President-elect Donald Trump broke all the rules on his way to winning the White House. As the world considers the implications of an unorthodox Trump-led administration, Geir Lode, Head of Global Equities at Hermes Investment Management, examines how ‘Trumponomics’ could shape the global economy and investment landscape.
Congress has been in a perpetual stalemate during Barack Obama’s presidency thanks to relentless policy obstruction by Republican opposition. However, Trump's election victory has now landed the GOP a full sweep of both Congress and the Senate. The upshot is that we may now see some major changes around fiscal and monetary policy, as well as regulation. All of this will have profound implications for a range of sectors, the economy and the environment.
Fiscal spending: catalyst for rapid rate cycle
Trump has accused the Federal Reserve of creating a “false economy” by keeping interest rates low. Now we are likely to see the antidote to monetary policy driven economics: the dawn of ‘Trumponomics’.
Trumponomics is a shift in economic thinking away from current central banking consensus and based on a combination of infrastructure spending and tax cuts. While a rate hike was expected in December, we believe the proposed fiscal splurge will act as a catalyst to accelerate the cycle. Higher inflation through infrastructure spending is likely to create a scenario where the FOMC is forced to raise rates more rapidly.
While there are some potential policies that would be positive for GDP, the prospect of a tighter economy and lower immigration under Trump's presidency could raise the spectre of dreaded stagflation. This is a situation in which prices rise alongside slower employment participation to create a shrinking or slowing economy.
Higher rates could lead to a banking resurgence
Some analysts have argued a Trump victory is the best thing to happen to banks in some time. We already believed banks were attractive, given low valuations and the upward pressure on rates. Trumponomics may now provide a further catalyst.
The banking sector has been hurting since the financial crisis, as ultra-low rates have eaten away at the sector’s top line. We believe higher rates will improve margins in a number of core banking services and lead to stronger earnings.
Furthermore, the recent rally of US banks also reflects the hope that the Republicans will cut red tape around regulations allowing banks to release greater amounts of capital or increase levels of lending. Firms such as Bank of America, with healthy capital ratios, could see their return on equity rise from 6% to 8 or 9%. In July of this year, we built a bigger position in US banks whilst reducing our exposure to insurance names.
Interest rates could be an ill wind for property yields
On the flipside, we believe high rates will be negative for areas of property investment, should we see an acceleration of the rate cycle. For example, property vehicles such as real estate investment trusts (REITs) have been an attractive investment for yield-starved investors in an environment of ultra-low rates. However, as that situation unwinds, the concern is the value of REITs, particularly those highly leveraged, will diminish as debt become more expensive. This risk was reflected in the market when REITs plunged over 4% following Trump’s victory.
Trumponomics might reverse landmark climate change deals
One of the biggest concerns around Trumponomics is the area of ESG and climate change. In recent times, we have seen dramatic progress on multi-lateral agreements tackling climate change. However, Trump’s scepticism on man-made climate change threatens key deals like the Paris climate accord. A US pullback from such deals may also embolden other nations to renege from key agreements. Although Trump won’t have it all his own way – already senior political figures in California have vowed to battle the incoming administration on key climate change issues.
While a pro-fossil fuel administration will buoy non-renewable energy stocks, for the alternative energy industry, Trump’s victory is a challenge. It will be down to innovators such as Elon Musk and companies already showing that alternative energy can be more cost effective to lead the debate – and make the investment case for sustainable energy sources.
Looking into 2017 with Hermes Investment Management