’t mean to downplay the significance of the recent populist wave that has shaped the geopolitical landscape in the U.S., U.K. and Europe and we further know that volatility will continue to be one of the more challenging aspects to investing. However, when you consider that there are more than 200,000,000 businesses in the world, three-hundred trillion dollars of financial assets, eighty trillion dollars of GDP, almost 200 countries and approximately seven billion people, it should be easy to conclude there are too many moving parts to consistently be able to predict recessions, bubbles, GDP growth and a myriad of other factors that affect businesses and the global economy. It is all too big and complex for one person, company or country even if that person is the president and that country is the United States. From an investment policy perspective, attempting to selectively time the equity markets or their sectors based on such things as geopolitical variables has a very low probability of adding value to return over the longer term. We remain bullish on the long-term prospects for global growth and believe that investors who embrace this investment policy will continue to be amply rewarded for providing capital to businesses around the world that will continue to prosper and profitably grow.
Urban Financial Advisory Corporation - January 2017