Now that we have a couple of weeks’ perspective – and as we wait for the broad thrusts of his administration to be fleshed out – here are some points that we think are important in relation to the election of Donald Trump.

The markets’ reaction:

• It is interesting to see how quickly investors/the markets have moved on from “Trump = disaster” to “Trump = saviour of the American economy”. Interesting too to see people who used to talk loudly about reducing the role of the state now strongly in favour of increasing public spending to stimulate the economy;
• The market is expecting growth to pick up on the back of an increase in infrastructure spending and a massive cut in personal and corporate tax rates. So it has upwardly revised its expectations for inflation and the budget deficit. These factors have led to a rise in bond yields, with the 10-year Treasury note surging from 1.80% to 2.30% in the space of a few days;

US 10-year yield

Source: Bloomberg

• On the stock market, cyclical and financial sectors have been among the leading beneficiaries: cyclicals on hopes of a new round of infrastructure spending and financials because of a steeper yield curve and in anticipation of potential financial deregulation. Apart from the healthcare sector (which had feared stricter controls on drug prices under Hillary Clinton), sectors traditionally viewed as defensive suffered from the rise in interest rates and uncertainties over future trade relations between the United States and the rest of the world. These uncertainties (and the fear of reprisals) also weighed on the technology sector, despite the possibility of a tax amnesty on the repatriation of cash held by the sector’s major companies abroad;

Change in stock price over 3 months

Source: Bloomberg

• In regional terms, the emerging markets suffered from the appreciation of the dollar (since a significant proportion of their debt is in USD), rising bond yields and fears of trade restrictions. The Mexican market was obviously particularly hard hit. At the other end of the scale, after an initial panic, the Japanese market benefited from the depreciation of the yen;
• Expectations of stronger growth in the United States, the rise in bond yields and anticipations of the Federal Reserve tightening its monetary policy also boosted the dollar. These same factors contributed to a drop in the gold price.

Economic considerations:

Does Donald Trump’s election really represent a paradigm shift in economic terms? Some reflections in this regard:

• Despite third-quarter data posting growth of 2.9%, compared to 1.4% in the second quarter, the US economy is showing signs of a slowdown (the Q3 figure is partly due to non-recurrent factors). This slowdown is normal as the current expansion cycle started over six years ago, such that a large part of the pent-up demand (which can accumulate during a recessionary period) should be satisfied;
• Even if the Federal Reserve does not raise interest rates as expected at the beginning of December, the rise in bond yields (and therefore in mortgage interest rates) and the appreciation of the dollar already equate to a significant monetary tightening which will weigh on economic growth, especially as the debt levels of the three main non-financial sectors (households, companies and the public sector) continued to increase sharply over the past year (in absolute terms and relative to GDP);
• The huge debt burden of the various economic agents makes the economy very vulnerable to interest rate rises. The low cost of debt is the only reason why this debt burden has not yet plunged the economy into recession. It is possible that the measures that the Trump administration puts in place will create inflation, especially if these measures are geared towards a degree of protectionism in trade relations. It is also true that one of the solutions often suggested to reduce excessive debt is to create inflation to reduce the real cost of the debt. However, if the rise in inflation provokes a rise in interest rates that is equal to or even higher than the increase in inflation, the economy will suffer;
• The expectations pinned on a potential increase in infrastructure spending are disproportionate. First, the great majority of infrastructure spending in the United States is decided at a local, not federal, level. Secondly, the measures that the Trump administration may take on public spending and tax cuts will not bear fruit for 12 to 18 months at the earliest (assuming that these measures are designed intelligently enough to have a positive multiplier effect on the economy).

In conclusion, the American economy is likely to slow down in the coming months, unless the election of Donald Trump prompts a wave of optimism that might generate a sharp increase in consumer spending and private investment. However, such an increase would not be sustainable given the financial position of households and companies.

Impact on our investment strategy:

What conclusions can we draw from all this for our investment strategy?    

• The economic reality has not changed in the space of a few days. This reality means is that the rise in bond yields in an environment of generalised excessive debt will lead to an economic slowdown which will then drive US bond yields back down. In other countries, this is less clear-cut since bond yields had fallen to levels which no longer bore any relationship to their economic fundamentals (unlike in the United States). Moreover, for the eurozone, other considerations could come into play, such as fresh fears over the periphery countries. After the unexpected results of the British referendum and the American elections, investors will be all the more wary in the run-up to the next round of political watersheds (the referendum in Italy, elections in France and Germany). The risk premiums on the asset classes that will be affected by these results should increase, especially if the ECB abandons its quantitative easing programme as planned in March 2017;
• It could be argued that even in the event of an economic slowdown, bond yields will continue to rise as investors demand a higher risk premium in the face of rising inflation. We will have to see how the Federal Reserve reacts if this happens. Market expectations have lurched from a deflation scenario to an inflation scenario with astonishing speed, however. Note also that it will be much easier for the Trump administration to implement an economic stimulus programme if interest rates remain low. A continuation of the simultaneous rise in bond yields, the dollar and the US stock market does not seem realistic given that 40% of the revenues from Standard & Poor’s 500 companies come from outside the United States;
• Although the market’s initial reaction to the upturn in bond yields was to switch out of quality defensive companies (often considered as long-duration assets and therefore vulnerable if yields rise) and into cyclical and financial stocks, this kind of sector rotation essentially reflects the short-term reactions of asset managers who compare themselves with the benchmark indices. For a start, the long-term outperformance of quality companies does not depend on the level of bond yields but is based on a much higher return on capital employed. This enables them to finance themselves so they do not have to resort to massive borrowing. In fundamental terms, they are therefore much less affected by the rise in interest rates than the highly cyclical stocks which investors have favoured recently;
• Then, as we noted in a previous blog, “Have quality companies become too expensive?”, quality stocks are not trading at a particularly high premium over the rest of the market compared to the past. In other words, although the share prices of these stocks have risen significantly more than the market as a whole in the last few years, it is not because they have become particularly expensive but because of their better performance in terms of earnings. Some of these companies could be damaged by measures taken by the Trump administration in terms of trade relations, but in general, they fully deserve their premium over the market. At the other end of the spectrum, lesser quality companies are more risky than ever;
• The one thing that seems certain in the wake of the election of Donald Trump is that there are now even more uncertainties. This only reinforces the investment case for gold. Gold remains a hedge against the financial risks emanating from unconventional monetary policies and historically high debt levels; 
• In the longer term and as we noted after the Brexit vote, the election of Donald Trump reflects a growing revolt against the political establishment and a loss of confidence in our political and monetary institutions. It is hard to see how this will be favorable for the financial markets which have been major beneficiaries of the principles promoted by these institutions: free trade, deregulation, immigration and globalisation. The risk premium built into the current valuation of financial assets seems insufficient to compensate the increase in economic and political uncertainties.

In short, and even if it is too early to make firm predictions, the performance of and within certain asset classes following the election of Donald Trump does not seem sustainable or is at least premature. Although we cannot rule out the possibility that the new administration will adopt measures that might increase the growth potential of the US economy in the longer term, the current fundamentals point to an economic slowdown. If this slowdown is confirmed, bond yields in the United States will drop back and the dynamic within the markets will change again. In the meantime, investors appear to be disregarding the fact that the economic and political environment has become even more uncertain.

Guy Wagner, Chief Investment Officer

Originally from a family of entrepreneurs in Luxembourg and with a degree in Economics from the Université Libre of Brussels, Guy joined Banque de Luxembourg in 1986, where he was successively responsible for the Financial Analysis and Asset Management departments, then became Managing Director of BLI - Banque de Luxembourg Investments, an asset management company newly created in 2005.

From July 2022 on, he devotes himself exclusively to his role as Chief Investment Officer, to the management of the portfolios and to the management of the team in charge management of the various funds.

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