Knowing that financial market results for November were going to be almost completely determined by the outcome of the U.S. election, we did position portfolios for results that would be closer than many of the traditional polls suggested.  However, like many investors, we thought that a Donald Trump upset election victory result in lower stock markets, especially in the U.S.  We also thought that a Trump victory would take the chance of a Fed rate hike in December off the table, push down the U.S. dollar and lead to some strength in gold.   All of that happened for the first six hours following his election victory on November 8th, and then completely reversed, sending U.S. markets to all-time highs. Emerging-market stocks and tax-free municipal bonds were among the few assets that reacted as the consensus predicted.  Emerging equity markets fell on fears that President-elect Trump’s protectionist proclivities would crimp their exports.  Of 68 emerging country stock indexes tracked by Bloomberg, 51 fell in the three days after the election.  Latin America took the biggest hit with Mexico, Brazil, Argentina and Colombia being the world’s worst performers as the U.S. ranks among all four countries’ top trading partners.  Bonds were the other major casualty of the election as 10-year government bond yields soared from 1.8% to over 2.4% in the three weeks following the election, leading to a $2 trillion loss to bond investors, the most since the so-called taper tantrum in June 2013.  The more the U.S. government spends, the more bonds it needs to sell, which leads to increasing supply, depressed prices and higher yields.

The rally continued through the rest of the month as stock market investors were convinced that the overall thrust of the Trump administration will be positive for business. The rush toward more economically sensitive stocks suggests the market is optimistic that Mr. Trump can stimulate growth as promised.  This initial response is premature and could ultimately be dead wrong, in our view.  Investors appear to have assumed that the President-elect will implement all the business-friendly policies he favours (e.g. lower taxes, less regulation, more infrastructure spending) and none of the negative positions he outlined (e.g. trade wars).  The thrust of the plan is to stimulate business and spending activity, boosting economic growth in the process. The problem is the cost.  Congressional Budget Office (CBO) estimates the plan would reduce U.S. federal government revenue by $9.5-trillion over the first 10 years and another $15-trillion over the next decade.  The U.S. is already running a huge deficit, projected to be $587-billion this year.  Without massive spending cuts, the Trump tax plan could increase the national debt by 30% over the next eight years.  Once debt levels start to rise, it is hard to turn them back, especially since the debt service costs also rise.  The chart below shows the long-term projections for U.S. debt growth by the CBO.  Trump plans accelerate U.S. debt

While certain elements of the Trump agenda, such as corporate tax cuts, deregulation and fiscal stimulus are generally supportive of stocks, the threats to global trade, however, are clearly not.  It seems hard to deny that Trump’s anti-globalization rhetoric represents a direct threat to corporate earnings.  While some of his protectionist proposals will undoubtedly be watered down, investors are underestimating the likelihood of disruptive trade measures.  China has been one of his more reliable targets, labelling the country a ‘currency manipulator’.  Raising the tension with China is liable to land the United States in a trade war with one of the most important trade countries in the world.  He may seize on the recent decline in their currency, the Yuan, to escalate his accusations and ask Congress to approve the introduction of tough new tariffs against that country. The result could be a disruptive trade war that would likely inflict harm on both countries.

Mr. Trump’s key election promise is to repatriate jobs to America’s factories.  The problem is that those factories, and the jobs inside, have been forever changed by a technology revolution which resulted in the globalization of labour and supply chains and which also improved the profitability of the multinational companies over the last two decades.  While China has been the major target of Mr. Trump’s scorn, American companies such as Uber and Google are the ones developing driverless cars and trucks which would displace even more jobs.  Today, manufacturing accounts for 8% of U.S. employment, compared to over 30% in the 1960s.  Factory output continues to increase, but manufacturing employment does not.  For every manufacturing job lost to trade in recent years, eight have been lost to automation.  Free trade is being blamed for all these losses since it is an easy target, but at least it produces additional jobs in export-competitive sectors.  The potential damage to the economy and corporate profits from trade disputes should not be under-estimated, in our view.

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