"As is often the case for this type of event, investors tend to underestimate the risks in the run-up to the event, and then blow the consequences out of proportion once it has actually happened. However, despite the significant blows suffered by some markets this morning (some equity indices, such as the Nikkei, have lost nearly 5%) and the initial shift of investors to safe heaven assets (Swiss franc, yen, gold), one can already notice a meaningful rebound from the lows and one has not witnessed a major flight to quality. By the time we are writing these comments (11:00am CET), major European equity indices are down around 1% from last night’s levels (above the levels of markets’ close on Friday 4th November) and S&P500 futures markets are down around 1.7%. In line with the protectionist policies Trump has advocated, some emerging assets (notably the Mexican market) are due to suffer more important drawdowns, due to the prospects of a slowdown in global trade while in Wall Street, some very global companies could be somewhat affected. But the subdued reaction of equity markets seems to take into account the relatively moderate and consensual speech which Donald Trump has made, after his election was confirmed.
The short term movement of anxiety is not a surprise for analysts used to the reaction of financial markets in the aftermath of the announcement of the outcome of presidential elections in the US. It was logic to anticipate some spike in equity markets’ volatility, considering the election of Donald Trump was, to a large extent, an unconventional outcome, thanks to his unpredictable character, the level of polarization of the population and its level of unpopularity amongst economic and financial American elites. But, let’s not forget that an emotional and negative reaction during the first hours, is often followed by opposite market movements, before markets stabilize. This typical trend seems to prevail again today.
A buy opportunity on the equity markets?
The key for investors is remain calm. Trends on the S&P500 in the aftermath of presidential elections, whether uptrends or downtrends, are absolutely no indicator of future performances for the ensuing period. By way of example, the market plummeted by close to 10% in two days of trading just after Barack Obama beat John McCain in the November 2008 election, but this did not stop the country witnessing one of the greatest bull markets ever seen in the following years, with average annual gains of 13.3% since November 4, 2008, a better showing than during 9 out of the last 12 US presidencies! After the 22 elections recorded since 1928, the S&P500 fell after 15 of them on the day after the election, with an average loss of 1.8%, so it is impossible to extrapolate clear indications on the markets’ future trends.
A market downswing, an over-reaction reflecting broadly emotional considerations, is therefore generally a buy opportunity, particularly if investors have a reasonable investment timeframe, as shown by the Brexit scenario (we note that the UK market has gained more than 9% in local currency since June 23).
At this stage, the increase in political uncertainty points to a rise in risk premiums on the equity markets, and a drop in share prices, but it is worth remembering that the S&P 500 has traditionally rallied in the three months following a presidential election and that some of Trump’s proposals could be good news for the equity markets, i.e. his plan to cut corporation tax to only 15% vs. 35% currently, along with his stimulus program for public infrastructure, worth close to €550bn over five years.
Bad news for the bond markets
While prospects should progressively tend to balance for equities, the same cannot be said for the bond market. The US T-bond market has already witnessed an initial sell off, with 10-year bond yields moving up by more than 8bps (to 1.94%) and 30-year bond yields moving up by 16bps (to 2.78%). Trump’s election does not look like good news for the bond markets over the next few months. His budget initiatives that look likely to be approved by Congress, which should remain under the control of the Republican party, are poised to trigger a very sharp increase in the public deficit due to a cut in tax revenues and the hike in infrastructure spending. Furthermore, the White House manages trade policy and Donald Trump has announced restrictive customs duties on Chinese and Mexican imports. The increase in prices that we are set to see on locally nonsubstitutable imported goods will lead to a surge in cost inflation. Initially this imported inflation, combined with an increase in Treasury bond issues, could put pressure on long-term rates (stagflation scenario). In six to nine months’ time, the recessionary impact of imported inflation on real household income and corporate margins could well restrict growth and go so far as to prompt fears of a recession. Long-term rates would then fall during H2 2017… but so would equities.
It is worth noting that there is a consensus with Congress to finance part of the infrastructure spending by a tax on overseas profits for multinationals, a measure that could lead to a 4-5% rebound in the dollar, as in 2004. Exporting sectors would then clearly be hampered by the strong greenback. Overall, our medium-term positioning on equities should focus on defensive stocks against cyclicals excluding construction.
Lastly, we should note the extent of Trump’s criticism of the Fed’s role and its independence – often opposing Hillary Clinton on this issue – as well as disapproval of the Chair of the Board of Governors herself. It seems highly unlikely that Trump will allow Janet Yellen to continue in office when her mandate ends in 2018, and this will clearly increase uncertainty on US monetary policy and point to a faster tightening of leading rates. While the extent of this fiscal easing is offset by Congress, these two potential risks could well trigger renewed volatility on US interest rates."
Head of Institutional & Retail Solutions
Investment and client solutions investment division
Natixis Global Asset Management