Financial markets can generally only focus on one thing at a time and today
that thing is Donald J Trump. Investors must consider the implications of a
barrage of tweets and some sweeping generalisations. They sense that this man represents economic regime change but how will this manifest itself? They sense
opportunity but are aware of risks.
In analysing what has happened so far, the most helpful aspect is that the election result was so unexpected. On the eve of the election Hillary Clinton was a very
short-priced favourite. Financial markets price in outcomes of significant known events before they occur. The fact that a Trump victory was considered so unlikely means that the post-market reaction is a relatively pure indicator of how
investors see the new world.
By now we all know the Trump narrative: America first, jobs for the US middle classes, tearing up trade deals, building walls, lowering taxes and spending aggressively. The result of this is supposed to be higher growth and inflation.
How does this stack up against what is happening in markets?
Expectations of annual US inflation over a five-year period starting in five years’ time moved up from 1.93 per cent on the eve of the election to a high of 2.14 per cent.
Since then, however, they have fallen back to 1.95 per cent. Hardly an inflationary regime change. The move from its recent low in February 2016 of 1.35 per cent — as
central banks took another doveish tilt, the oil price bottomed and global financial conditions eased — was much more significant.
Emerging markets have been singled out as the obvious loser from President Trump and in the immediate aftermath of the election the MSCI Emerging Market Index
underperformed the S&P 500. However, this has started to unwind and in January emerging markets recouped almost two thirds of this underperformance.
These are only two examples of the “obvious” implications of a Trump presidency that are not necessarily panning out. The reason is that there are incredibly
powerful forces at work. Demographic trends, the generational falls in bond yields and the accompanying rise in debt are pushing in the opposite direction to
the Trump inflationary impulse. President Trump does not have a magic wand to wave these trends away. My sense is that these longterm forces will reassert themselves, particularly if the Federal Reserve and a strengthening US dollar
counterbalance his policies.
However, over time it would be foolish to underestimate a man who has been underestimated from day one.
When Mr Trump examines his hand he figures that he has the most powerful military, issues the world’s reserve currency, has the biggest and least externally dependent domestic economy, the best demographics of any developed country, energy independence, unparalleled geography and world-leading corporations and technology. He has played far worse hands. He is only interested in the success of those whose votes drove him to power and can do so again in four years’ time. If that means taking more of the existing pie from others then so be it and this points to major dislocations in financial markets in the years ahead.
This brings us to the most significant dichotomy in financial markets today. Economic policy uncertainty has almost never been higher yet equity market volatility has almost never been lower. In nature, avalanches and forest fires
trade short-term instability for greater stability in the long term.
Business cycles and market volatility are the economic and financial market equivalents.
Since the financial crisis of 2008 central banks have turned this dynamic on its head, suppressing these natural tendencies in pursuit of stability today. Sooner or later Mr
Trump will impose his view of the world on all of us. This will be disruptive to many of the pillars that have underpinned the stability of recent years. The current eerie calm is unlikely to last.