Following Donald Trump's unexpected victory in the US Presidential election, the Scottish Widows Asset Allocation team has made an initial assessment of how the markets have reacted and what the implications might be.
Trump's election win was a big surprise to markets. We are seeing a short-term surge in volatility and a ‘flight to quality', although we caution against reading too much into the market's knee-jerk reactions amid thin liquidity this morning. We may well see more of an uncertainty premium built into valuations over time as Trump is less predictable than Clinton would have been. The Republican "clean sweep" of Congress at least suggests less chance of gridlock and increases the chances of an orderly management of the federal debt ceiling, currently due to come back into force in March 2017. Given the uncertainty over what a Trump presidency will look like, we think it wouldn't be prudent to make fundamental changes to our asset allocation decisions for now. We continue to believe our existing medium term views are sound.
Details and possible implications
The result was unexpected and uncertainty has increased, leading to greater market volatility and a ‘flight to quality' as an immediate reaction. Safe-haven assets like the yen, Swiss franc, gold and US Treasuries are up, while emerging market currencies and equities are down - although some early moves are already partially unwinding. Overall, the reaction so far is similar to the short-term response to the Brexit referendum, although more muted. For instance immediately after the UK's EU referendum result, EuroStoxx futures opened down 11.1%, whereas S&P 500 futures had fallen by only around 2.9% as at 8.15am GMT today.
It is important to see this volatility in context. Globally, stock markets are down 2%-3% at the time of writing on the morning after the election. However year-to-date the S&P500 is up 4.3% and the FTSE100 is up 9.6% in sterling terms.
Markets are pricing in a decreased chance of a Federal Reserve rate increase in December (seen as less than a 50% chance now, as against about 80% before the election). However US macroeconomic data have been pointing to a rate increase, for example the solid jobs report that was announced on Friday 4th November. We think the Fed will be looking for any evidence of an impact on business or consumer confidence before deciding to go slower on rate hikes.
The longer-term implications of Trump's victory are uncertain - we have never seen a president come to office with so little political track record. We could see more of an uncertainty premium priced in as he is likely to be less predictable than Clinton. We may get some early information from the economic team he recruits. The Republican "clean sweep" (winning majorities in both houses of Congress as well as the White House) does at least point to less chance of gridlock - particularly important as the federal debt ceiling suspension is due to expire in March 2017.
Given the degree of uncertainty, we do not think it would be prudent to make immediate changes to our fundamental asset allocation views. We continue to believe our medium-term views remain sound.
Trump's campaign trail promises were on corporate tax cuts, immigration restriction and trade protection, and it is hard to see how he can back away from those once he's in office. Below we highlight a few possible longer-term implications that we will be watching for.
Equities: If Trump implements his corporate tax cut plans, this could be significantly positive for US corporate after-tax earnings. However a weaker US macroeconomic performance arising from protectionism and restricting labour force growth (because of less immigration) will work against this. We will monitor the balance of developments closely.
Bonds: Trump's tax plans would significantly increase US government debt over time which would point to higher bond yields. The risk of further easing by the Fed would be reduced as the tax cuts would add significant fiscal stimulus to the economy. Overall, we think this would point to a steeper yield curve, in line with our existing view. We would expect to see some spill-over from the US to other markets, including UK gilts.
Emerging Markets: Emerging markets are likely to come under short term pressure but we continue to see long-term value in EM relative to developed market equities. The threat of increased US protectionism is there, but EM currencies are weakening which provides some lift to EM economies.
Investment markets and conditions can change rapidly and, as such, the views expressed in this update should not be taken as statements of fact nor be relied on when making investment decisions. Forecasts are opinions only, cannot be guaranteed and should not be relied on when making investment decisions.