Letter from America - part four: What will Trump's trade and defence policies mean for markets?
- Trump is committed to defence spending but the budgetary cycle is long term and already in recovery. Many defence stocks have performed well already and look vulnerable, particularly if Trump continues to talk about reimbursement.
- Although trade policy is a major concern, we expect that Trump’s team will talk tough but be pragmatic enough to avoid a trade war.
- The implications of Trump for the world economy and asset markets are significant but our sense is that his presidency will further the “narrative” which emerged in 2016 of a normalisation of bond yields, inflation, growth and monetary policy.
“Making America safe again” – defence
Trump has talked about “fighting for peace”, adding that “the best way not to have to use your military power is make sure that power is visible … building up our military is cheap when you consider the alternative. We’re buying peace and we’re locking in our national security”.
These views, combined with tax cut hopes, led to a strong rally in defence stocks but the sector was already in the early stages of a long term spending recovery cycle prior to the election. This trend should continue and there will be extra demand from European members of NATO who are being “encouraged” by Trump to “pay their fair share”.
Many of the defence stocks are already priced to reflect this, however, and there may be less upside than many investors expect, particularly if the president starts looking at programme costs.
The Art of the Deal – trade policy
Perhaps the biggest anxiety for markets is the protectionist tone of Trump’s comments on trade. In his inauguration address he emphasised his belief in “America First” and “Buy American and hire American” and said that America’s borders must be protected “from the ravages of other countries making our products, stealing our companies and destroying our jobs. Protection will lead to great prosperity and strength”. One of his first actions thereafter was to announce his withdrawal from the Trans-Pacific Partnership.
A number of his appointments have caused concerns about trade hostilities. Peter Navarro, incoming head of the National Trade Council (NTC) is the author of Death by China; Robert Lightizer, nominee for US trade representative, is a trade litigator; while Wilbur Ross, nominee for commerce secretary, has sought a renegotiation of NAFTA and has bemoaned what he sees as unfair trade in steel, auto parts and textile.
Trump himself has long been pre-occupied with trade and trade frictions are inevitable but he also sees himself as a believer in free markets as underscored by the choice of words in his campaign document, a Seven Point Plan to Rebuild the American Economy by Fighting for Free Trade.
He also sees himself as a dealmaker, as articulated in his 1987 bestseller Trump: The Art of the Deal, and it is telling that the NTC will be tasked to “advise the President on innovative strategies in trade negotiations”.
This suggests that Trump’s team will talk tough but will be pragmatic enough to avoid a trade war. This approach already seems to be having an effect with China working hard to support its currency and President Xi of China coming to Davos to extoll the virtues of globalisation.
Protectionist trade wars remain a tail risk not priced into markets. On balance, despite inevitable trade fictions, we feel that Trump will avoid greater hostilities, an intention represented by his choice of Iowa Governor Terry Branstad, a long-standing friend of President Xi, as US ambassador to China.
Ceteris non paribus – wider implications
On the basis that all other things are rarely equal, it is important to remember that Trump will not be operating in a vacuum. In macroeconomic terms we have already seen the president fret about the strength of the dollar, a development exacerbated by the foreign exchange market’s belief that his policies will be reflationary.
Further down the track, markets could well start to worry about inflation, particularly since his pro-growth approach is coming when the economic cycle is long in the tooth, the unemployment rate is low and the national debt is still elevated.
Were this to occur, the likelihood of the Fed accelerating policy tightening would increase, with obvious implications for the US economy and asset markets.
Trade policy is a notable area where negative feedback loops are possible, not least because of the scope for retaliation and increasing geopolitical tensions. It also has potential knock-on effects in the sense that the very US consumer which Trump is trying to protect will be vulnerable to any rise in the cost of imported goods.
There are any number of other risks to consider in the year ahead. The eurozone electoral timetable, the mechanics of Brexit and the health of the Chinese economy will be important, as will evolving expectations of global monetary policy as investors digest inflation and activity indicators.
On balance, however, we believe that the “narrative” which emerged in 2016 of a normalisation of government bond yields, inflation, growth and monetary policy will continue to inform markets in 2017. To this extent the Trump victory has boosted trends which have been in place for some months already.
There are certainly tensions within his policy priorities. Deregulation jars with industrial intervention and fiscal easing sits uneasily alongside the goal of national debt reduction. However, overall, our sense is that the new reflationary investment environment has continued longevity.
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